Federal Reserve Vice Chair for Supervision Michael Barr has two distinct, if not contradictory, messages to convey on Capitol Hill this week.
Barr will
"The events of the last few weeks raise questions about evolving risks and what more can and should be done so that isolated banking problems do not undermine confidence in healthy banks and threaten the stability of the banking system as a whole," Barr will tell lawmakers, according to written remarks released by the Fed on Monday. "At the forefront of my mind is the importance of maintaining the strength and diversity of banks of all sizes that serve communities across the country."
The duality of Barr's remarks — which largely mirror views
Playing up
Dennis Kelleher, head of the consumer advocacy group Better Markets, said the comments encapsulate "the tension between what public officials have to say to stop a crisis and contagion, and their duty to address the regulatory and supervisory flaws that caused the crisis and contagion."
"Accomplishing the former undermines building the political will necessary to do the latter," Kelleher added.
Early in his remarks, Barr blames Silicon Valley Bank for its own failure, calling it "a textbook case of mismanagement." He cited the Santa Clara, Calif.-based bank's concentration in the venture-funded tech space, its failure to hedge its long-dated bonds against the risk of rising interest rates and its reliance on uninsured deposits for funding as fatal flaws by the bank.
He also emphasizes that the bank's demise came under "extraordinary" circumstances, noting that depositors coordinated to request more than $40 billion of withdrawals in a single day. The rapid drawdown occurred after the bank crystallized a $1.8 billion loss on its securities portfolio and attempted to raise capital to improve its liquidity position.
"Uninsured depositors interpreted these actions as a signal that the bank was in distress," Barr said. "They turned their focus to the bank's balance sheet, and they did not like what they saw."
While noting the Fed's actions to address these issues counters the argument that its supervisors were
"The obvious question is, 'If you saw all these weaknesses in 2021, why didn't you do something about it?'" Michel said. "If this was something that could have been handled at the supervisory level or through supervision — and presumably it could be because they flagged it — why didn't they stop it? Why didn't they make them hedge?"
Karen Petrou, managing partner at Federal Financial Analytics, said Barr's credibility this week will rely, at least partly, on his acknowledgment of the role supervisors played in failing to address blatant issues within the two failed banks.
"It is a dereliction of duty for the Fed to blame SVB or Signature's problems solely on bad management," Petrou said. "The M in CAMELS [supervisory ratings] stands for management, and supervisors are supposed to judge and discipline it. Indeed, poor management is usually the leading edge of problems in each of the other CAMELS factors, making this judgment the linchpin of supervisory responsibilities."
Barr is
"The report will include confidential supervisory information, including supervisory assessments and exam material, so that the public can make its own assessment," Barr said. "Of course, we welcome and expect external reviews as well."
Barr's prepared remarks also outline several supervisory actions taken against Silicon Valley Bank during the past two years. He said examiners took issue with the bank's liquidity stress testing, contingency funding, liquidity risk management, board oversight, risk management and internal auditing. These citations led to downgrades to the bank's management scores and subjected it to a growth restriction.
As recently as mid-February, Barr notes, the Fed was in touch with the bank over its concerns.
"Staff discussed the issues broadly and highlighted SVB's interest rate and liquidity risk in particular," Barr said. "Staff relayed that they were actively engaged with SVB but, as it turned out, the full extent of the bank's vulnerability was not apparent until the unexpected bank run on March 9."
Kathryn Dick, CEO of Salt of the Earth Consulting and a former deputy comptroller for risk evaluation in the Office of the Comptroller of the Currency, said these types of disconnects are not uncommon in bank supervision. Agencies can only do so much to compel banks to address risks, she said, and sometimes external factors intervene before remedies can be made.
Still, Dick said, nothing that has been made public about the incidents involving Silicon Valley Bank or Signature Bank thus far indicates that they represent endemic issues in the banking system. Unless findings from the Fed's internal review of the failure or other probes show otherwise, she said, she does not see the need for broader reforms to supervision.
"Hopefully, calmer views will prevail and if there are rulemaking changes that need to happen, that will happen," Dick said. "I don't see any rulemaking change right now that I think would be appropriate, given what we know. But I'm sure some parties will be clamoring for it."
In his remarks, Barr makes the case that the Fed's regulatory changes made after the passage of the 2019 Economic Growth, Regulatory Relief, and Consumer Protection Act — which applied stricter tailoring requirements to the Dodd Frank Act of 2010 — resulted in Silicon Valley Bank being less financially sound than it otherwise would have been. He notes that, because of those reforms, the bank was subject to less frequent stress testing by the Fed, no bank-run capital stress testing requirements and less rigorous capital planning and liquidity risk management standards.
Barr, who is leading a holistic review of the Fed's capital requirements, said the Silicon Valley Bank episode "illustrates the need to move forward with our work to improve the resilience of the banking system." He pointed to the implementation of the Basel III endgame, expanding long-term debt requirements to more banks and crafting more encompassing stress-testing scenarios as key reform efforts that could be informed by the ordeal.
"Part of the Federal Reserve's core mission is to promote the safety and soundness of the banks we supervise, as well as the stability of the financial system to help ensure that the system supports a healthy economy for U.S. households, businesses, and communities," Barr said. "Deeply interrogating SVB's failure and probing its broader implications is critical to our responsibility for upholding that mission."
Kelleher also feels the recent crisis should be a call to action for the Fed to reinstate and bolster a litany of regulatory and supervisory policies that have been rolled back in recent years. But doing so, he said, would require a full acknowledgement that the Fed and its recent leadership — including Powell — have been on the wrong course.
Kelleher said how Barr handles this week and the internal review will reveal just how much autonomy lies with the Fed's vice chair for supervision — a presidentially-appointed position held by just one other person before.
"The current crisis is an acid test for the independence and strength of the position of the vice chair for supervision and will, in many ways, determine whether or not the vice chair of supervision is or is not subordinate to the chair, who dictates what the vice chair does," he said.
