The Federal Reserve Board will likely recommend strengthening regulatory and supervisory procedures for mid-sized regional banks in the aftermath of the failure of Silicon Valley Bank (SVB).
An analysis of the failure of SVB—and the Fed’s inability to prevent it—was the subject of a report released Friday by the agency and its vice chair for supervision, Michael Barr. The Federal Deposit Insurance Corporation (FDIC) and New York State Department of Financial Services (NYDFS) also released their own reports Friday analyzing their supervision of New York-based Signature Bank.
SVB collapsed and entered receivership March 10. Signature Bank followed suit March 12.
The Fed report found its supervisors “did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity,” and when they did identify vulnerabilities, “They did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.” The FDIC report found similar missteps with its supervision of Signature Bank, as well as a lack of timely communication between the bank and the NYDFS.
Relaxing of supervisory requirements for mid-sized banks during the Trump administration “impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach,” the Fed report said.
The report telegraphed new recommendations the Fed will likely propose to tighten up the regulation of mid-sized banks, particularly those that grow rapidly like SVB, which tripled in size from 2019-21. The changes might not be implemented for several years, the report noted.
The first likely recommendation will be to bring back heightened supervisory requirements for banks with $100 billion or more in assets, including management of interest rate and liquidity risks, particularly as it pertains to uninsured deposits, standardizing liquidity requirements for a broader set of firms, and increasing capital requirements so they are “better aligned with [a firm’s] financial positions and risk,” the report said.
The report also recommended a return to more regular stress testing of banks with more than $100 billion in assets, as well as increased oversight of incentives for bank managers.
Drilling down on supervisory missteps
Repeatedly, Fed supervisors were slow to escalate the seriousness of risks they recognized within SVB, the report said. Part of the problem was SVB’s rapid growth pushed it into a new supervisory category in 2021, but the transition to comply with those heightened standards for larger banks was too long. In addition, less-experienced Fed supervisory personnel were slow to hand off the regulation of SVB to their counterparts with more experience with larger banks.
As a result of those findings, the Fed must “improve the speed, force, and agility of supervision,” the report said.
Another problem from a regulatory perspective was a relative timidity by Fed supervisors to escalate issues and force SVB to address them.
“We need to develop a culture that empowers supervisors to act in the face of uncertainty,” the report said. “In the case of SVB, supervisors delayed action to gather more evidence even as weaknesses were clear and growing. This meant that supervisors did not force SVB to fix its problems, even as those problems worsened.”
SVB’s holding company, Silicon Valley Bank Financial Group (SVBFG), had 31 open supervisory findings when it failed in March, “about triple the number observed at peer firms,” the report said. The findings spanned core areas, “such as governance and risk management, liquidity, interest rate risk management, and technology.”
Regulators found it was difficult to get SVB management to take the Fed’s warnings seriously, the report said.
“In some cases, significant risks were treated by SVBFG more as a process to fix than as a clear and present threat to the viability of a firm,” the report said.
Where SVB went wrong
The Fed report repeated SVB’s mismanagement of several basic banking risks was the primary cause of the bank’s collapse—something Barr and Martin Gruenberg, chairman of the FDIC, told Congress in a March 28 hearing. Both SVB and Signature Bank had concentration risk in specific industries and did not have enough cash on hand to satisfy an outflow of uninsured deposits when customers were spooked about each bank potentially failing.
SVB’s growth obscured serious risk management failures within the bank, the Fed report said. In addition, its management failed to make the bank’s board of directors aware of serious risks to the bank’s continued existence, the report said, including repeated failures of internal liquidity stress tests over several years.
“[SVB] managed interest rate risks with a focus on short-run profits and protection from potential rate decreases and removed interest rate hedges rather than managing long-run risks and the risk of rising rates,” the report said. “In both cases, the bank changed its own risk management assumptions to reduce how these risks were measured rather than fully addressing the underlying risks.”
SVB’s incentive compensation practices for its management team “may have encouraged excessive risk-taking,” the report noted. Fed supervisors concluded the bank offered no financial incentives to SVB managers to manage risk but found incentives were based on return on equity, allowing for certain adjustments, and total shareholder return, the report said.
Indeed, a sign of how little attention was paid to risk management by SVB was evident when the bank went without a chief risk officer for eight months in 2022.
“SVB’s foundational problems were widespread and well-known, yet core issues were not resolved and stronger oversight was not put in place,” the report said.