WASHINGTON — Silicon Valley Bank grew steadily in 2018 and 2019 — and regulators at its main regulator, the Federal Reserve Bank of San Francisco, were preparing it for a tighter oversight panel in which specialists from across the Fed system would review its risks and vulnerabilities Clues.
But a decision by officials in Washington halted that move.
The Federal Reserve Board — which sets the Fed’s standards for banking regulation — was about to enact a bipartisan 2018 law aimed at making regulation less onerous for small and medium-sized banks. When the board did so, Randal K. Quarles, the Trump-appointed vice chairman for oversight, and his colleagues also decided to adapt the way banks were overseen to meet the new requirements.
As a result, Silicon Valley Bank’s move to the more stringent oversight group would be delayed. The bank would have previously been promoted to the Large and Foreign Bank Organization group after averaging more than $50 billion in assets in one year; Now, that shift wouldn’t happen until wealth consistently averages more than $100 billion.
The change turned out to be fateful. The Silicon Valley Bank only switched completely to the stronger supervisory group at the end of 2021. Its assets had nearly doubled this year, to about $200 billion, when it came under tighter scrutiny.
By then, many of the issues that would ultimately lead to his downfall had already begun to fester. These included a customer base heavily dependent on the success of the technology industry, an unusually large proportion of deposits above the $250,000 limit the government insures in the event of a bank failure, and an executive team that paid little attention to risk management.
These vulnerabilities seem to have remained unresolved when Silicon Valley Bank was overseen the way small and regional banks are: by a small team of overseers who were in some cases generalists.
When the bank finally moved into more sophisticated oversight for big banks in late 2021, placing them under the purview of a larger team of specialized bank supervisors with input from across the Fed system, it was immediately hit with six allegations. These highlighted various issues, including how it managed its ability to raise money quickly during tough times. The next summer, its management was found to be failing, and in early 2023 the intense scrutiny of the bank extended to the highest levels of the Fed.
Big questions remain as to why supervisors did not do more to ensure deficiencies were addressed once they were alerted enough to begin issuing subpoenas. The Fed is conducting an internal investigation into the incident, the results of which are expected on May 1st.
But the picture that is emerging is one in which a slow response in 2022 wasn’t the only problem: Silicon Valley Bank’s troubles also seem to have come to the fore too late to fix easily, in part due to the rollbacks of the Trump era. By making the much later decision to put banks under supervision of big banks, Mr. Quarles and his colleagues had created a system that treated even large and rapidly expanding banks with a light touch when it came to how aggressively they were being supervised.
That has drawn the attention of Fed and White House officials, who are reviewing the aftermath of the dramatic collapse of the Silicon Valley bank on March 10 and asking what lessons should be learned from the disaster.
“The way Federal Reserve regulation laid out the structure for the approach to oversight treated companies in the $50 billion to $100 billion range with lower requirements,” said Michael Barr, the Fed’s vice chairman for oversight. to lawmakers this week, explaining that by the time Silicon Valley Bank’s problems were fully recognized, “it was sort of very late in the process.”
According to a person familiar with the matter, about five people oversaw Silicon Valley Bank in the years before it rose to become a major bank overseer. The bank was subject to quarterly reviews, and its supervisors could choose to subject it to horizontal reviews – in-depth reviews that test for a specific weakness by comparing a bank to companies of a similar size. But these would not have been a standard part of their oversight based on the way the Fed operates oversight of small and regional banks.
As it grew to oversee large banks, the oversight team responsible for the bank swelled in size. About 20 people were working oversight at Silicon Valley Bank when it failed, Mr Barr said this week. It had been subject to horizontal reviews that had revealed serious risks.
But such warnings often take time to be acted upon. Although bank supervisors began pointing out major problems in late 2021, banks typically have leeway to fix problems before they face penalties.
“One of the defining characteristics of oversight is that it is an iterative process,” said Kathryn Judge, a financial regulation expert at Columbia Law School.
The Fed’s response to the problems at Silicon Valley Bank seemed to falter, even after recognizing risks. Surprisingly, the company was given a satisfactory liquidity rating in early 2022 after regulators began pointing out problems, Mr Barr acknowledged this week. Several people familiar with the surveillance found this unusual.
“We’re trying to understand how that compares to the other material,” Mr. Barr said this week. “The question is, why hasn’t this been escalated and why hasn’t further action been taken?”
However, the high liquidity rating could also be due to the bank’s belated switch to the large banking supervisory authority. Bank regulators sometimes treat a bank more gently during the first year of tighter supervision, one person said, as they adjust to the more onerous attention from regulators.
There was also turmoil within the ranks of the San Francisco Fed regulator as Silicon Valley Bank’s risks mounted. Reserve Bank President Mary Daly called a meeting with a number of heads of the Banking Regulatory Group in 2019 to insist they work to improve staff satisfaction, according to people with knowledge of the event. The meeting was previously reported by Bloomberg.
Of all Fed employees in San Francisco, bank supervisors had the lowest satisfaction scores, with employees reporting that they face retaliation for speaking out or disagreeing, according to one person.
Several supervisors resigned, retired, or resigned for other reasons in the years that followed. As a result, relatively new managers were at the helm as Silicon Valley Bank’s risks grew and became clearer.
It’s hard to tell whether San Francisco regulators — and Fed board staff who would have been involved in evaluating Silicon Valley Bank — have been unusually slow to respond to the bank’s troubles given the secrecy of banking regulators, Ms Judge said.
“We don’t have a base,” she said.
Even as the Fed tries to understand why issues weren’t addressed more quickly, the fact that the Silicon Valley bank remained under less stringent oversight, which may not have been tested for its specific weaknesses until relatively late in the game, is increasingly coming into focus.
“The Federal Reserve’s supervisory and regulatory system is based on a tailored approach,” Mr Barr said this week. “This framework, which is really focused on asset size, isn’t prone to the kind of problems we’ve seen here in terms of rapid growth and a concentrated business model.”
Also, the 2018 law and its implementation by the Fed likely impacted Silicon Valley Bank’s oversight in other ways. Had it not been for the changes, the Fed would likely have started conducting full stress tests on the bank sooner, and the bank may have had to strengthen its ability to raise money in an emergency to meet what it calls the “liquidity coverage ratio,” some research has suggested.
The White House on Thursday asked regulators to consider reinstating stricter rules for banks with assets of $100 billion to $250 billion. And the Fed is re-examining size limits for tighter banking supervision and working on ways to test for “new” risks that may not be neatly related to size, Mr Barr said this week.
But Mr Quarles, who tailored the 2018 banking rule, has insisted the bank’s collapse was not the result of changes the law mandated or he had made. Even the most basic level of oversight should have recognized the obvious problems that killed Silicon Valley Bank, he said, including its lack of protection from rising interest rates.
“It was the easiest risk imaginable,” he said in an interview.
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