The Fed on Silicon Valley Bank Collapse: We May Have Dropped the Ball There

The Fed on Silicon Valley Bank Collapse: We May Have Dropped the Ball There

In a highly anticipated report on the collapse of Silicon Valley Bank, the Federal Reserve admits that it maybe shouldn’t been paying slightly closer attention to the tech-centric bank before it unceremoniously collapsed last month. At the same time, the Fed’s report also reveals what everybody already could’ve guessed: SVB was a poorly run bank.

Long a headquarters for the money of tech startups and venture capital, SVB collapsed in March as the result of a number of screwy financial decisions that reduced confidence in the bank, ultimately leading to a run on its deposits. After it collapsed, SVB was subsequently seized by the California government but the Fed later decided to essentially bail it out, in a decision some have called questionable. Since then, everybody’s been wanting a little clarity on how all this happened — a question that Friday’s report attempts to answer.

As previously noted, the report isn’t kind to anybody involved — neither the bank’s managers who ran the financial entity into the ground, nor the Fed’s own regulators, who were supposed to be watching out for this kind of thing.

“Following Silicon Valley Bank’s failure, we must strengthen the Federal Reserve’s supervision and regulation based on what we have learned,” said the Fed’s Vice Chair for Supervision Michael S. Barr on Friday. “This review represents a first step in that process — a self-assessment that takes an unflinching look at the conditions that led to the bank’s failure, including the role of Federal Reserve supervision and regulation.”

Here’s a few takeaways from the report.

SVB was run poorly

This might not come as a huge surprise but one of the key takeaways from the Fed’s report is that SVB was not a particularly well run bank. The report notes that the bank’s board of directors and its managers were not very good at negotiating — or communicating about — the risks in the bank’s business strategy. At the same time, the bank is said to have not had any real plan for if things went South — like they ended up doing last month. Indeed, it “failed its own internal liquidity stress tests” and it also didn’t have functional plans to “access liquidity in times of stress.” The report summarises:

Silicon Valley Bank was a highly vulnerable firm in ways that both its board of directors and senior management did not fully appreciate. These vulnerabilities — foundational and widespread managerial weaknesses, a highly concentrated business model, and a reliance on uninsured deposits — left Silicon Valley Bank acutely exposed to the specific combination of rising interest rates and slowing activity in the technology sector that materialised in 2022 and early 2023

The Fed admits it was a sleeping watchdog

A refreshing if slightly maddening admission in the Fed’s report is that it majorly dropped the ball when it came to monitoring the situation at SVB. Indeed, despite admitting it served as the “primary federal supervisor” for SVB, the Fed notes that the bank failed anyway. So, uh, what happened, guys? Were you taking a nap while all this was happening?

According to the Fed, they missed some of the warning signs related to SVB’s problems. Or, rather, though they saw some stuff that didn’t look so hot, they decided it wasn’t such a big deal. The report states:

The Federal Reserve did not appreciate the seriousness of critical deficiencies in the firm’s governance, liquidity, and interest rate risk management. These judgments meant that Silicon Valley Bank remained wellrated, even as conditions deteriorated and significant risk to the firm’s safety and soundness emerged.

At the same time, the Fed admits that, when it did see red flags, it was slow to act on them:

Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment.

In other words, federal regulators felt they needed to have an open-and-shut case before taking action against SVB.

Important takeaway: actually, regulations are good!

One of the reasons that SVB got away with making so many dumb decisions is that the banking industry has seen deregulation over the past decade, largely at the behest of corporate lobbyists. This meant that financial regulators had less obligation to keep a close watch on what the bank was doing.

After the 2008 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was supposed to institute protections that would prevent bank failures of the kind that characterised the 08′ crisis. However, in 2018, after a substantial lobbying effort, a new banking law was passed that rolled back some of those protections. The Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) did a number of things, but one of is that it lowered the bar for supervision of banks of SVB’s size. In its report, the Fed notes that the rollback of such Dodd-Frank protections contributed to SVB’s collapse, as the EGRRCPA “resulted in lower supervisory and regulatory requirements, including lower capital and liquidity requirements” for banks like SVB. It also changed the culture at the Fed, ushering in “changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory actions.” In other words, staff were pressured to take it easy on the banks.

Appropriately, one of the industry figures who lobbied heavily for the shift in regulations was the CEO of SVB, Greg Becker, who argued that a failure to ease up on banks of SVB’s size would “stifle our ability to provide credit to our clients.” That’s funny because you know what also negatively impacts credit for clients? Having your bank implode.

Fed’s top suggestion to avoid future failures: we’ll try to do our job more often

In the conclusion of the report, the Fed admits that there are some things it could probably do to make sure this sort of thing doesn’t happen again. Those suggestions include a “shift [in] the culture of supervision toward a greater focus on inherent risk, and more willingness to form judgments that challenge bankers with a precautionary perspective.” Additionally, Vice Chair for Supervision Barr has said that he wants to see an increase in the “speed, force, and agility of supervision” of banks. Whatever that means, hopefully it means better regulations, yes? Yes.

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