Fed official: Bank rules under review in wake of SVB failure

The Federal Reserve’s bank supervisors informed Silicon Valley Bank’s management as early as the fall of 2021 of risks stemming from its unusual business model, a top Fed official said Tuesday, but the bank’s managers failed to take the steps necessary to fix its problems.

The Fed official, Michael Barr, the nation’s top banking regulator, said during a Senate Banking Committee hearing that the Fed is considering whether stronger bank rules are needed to prevent a similar bank failure in the future.

“Supervisors had rated the bank at a very low rating,” Barr said. “At the holding company level it was rated deficient, which is also clearly not well-managed.”

The timeline that Barr laid out for when the Fed had alerted Silicon Valley Bank’s management to the risks it faced is earlier than the central bank has previously said the bank was on its radar screen.

Silicon Valley’s deposits grew rapidly and were heavily concentrated in the high-tech sector, which made it particularly vulnerable to a downturn in a single industry. It had bought long-term Treasurys and other bonds with those funds.

The value of those bonds fell as interest rates rose. When the bank was forced to sell those bonds to repay depositors as they withdrew funds, Silicon Valley absorbed heavy losses and couldn’t repay all its customers.

Barr said that as a result, the Fed’s review of what happened with Silicon Valley will consider whether stricter regulations are needed, including whether supervisors have the tools they need to prevent banks from failing. The Fed will also consider whether tougher rules are needed on liquidity—the ability of the bank to access cash—and capital requirements, the level of funds held by the bank.

“A review will consider whether the supervisory warnings were sufficient and whether supervisors had sufficient tools to escalate,” Barr said. “I anticipate the need to strengthen capital and liquidity standards for firms over $100 billion,” which would have included SVB.

Barr said Silicon Valley Bank’s own management was largely to blame for the bank’s failure.

“SVB’s failure is a textbook case of mismanagement,” he said in written testimony prepared for the hearing.

Barr pointed to the bank’s “concentrated business model,” in which its customers were overwhelmingly venture capital and high-tech firms in Silicon Valley.

Silicon Valley Bank, based in Santa Clara, California, was seized by the Federal Deposit Insurance Corp. on March 10 in the second-largest bank failure in U.S. history. Late Sunday, the FDIC said that First Citizens Bank, based in Raleigh, North Carolina, had agreed to buy about one third of Silicon Valley’s assets—about $72 billion—at a discount of about $16.5 billion. The FDIC said its deposit insurance fund would take a $20 billion hit from its rescue of SVB, a record amount, in part because it agreed to backstop all deposits at the bank, including those above a $250,000 cap.

The Senate Banking Committee will hold the first formal congressional hearing Tuesday on the failures of Silicon Valley Bank and New York-based Signature Bank and the shortcomings of supervision and regulation, by the Fed and other agencies, that preceded them. The committee will also likely question Barr and other officials about the government’s response, including its emergency decision to insure all the deposits at both banks, even as the vast majority exceeded the $250,000 limit.

Martin Gruenberg, chairman of the FDIC, and Nellie Liang, the Treasury undersecretary for domestic finance, will also testify at the Senate hearing. On Wednesday, all three will testify to a House committee.

Gruenberg said in his prepared testimony that the FDIC, which insures bank deposits, will investigate and potentially impose financial penalties on executives and board members of the two failed banks. The FDIC can also seek to bar them from working in the financial industry again.

Members of Congress will surely use the hearings to stake out their positions on issues raised by the bank failures. These issues include whether the $250,000 limit on federal deposit insurance should be raised, a change that would require Congress’ approval.

Also sure to be debated will be whether the failures can be blamed, to some extent, on the 2018 softening of the stricter bank regulations that were enacted by the 2010 Dodd-Frank law.

The Fed will evaluate whether “higher levels of capital and liquidity would have forestalled the bank’s failure or provided further resilience to the bank,” Barr said.

The 2018 law exempted banks with assets between $100 billion to $250 billion — Silicon Valley’s size — from requirements that it maintain sufficient cash, or liquidity, to cover 30 days of withdrawals. It also meant that banks of that size were subject less often to so-called “stress tests,” which sought to evaluate how they would fare in a sharp recession or a financial meltdown.

Simon Johnson, an economist at the Massachusetts Institute of Technology who co-wrote a book about the 2008-2009 financial crisis, said he believed the 2018 regulatory rollback “contributed to a big relaxation of supervision and fed into this lackadaisical attitude around Silicon Valley Bank.’’

The two bank failures, Johnson said, suggest that banks with $100 billion to $250 billion in assets can pose a risk to the entire financial system. The reduction of rules for banks of that size was based on the idea that they didn’t pose a systemic risk.

But Steven Kelly, senior research associate at the Yale program on financial stability, said he believed that Silicon Valley Bank’s business model was so flawed that requiring it to hold more liquidity wouldn’t have helped it withstand the lightning-fast bank run that toppled it. On Thursday, March 9, depositors—many of them operating swiftly, using smart phones—withdrew $42 billion, or 20% of its assets, in a single day.

“You’re never going to write liquidity regulations that are strict enough to prevent that, when there’s a run on a fundamentally unviable bank,” Kelly said.

In his prepared testimony, Barr also pledged that the Federal Reserve and other agencies would take whatever steps they deem necessary to protect depositors and the banking system. Regulators “are prepared to use all of our tools for any size institution, as needed, to keep the system safe and sound,” he said.

The Fed has come under harsh criticism by groups advocating tighter financial regulation for failing to adequately supervise Silicon Valley Bank and prevent its collapse, and Barr will likely face tough questioning by members of both parties.

Barr said he would ensure that the Fed “fully accounts for any supervisory or regulatory failings” in a previously announced review of the bank’s collapse.

He said officials at the Federal Reserve Bank of San Francisco, which directly supervised Silicon Valley Bank, had sent multiple warnings to the bank’s management about the risks it was taking, including its substantial holdings of Treasurys and other bonds that were steadily losing value as interest rates rose.

As recently as mid-February 2023, Barr says in his prepared testimony, Fed staffers told the central bank’s board of governors that rising rates were threatening the finances of some banks and highlighted, in particular, the risk-taking at Silicon Valley Bank.

“But, as it turned out,” Barr says, “the full extent of the bank’s vulnerability was not apparent until the unexpected bank run on March 9.”