Update 680 — Regulatory Response to SVB:
Feds Saw Problems but Hands Tied by Regs
To hear some (the GOP, the WSJ) tell the story, the collapse of Silicon Valley Bank was caused by the Fed’s interest rate policy and regulators asleep at the wheel. But as today’s House Finance Services and yesterday’s Senate Banking Committee hearing on the regulatory response to the meltdown made clear, regulators were on the case as early as 2021 and are now examining deficiencies in regulations that constrained their response, with a critical report from the Federal Reserve expected on May 1st.
SVB is not subject to the regulatory scrutiny that it would have been as a designated systemically important financial institution prior to the S. 2155 rollbacks of 2018. But it has the discretion to include banks like SVB with $100-250 billion in consolidated assets, a point made by Sen. Warren and confirmed yesterday by the regulators. The regulatory response to the run on SVB, constraints faced by regulators, preliminary lessons learned and policy options ahead are covered below.
This week, the House Financial Services Committee and Senate Banking Committee held their respective hearings to examine federal regulators’ response to recent bank failures. Federal Deposit Insurance Corporation Chair Martin Gruenberg, Federal Reserve Board of Governors Vice Chair for Supervision Michael Barr, and Treasury Department Under Secretary for Domestic Finance Nellie Liang, defended the regulatory response to stabilize the banking sector amidst tight questions on supervision, capital requirements, deposit insurance, and holding bank executives accountable.
Despite Republican attempts to blame bank collapses on work by banks and regulators to account for the risks of climate change and to promote diversity, equity and inclusion, the hearings served as a forum to dissect the collapses of Silicon Valley Bank (SVB) and Signature Bank and discuss accountability and regulation moving forward. While some legislators questioned whether regulators were asleep at the wheel, Committee members were clear that failures of bank management were primarily responsible for collapses and that focus must be placed on opportunities to improve the system.
Following the 2008 financial crisis, Dodd-Frank provided critical protections to the banking sector, including but not limited to:
- 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 stress;
- And other pillars of systemic risk regulation, such as living wills guide regulators in the event of receivership.
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 for $100 billion to $250 billion.
After the bill was implemented,
- SVB’s assets grew from under $60 billion at the end of 2019 to $209 billion at the end of 2022
- Signature’s assets grew from about $50 billion at the end of 2019 to $110 billion at the end of 2022
S. 2155 has since become the target for post-SVB reform. Senator Elizabeth Warren (D-MA), who vehemently opposed the 2018 legislation, and Representative Katie Porter (D-CA) introduced the Secure Viable Banking Act which would repeal 2018 capital and stress test rollbacks. All three witnesses agreed that bank rules need to be strengthened.
Republicans, meanwhile, suggested that S. 2155 never prevented the Fed from requiring the standards that would have prevented SVB and Signature’s failures and stated that the central bank has had such authority all along. Senator Mike Crapo (R-ID), the primary author of S. 2155, used his floor time to blame regulators for upholding the standards under his bill that defined SVB and Signature as “well capitalized” prior to their failures. Senator Thom Tillis (R-NC) similarly targeted the Fed. That line of questioning stood in stark contrast to a letter both Tillis and Crapo signed on to just a week before the collapse of SVB, in which they and eight other Senate Banking Committee Republicans told the Fed that an increase in capital requirements was “unfounded.”
The Role of Supervision
The hearing also raised questions about the supervisory process through which red flags in the banking sector are detected and escalated. Barr said that supervisors met with the CEO of SVB in Fall 2021 to convey the seriousness of their findings. SVB was issued an MRIA (matter requiring immediate attention) based on the inaccuracy of their interest rate risk modeling after previously being cited for issues with liquidity and interest rate management. Despite the series of citations and a six-month period over which SVB lacked a risk manager, Barr said that he only became aware of the seriousness of SVB’s issues in February of this year.
