Weak federal oversight contributed to bank collapse, Fed report says

Washington — Federal regulators didn't go far enough to push Silicon Valley Bank to fix the problems that led to its collapse last month, the Federal Reserve’s top bank regulator said in a report released Friday.

That was caused in part by policy changes during the Trump administration that rolled back oversight of midsized banks, wrote Vice Chair for Supervision Michael Barr in a scathing review of events that led to the bank’s failure. 

Silicon Valley Bank’s “senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable,” Barr wrote. “And Federal Reserve supervisors failed to take forceful enough action.”

Tailoring changes put in place in 2019 removed thousands of banks with fewer than $250 billion in assets from stricter federal oversight, including regular "stress tests" that show whether banks could survive a recession. Those changes made regulators slower to identify risks and slower to take action once the risks were identified, Barr wrote. 

He also said the Fed needs to develop “a culture that empowers supervisors to act in the face of uncertainty,” and “to guard against complacency.” 

“More than a decade of banking system stability and strong performance by banks of all sizes may have led bankers to be overconfident and supervisors to be too accepting,” he wrote. “Supervisors should be encouraged to evaluate risks with rigor and consider a range of potential shocks and vulnerabilities, so that they think through the implications of tail events with severe consequences.”

Read more: Michigan's Barr leads Fed's review of March banking collapse, aims to avert new calamity

Barr said the Fed plans to revisit the tailoring framework that contributed to weak oversight, including potentially strengthening rules for banks with more than $100 billion in assets. Silicon Valley Bank had $209 billion in total assets when it failed.

Higher capital and liquidity requirements for banks with inadequate planning or controls can also help shore up banks, he argued. Those requirements would be phased in over the next several years after going through a rulemaking process. 

The Fed should also consider “setting tougher minimum standards for incentive compensation programs” to make sure bank managers respond to oversight warnings, he said.

He also noted that new technology fueled the bank run in unprecedented ways: Social media allowed panic to spread quickly while online banking allowed customers to immediately withdraw their funds. 

The proposed changes can be made through regulatory processes within the Fed and will not require legislative approval, a top Federal Reserve official told reporters in a briefing Friday morning. The official also said the staff that conducted the review was not involved in the direct supervision of Silicon Valley Bank, though the agency welcomes further outside review and recommendations.

Bart Naylor, a financial policy advocate with left-leaning consumer rights advocacy group Public Citizen, said the report "exceeded expectations" with the Fed pointing the finger at itself. The report also offered a "fairly elegant" solution, he said — further enforcement of a Dodd-Frank provision that says executive bonuses should not incentivize inappropriate risk taking, as SVB's structure did.

"This is a poster child of inappropriate risk taking," he said. "If that rule was to go into effect, I think this wouldn't have happened. You show me bad banker behavior, and I'll show you a paycheck that incentivizes it."

Barr has previously warned Congress that loosening regulations could prevent officials' ability to prevent bank instability, and told lawmakers last month that there was a question of whether the Fed's supervision was "appropriate for the rapid growth and vulnerabilities of the bank."

Republicans and some moderate Democrats have pushed back on the implication that loosening oversight contributed to the bank collapse, and have instead laid the blame at the feet of Federal Reserve officials.

Rep. Bill Huizenga, R-Holland, serves on the House Financial Services Committee and chairs the panel's Oversight and Investigations subcommittee. He said the report "recognizes the clear failure of bank management" to address the risk of rising interest rates, but "it falls short of fully exploring why the Federal Reserve’s own supervisory actions failed so spectacularly."

"Instead and unsurprisingly, the report dovetails into the Democrats’ long-held push for greater regulation and more power. A federal regulator asking for more authority in the wake of a crisis is one of the oldest calls in Washington’s playbook," Huizenga said in a statement.

"Our Subcommittee will continue to conduct a thorough and independent review into the collapse of Silicon Valley Bank as well as the role the Federal Reserve played in it."

Barr, 57, is on leave from his position at the University of Michigan, where he is the dean of the Ford School of Public Policy. In 2009 and 2010, he led efforts in the Obama administration to shape the Dodd-Frank Act, which strengthened banking regulations in the wake of the Great Recession.

Barr told The Detroit News in an interview this week that the 22 years he has lived in Michigan witnessing the devastation of the Great Recession has underscored the importance of safe banking systems. He said the recession's impact on Detroit was "devastating."

"The fact that I saw up close what the consequences of the financial crisis were for my neighbors and my friends definitely made that real to me," he said. "When I was working in the Obama administration, it made me fight even harder for financial reform because I could see that having a financial system that was not safe enough or fair enough really hurt people."

Based in Santa Clara, California, Silicon Valley Bank was a hub for technology companies and venture capital firms. It put most of its funds in Treasury bonds, which are typically safe, long-term investments.

But as the Fed increased interest rates to stifle inflation, those assets became worth less than what SVB had paid for them. The bank also had a large amount of uninsured depositors — big deposits that exceed a $250,000 limit set by the Federal Deposit Insurance Corp. At the same time, startup funding began to dry up, causing some of SVB's clients to try to pull out their money.

SVB had to sell off investments to meet the demand. When it became clear they might face huge losses because of these conditions, their clients rushed to take out their money, causing the bank's failure on March 10.

The panic spilled over to New York-based Signature Bank, which also held a high number of uninsured deposits and which catered to cryptocurrency companies. Regulators seized the bank to prevent further fallout.

Regulators concluded that the two banks' failure could spark further panic. So the FDIC guaranteed all of their deposits, ensuring that anyone who had money in either bank could get it back, even if it exceeded the $250,000 threshold. The move raised alarms for Republicans and some banking experts, who argued it could create a precedent for other risky banks.

Barr told lawmakers last month it was a "textbook case of mismanagement" and that bank managers ignored repeated warnings and failed to calculate the risk of its investments.

rbeggin@detroitnews.com

Twitter: @rbeggin