Update 687: Fed Review of its SVB Oversight
What to Look, Hope for in Friday’s Report
Much of Washington is standing by for a vote planned later today on Speaker McCarthy’s “Limit, Save, Grow” bill to extend the debt limit for less than a year in exchange for innumerable and devastating fiscal concessions by the Democrats. The bill is famously DOA in the Senate but passage by the House would formally open the debt limit negotiations.
Also by week’s end, the Fed is expected to release its internal report detailing its oversight of Silicon Valley Bank ahead of its collapse. The review is the Fed’s first comprehensive look at the role of banking regulation and supervision in the Bank’s massive failure. The report comes ahead of Barr’s holistic review to be released this summer. These reports offer hope that we might see strong recommendations for regulatory and supervisory reform of the financial system.
The collapses of Silicon Valley Bank (SVB) and Signature Bank last month represented the biggest bank failures since the 2008 financial crisis. While the failures of the banks’ management are clear, significant questions remain for regulators in the wake of this crisis. Fundamentally, why didn’t regulators see the bank failures coming, and how can they stop the next failure before it happens?
On Friday, the Federal Reserve will release a report on its supervision and regulation of SVB ahead of the bank’s failure. The internal probe is being led by Fed Vice Chair for Supervision Michael Barr and will provide a look at the Fed’s relevant work ahead of the collapse and the agency’s recommendations for change moving forward. The report is set to include confidential supervisory information, including supervisory assessments and exam material not typically shared by the Board of Governors.
The collapse of SVB came as Barr was conducting a “holistic review” of capital standards that he announced just months after his term at the Fed began last year. That report is expected later this year and will likely echo recommendations in Friday’s report. The Fed was responsible for the federal supervision and regulation of SVB as the firm was a state member bank with a bank holding company.
Strengthening and Supporting Supervision
Barr’s review is expected to tell the most comprehensive story of Fed supervision of SVB yet, but some details are already clear. Outside of global systemically important banks (G-SIBs), the Fed categorizes its supervision of banks based on their assets. These include:
- Regional Banking Organization or RBO portfolio (assets from $10 to $100 billion) — these banks are supervised by smaller teams that typically engage with the banks on a quarterly basis and conduct a limited number of targeted exams and a full-scope examination each year.
- Large and Foreign Banking Organization or LFBO portfolio (assets from $100 to $250 billion) — these banks are supervised by larger teams that engage with banks on an ongoing basis and are subject to a greater number of targeted exams and horizontal (cross-bank) exams throughout the year. These banks are also subject to a supervision framework with higher supervisory standards, including heightened standards for capital, liquidity, and governance.
Between 2019 and 2022, SVB’s asset size tripled. In 2021, the bank was moved from the Fed’s RBO portfolio to its LFBO portfolio and assigned a new team of supervisors.
The pace of SVB’s growth was extraordinary and far beyond that typically seen by examiners in their oversight of banks. This rapid growth in combination with SVB’s concentrations on both the asset and liability sides should have captured examiners’ attention and prompted more dramatic escalation.
SVB’s new supervisory team raised red flags. Near the end of 2021, supervisors issued six supervisory findings — Matters Requiring Attention (MRA) and Matters Requiring Immediate Attention (MRIA) — related to the bank’s liquidity stress testing, contingency funding, and liquidity risk management. In May 2022, supervisors issued three additional findings related to ineffective board oversight, risk management weaknesses, and the bank’s internal audit function.
By last summer, supervisors downgraded the bank’s management rating to “fair” and rated its enterprise-wide governance and controls “deficient-1,” which limited SVB’s ability to expand its nonbank activities through mergers and acquisitions. By late 2022, supervisors took the decision to meet directly with SVB’s senior management about its interest rate profile and delivered a further supervisory finding on interest rate risk management.
Despite supervisors’ established concerns and unsuccessful steps to induce bank management to rectify glaring issues, Barr said that he became aware of SVB’s interest rate and liquidity risk a month before the bank’s failure and that the full extent of the bank’s vulnerability was not clear until after the fact.
Barr’s review will consider whether the Fed’s supervisory framework was appropriate for SVB, given its unique business model, the speed with which it grew, and its vulnerabilities. Specifically, the review will examine the effectiveness of the supervisory approach in identifying risks, supervisors’ ability to identify which risks represent major threats to a bank’s safety and soundness, whether supervisors have the tools they need and whether the Board’s culture, policies, and practices effectively support supervisors in using those tools.
Rollback of Regulatory Rollbacks?
Barr’s review will consider the impact of regulatory rollbacks in the years prior to SVB’s failure which directly impacted the Fed’s oversight of the bank. The report is expected to recommend reinstating stronger requirements for banks, effectively rolling back the rollbacks.
Following the 2008 financial crisis, Dodd-Frank provided critical protections to the banking sector, including:
- Capital requirements for banks to protect against the danger of bank runs
- Stress tests to ensure banks were strong enough to respond to periods of existential pressure
In 2018, S.2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act was signed into law. The bill increased the asset threshold at which those prudential standards would apply, effectively allowing banks of SVB’s asset size to escape stronger requirements. In 2019, the Fed revised its regulatory framework to tailor its rules for banks in line with requirements under the law.
S.2155 directly impacted federal regulation applied to SVB, which held between $100 billion and $250 billion in assets when it failed. Prior to 2019, SVB would have been subject to:
- More frequent stress testing by the Fed’s Board
- Bank run capital stress test requirements
- More rigorous capital planning and liquidity risk management standards
Further regulatory rollbacks that took place in 2019 meant that SVB was not subject to certain standards, including but not limited to, the:
- Liquidity Coverage Ratio — requires banks to hold enough high-quality liquid assets to fund cash outflows for 30 days
- Supplementary Leverage Ratio — measures tier 1 capital relative to total leverage exposure
- California’s Department of Financial Protection and Innovation SVB Report
In early May, the department charged with overseeing state level regulation and supervision of SVB — the California Department of Financial Protection and Innovation — will release its own comprehensive review of the department’s oversight and regulation of Silicon Valley Bank.
- FDIC Signature Bank Report
On Monday, the Federal Deposit Insurance Corporation is set to release its review — led by its Chief Risk Officer Matters Requiring Attention (MRA) and Matters Requiring Immediate Attention (MRIA) — of the FDIC’s supervision of Signature Bank ahead of its failure.
- FDIC Deposit Insurance Report
Additionally, on Monday, the FDIC will issue a comprehensive review of the deposit insurance system which will include policy options related to:
- Deposit insurance coverage levels
- Excess deposit insurance
- Implications for risk-based pricing and deposit insurance fund adequacy
- Barr’s Holistic Review
Months after Barr’s term began last year, he began a “holistic review” of capital standards which is expected later this year. Barr has previously suggested that the review would lead to suggestions to increase capital standards.
Shifting Attitudes on Regulation
Last month’s bank failures highlight the power of isolated institutional failures to initiate fears of instability within the wider financial system. Before the collapses of SVB and Signature, Republicans in Congress were so opposed to anticipated recommendations in Barr’s yet-to-be-released holistic review that ten Senate Banking Republicans led by Ranking Member Tim Scott (R-SC) sent a letter to Fed Chair Jerome Powell expressing concern that recommended capital requirements may not be sufficiently tailored to risk. House Financial Services Republicans pressed Powell on this when he testified before the committee a day before the run on SVB.
Since then, there has been a clear shift in the conversation around capital requirements. When recommendations included in Barr’s report on the failure of SVB and his holistic review are released, we urge regulators and legislators to be more receptive to strengthening the guardrails that protect our financial system.