Regulators currently function on the front and back ends of bank collapses. They detect issues and escalate the urgency with which they encourage bank management to address them. After a failure, they take measures to stem the fallout, whether it be dissecting the collapse, protecting depositors, shoring up confidence in the banking system, or seeking to hold those at fault accountable. These collapses present an opportunity to examine the gap, and whether regulators should have the ability to compel more responsible bank management to prevent bank failures rather than signaling impending disaster and cleaning up the mess thereafter.
A central focus of the hearings was the need to hold former executives accountable, particularly by clawing back bonuses and stock sale proceeds they received in the lead-up to their banks’ collapses. SVB CEO Greg Becker sold $3.6 million in SVB stock and SVB employees received bonuses hours before the bank’s failure. Committee members in both the House and Senate were largely receptive to the proposition.
Gruenberg said that while the FDIC lacks the ability to directly claw back executive compensation, the regulator is required to review the conduct of the board of failed banks, after which it can impose civil money penalties, seek restitution, and bar former executives from holding banking positions. Senate Banking Committee members, including Brown, Kennedy, Van Hollen, and Sinema, said that they were working to introduce bipartisan legislation to strengthen regulators’ ability to claw back executive compensation.
Following the 2008 financial crisis, legislators saw the danger of tying executive compensation to risky bank management. Section 956 of Dodd-Frank instructed regulatory agencies to ban incentive-based executive compensation that encourages “inappropriate” risk-taking. Such a rule has yet to be put forth. Over a dozen organizations, including 20/20 Vision, have joined AFREF, the Institute for Policy Studies, Global Economy Project, and Public Citizen in calling for the Fed, FDIC, OCC, Federal Housing Finance Agency, SEC and National Credit Union Administration to issue a final rule this year that includes:
- A 10-year deferral of a significant percentage of executive compensation;
- Making failed financial institutions subject to forfeiture to pay fines and reduce the cost of insuring depositors or if it engaged in misconduct;
- A ban on stock options;
- A ban on executives hedging bonus pay.
The Deposit Debate
Following the collapses of SVB and Signature, the FDIC, Fed, and Treasury Department jointly announced plans to insure all deposits, both insured and uninsured, of the failed banks. In his opening statement, Brown raised the question of deposit insurance. Gruenberg testified that a failure to protect depositors would have created significant risk of contagion. His written testimony emphasized the latent vulnerability within the banking system posed by interest rate hikes.
Unrealized Gains (Losses) on Investment Securities
Source: FDIC; Statement of Martin J. Gruenberg, Chairman FDIC on “Recent Bank Failures and the Federal Regulatory Response”
Gruenberg noted that there was a need to reassess the consideration of uninsured deposits in calculating bank risk. He stated that heavy reliance on uninsured deposits creates liquidity risks that are difficult to manage given the speed with which money can be moved between financial institutions and the power of social media to amplify news. Additionally, he said the FDIC was conducting a review of the deposit insurance system and would release a report, inclusive of policy options by May 1.
Debate and Investigations Continue
These hearings presented Congress’s first investigations into the failures of SVB and Signature Bank and the subsequent response. While executives did not testify in the opening hearings, Committee members of both parties placed the primary responsibility on SVB and Signature execs. The Justice Department and SEC have reportedly begun separate investigations into the collapse of SVB.
Additionally, Barr’s review of the oversight of Silicon Valley Bank will be released on May 1st. Barr’s “holistic review” of capital standards, which he began last year and has been a point of concern for Republicans, is expected in May as well. Barr has previously suggested that the review would lead to suggestions to increase capital standards. Comments from members on both sides of the aisle, including those from Warren, Scott, Crapo, and Britt, reinforce the Fed’s power to strengthen capital requirements without legislative action. These hearings have shown a clear shift in the conversation around capital requirements since the collapses of SVB and Signature. When recommendations included in Barr’s review are released, we urge Republicans on Senate Banking and HFSC to be more receptive.