Silicon Valley Bank’s risky practices were on the Federal Reserve’s radar for more than a year — an awareness that proved insufficient to stop the bank’s demise.
The Fed repeatedly warned the bank that it had problems, according to a person familiar with the matter.
In 2021, a Fed review of the growing bank found serious weaknesses in how it was handling key risks. Supervisors at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six citations.
Those warnings, known as “matters requiring attention” and “matters requiring immediate attention,” flagged that the firm was doing a bad job of ensuring that it would have enough easy-to-tap cash on hand in the event of trouble.
But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was in a full supervisory review — getting a more careful look — and was ultimately rated deficient for governance and controls.
The Fed has initiated an investigation into what went wrong with the bank’s oversight, headed by Michael S. Barr, the Fed’s vice chair for supervision.
Congressional hearing March 29
The inquiry’s results are expected to be publicly released by May 1. Lawmakers are also digging into what went awry. The House Financial Services Committee has scheduled a hearing on recent bank collapses for March 29.
In 2022, the Santa Clara-based bank was placed under a set of restrictions that prevented it from growing through acquisitions. Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose.
It became clear to the Fed that the firm was using bad models to determine how its business would fare as the central bank raised rates: Its leaders were assuming that higher interest revenue would substantially help their financial situation as rates went up, but that was out of step with reality.
By early 2023, Silicon Valley Bank was in what the Fed calls a “horizontal review,” an assessment meant to gauge the strength of risk management. That checkup identified additional deficiencies — but at that point, the bank’s days were numbered.
In early March, it faced a run and failed, sending shock-waves across the broader American banking system that ultimately led to a sweeping government intervention meant to prevent panic from spreading.
On Sunday, Credit Suisse, which was caught up in the panic that followed Silicon Valley Bank’s demise, was taken over by UBS in a hastily arranged deal put together by the Swiss government.
Major questions have been raised about why regulators failed to spot problems and take action early enough to prevent Silicon Valley Bank’s March 10 downfall.
Many of the issues that contributed to its collapse seem obvious in hindsight:
- Measuring by value, about 97 percent of its deposits were uninsured by the federal government, which made customers more likely to run at the first sign of trouble.
- Many of the bank’s depositors were in the technology sector, which has recently hit tough times as higher interest rates have weighed on business.
- Silicon Valley Bank also held a lot of long-term debt that had declined in market value as the Fed raised interest rates to fight inflation. As a result, it faced huge losses when it had to sell those securities to raise cash to meet a wave of withdrawals from customers.
SVB bosses failed to plan
The picture that is emerging is one of a bank whose leaders failed to plan for a realistic future and neglected looming financial and operational problems, even as they were raised by Fed supervisors.
For instance, according to a person familiar with the matter, executives at the firm were told of cybersecurity problems both by internal employees and by the Fed — but ignored the concerns.
The Federal Deposit Insurance Corporation, which has taken control of the firm, did not comment on its behalf.
Still, the extent of known issues at the bank raises questions about whether Fed bank examiners or the Fed’s Board of Governors in Washington could have done more to force the institution to address weaknesses. Whatever intervention was staged was too little to save the bank, but why remains to be seen.
“It’s a failure of supervision,” said Peter Conti-Brown, an expert in financial regulation and a Fed historian at the University of Pennsylvania. “The thing we don’t know is if it was a failure of supervisors.”
Barr’s review of the Silicon Valley Bank collapse will focus on a few key questions, including why the problems identified by the Fed did not stop after the central bank issued its first set of matters requiring attention.
The existence of those initial warnings was reported earlier by Bloomberg. It will also look at whether supervisors believed they had authority to escalate the issue, and if they raised the problems to the level of the Federal Reserve Board.
The Fed’s report is expected to disclose information about Silicon Valley Bank that is usually kept private as part of the confidential bank oversight process. It will also include any recommendations for regulatory and supervisory fixes.
The bank’s downfall and the chain reaction it set off is also likely to result in a broader push for stricter bank oversight.
Barr was already performing a “holistic review” of Fed regulation, and the fact that a bank that was large but not enormous could create so many problems in the financial system is likely to inform the results.
Typically, banks with fewer than $250 billion in assets are excluded from the most onerous parts of bank oversight — and that has been even more true since a “tailoring” law that passed in 2018 during the Trump administration and was put in place by the Fed in 2019. Those changes left smaller banks with less stringent rules.
Tighter rules possible
Silicon Valley Bank was still below that threshold, and its collapse underlined that even banks that are not large enough to be deemed globally systemic can cause sweeping problems in the American banking system.
As a result, Fed officials could consider tighter rules for those big, but not huge, banks. Among them: Officials could ask whether banks with $100 billion to $250 billion in assets should have to hold more capital when the market price of their bond holdings drops — an “unrealized loss.” Such a tweak would most likely require a phase-in period, since it would be a substantial change.
But as the Fed works to complete its review of what went wrong at Silicon Valley Bank and come up with next steps, it is facing intense political blowback for failing to arrest the problems.
