Top bank regulator calls for revamping a range of rules for midsize banks.
By guest authors Andrew Ackermanand Ben Eisen from the Wall Street Journal. Nick Timiraos contributed to this article.
Updated April 28, 2023
The Federal Reserve’s banking supervisors failed to take forceful action to address growing problems at Silicon Valley Bank before it collapsed last month, the central bank’s top regulator said, signalling a broad push to toughen rules on the industry.
Michael Barr, the Fed’s vice chair for supervision, said supervisors didn’t fully appreciate the extent of the vulnerabilities as SVB grew in size and complexity. When supervisors did find risks, they didn’t take sufficient steps to ensure the firm fixed those problems quickly enough, he said in a report Friday.
Regulators took control of Santa Clara, Calif.-based SVB on March 10. The collapse sparked a panic that led to the failure of New York-based Signature Bank and an intervention by financial regulators to protect uninsured depositors at both banks. The Fed supervised SVB and the Federal Deposit Insurance Corp. supervised Signature.
The chaos has since quieted, but some banks still face concerns. San Francisco-based First Republic Bank faces significant challenges, and there are no easy options for stemming the crisis at the bank.
The FDIC issued a separate report Friday analysing its oversight of Signature, which failed two days after SVB. The FDIC said that it was slow to escalate issues that it had identified with the bank’s management. It put much of the blame on Signature, which it said grew too fast and wasn’t responsive enough when the FDIC raised concerns.
Yet another report on Friday from the Government Accountability Office, a congressional watchdog, said regulators identified problems at both banks in recent years but didn’t escalate supervisory actions in time to prevent their failures.
Mr. Barr on Friday called for revamping a range of rules that apply to banks with more than $100 billion in assets, and he called for re-evaluating how regulators treat deposits above a USD 250000 federal insurance limit. Both banks had a large amount of such deposits, which fled quickly as trouble mounted.
In a statement accompanying the Fed’s report, Fed Chair Jerome Powell said he would back steps outlined by Mr. Barr to toughen industry oversight over the coming years. That would essentially reverse some moves made earlier in Mr. Powell’s tenure to ease the rules for midsize banks. The Fed chair said such changes would lead to “a stronger and more resilient banking system.”
Some congressional Republicans criticized the report’s calls for more regulation. Rep. Patrick McHenry (R., N.C.), chairman of the House Financial Services Committee, characterized it as a “self-serving…justification of Democrats’ long-held priorities.”
Of Mr. Barr’s four top takeaways about the events leading to SVB’s collapse, three are tied to perceived shortcomings with the Fed’s banking oversight. The report focuses on errors by the agency but not on individuals’ responsibility.
Mr. Barr said mistakes by Fed regulators were driven in part by the Trump-era changes that generally eased rules on midsize banks. He also said a shift in the agency’s culture appears to have resulted in a lighter-touch form of supervision.
Those changes “impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach,” he said.
Mr. Barr’s predecessor as vice chair for supervision, Randal Quarles, disputed that finding. He said the report “provides no evidence at all for what it describes as one of its main conclusions—that a ‘shift in the stance of supervisory policy’ impeded effective supervision of the bank.”
The Fed also pinned some blame on its own bureaucratic structure. Authority for overseeing banks is parceled out to the Fed’s regional bank branches, but in practice, the central hub in Washington provides extensive input and must approve some enforcement actions.
The Fed said that while supervisors had identified issues around interest-rate risk that contributed to SVB’s failure, the process was “too deliberative” and focused on building evidence before it took action. The firm failed before the Fed completed a planned downgrade of one of its key regulatory ratings of the bank.
Two staffers briefed the Fed’s Board of Governors on Feb. 14 about the risks of unrealized losses banks faced from falling securities prices, according to the Fed. The 11-slide presentation, delivered by a Fed staffer from the D.C.-based board and an employee of the Kansas City Fed, drew attention to one institution: SVB.
SVB had 31 open supervisory findings, or warnings from regulators, when it failed, which was three times the number at peer firms, the Fed said. They spanned everything from liquidity to technology.
In August, the San Francisco Fed gave the bank a failing rating for its governance and control practices. As the firm grew rapidly in 2021, it “did not maintain a risk management function commensurate with the growing size and complexity of the firm,” examiners said in a letter to the bank. The firm’s risk management wasn’t effective, the San Francisco Fed warned.
That month, regulators said “interest rate hedges implemented in 2021 have effectively mitigated the bank’s exposure to rising interest rates.” A few months earlier, SVB had removed some of its hedges against rising rates. It was effectively preparing its balance sheet for rates to fall, rather than to continue rising, which is what ultimately happened.
The Fed overlooked broader problems in recent years as the bank grew. For a long time, it used metrics for liquidity that suggested SVB had a stable deposit base and rated the bank’s interest-rate risk as satisfactory despite the firm breaching internal risk limits over a number of years.
The report also pinned blame on the bank’s poor oversight of itself, saying “the board put short-run profits above effective risk management and often treated resolution of supervisory issues as a compliance exercise rather than a critical risk-management issue.” Through last year, the bank paid management based on earnings and stock returns, and didn’t focus on risk management.
The Fed’s report describes risk-management failures that built up over a period of years, but they showed up acutely in the bank’s final days. For example, SVB had not tested its capacity to borrow at the Fed’s emergency lending facility last year, making a last-minute scramble for funding impossible. Having those safeguards in place might have made the bank’s resolution more orderly, the Fed said.
Problems at Signature Bank had been flagged by the FDIC, but the regulator said in its own report that it could have gone farther. It downgraded its rating of the bank’s liquidity risk management in 2019, signalling that it needed to improve, but said it should have also downgraded its rating of management because its faulty oversight persisted. The bank had high concentrations of uninsured deposits, with some 60 clients holding balances of more than USD 250 million, making up about 40 % of total deposits, the agency said.
Signature’s deposits more than doubled between the end of 2019 and the end of 2021, tracking the growth of the cryptocurrency industry, which made up a chunk of its customer base. A buildup of cash on its balance sheet masked continued problems with liquidity risk management. Then, a downdraft in crypto in 2022 depleted the cash, the FDIC said.
The FDIC also said that staffing shortages hampered its ability to communicate issues to Signature in a timely manner. Since the pandemic started, the supervisory group overseeing large financial institutions in its New York office has had average vacancies of 40 percent, the agency said. For the last six years, it couldn’t adequately staff the team dedicated to Signature.
Another round of congressional hearings with top bank regulators is planned for mid-May. The House Oversight Committee has said that it plans to investigate the San Francisco Fed, which shared jurisdiction of SVB with the Fed board in Washington. The Fed’s Office of Inspector General has launched its own review.
Another report expected Monday will assess deposit insurance and may outline options to overhaul the existing system.