Some of the concerns center on the fact that the bank’s chief executive, Greg Becker, sat on the Federal Reserve Bank of San Francisco’s board of directors until March 10. While board members do not play a role in bank supervision, the optics of the situation are bad.
“One of the most absurd aspects of the Silicon Valley bank failure is that its CEO was a director of the same body in charge of regulating it,” Sen. Bernie Sanders, a Vermont independent, wrote on Twitter on Saturday, announcing that he would be “introducing a bill to end this conflict of interest by banning big bank CEOs from serving on Fed boards.”
Other worries center on whether Jerome H. Powell, the Fed chair, allowed too much deregulation during the Trump administration. Randal K. Quarles, who was the Fed’s vice chair for supervision from 2017 to 2021, carried out a 2018 regulatory rollback law in an expansive way that some onlookers at the time warned would weaken the banking system.
Powell typically defers to the Fed’s supervisory vice chair on regulatory matters, and he did not vote against those changes. Lael Brainard, then a Fed governor and now a top White House economic adviser, did vote against some of the tweaks — and flagged them as potentially dangerous in dissenting statements.
“The crisis demonstrated clearly that the distress of even noncomplex large banking organizations generally manifests first in liquidity stress and quickly transmits contagion through the financial system,” she warned.
Sen. Elizabeth Warren, Democrat of Massachusetts, has asked for an independent review of what happened at Silicon Valley Bank and has urged that Powell not be involved in that effort. Powell “bears direct responsibility for — and has a long record of failure involving” bank regulation, she wrote in a letter on Sunday.
Friday bankruptcy filing
On Friday SVB Financial Group, the former parent company of Silicon Valley Bank, the lender that regulators seized March 10 after a devastating run on deposits, filed for bankruptcy.
The move would place SVB Financial, which owns other businesses aside from Silicon Valley Bank, into a court-led process, as it auctioned off units that include the investment manager SVB Capital and the brokerage firm SVB securities. Those units continue to operate and were not part of the bankruptcy filing.
The bankruptcy process would be separate from the sale of assets led by the Federal Deposit Insurance Corporation to repay Silicon Valley Bank’s depositors. SVB Financial said in a statement that it “believes it has approximately $2.2 billion of liquidity.” The company had about $3.3 billion in debt outstanding and a type of shares worth $3.7 billion.
Maureen Farrell, Lauren Hirsch and contributed reporting. Jeanna Smialek writes about the Federal Reserve and the economy for The Times. Copyright, 2023, The New York Times.
Update from San Jose Inside:
The Wall Street Journal reported today that the Federal Reserve had raised concerns about risk management at Silicon Valley Bank starting at least four years before its failure earlier this month, documents show.
In January 2019, the Fed issued a warning to SVB over its risk-management systems, according to a presentation circulated last year to employees of SVB’s venture-capital arm.
On Friday, the Mid-Size Bank Coalition of America urged regulators to immediately guarantee all deposits in the country for two years. In a letter, the group said deposits are leaving banks of all sizes and flooding into the four biggest banks, putting everyone at risk of a wider panic.
Yes, these are troubling, but…
“Measuring by value, about 97 percent of its deposits were uninsured by the federal government, which made customers more likely to run at the first sign of trouble.”
This was SVB’s business model and target customers forever. It catered to business who needed a operating account, particularly startups.
“Many of the bank’s depositors were in the technology sector, which has recently hit tough times as higher interest rates have weighed on business.”
Again, this was SVB business model forever, it’s a Mensa club for the elect of our society – “entrepreneurs”. I wouldn’t say they have hit hard times, just relatively low capitalization compared to the cash firehose pandemic years. Which is why SVB was so exposed, as it had to put it somewhere and they incompetently thought treasuries were safe.
“Silicon Valley Bank also held a lot of long-term debt that had declined in market value as the Fed raised interest rates to fight inflation. As a result, it faced huge losses when it had to sell those securities to raise cash to meet a wave of withdrawals from customers.”
Yes, but we aren’t talking about hiding bad loans, securitized subprime, or other shady dealings. These were treasuries for goodness’ sake. They foolish bought long term instead short-term bonds and were undone by poorly managed duration risk. Managing duration risk is taught in Banking 101, but hardly “bare knuckle tactics”, greedy capitalism or back-room corruption. Just basic incompetence coupled with a customer base who were effectively insiders and once they decided to pull cash, they did it at the same time. I guess Peter Theil wasn’t on their group text.
SVB was a poorly conceived bank and should have only dealt in low-return cash equivalents and charged HEFTY fees instead of investing in bonds or offering loans (and the loans don’t seem to be the issue here, just the dramatic drop in deposits). Yes, this is a story, but hardly one for all you Marxists to proclaim Karl was right and parade into the street to juice the lumpen-proles into a revolutionary ecstasy.
Just an Observation,
To try to claim that Marxism is the cause of the bank failure is insane.
The facts was BAD MANAGEMENT was the cause of the problem.
I can hardly think a bank would be anti-captialist.
Face the facts that all banks rely on a mathematical formula they PREDICT would be safe and reliable regarding practices. But like we are doing again today what we did in 2005-2008, those formulas are proving to be a failure.
Face it, we did it again, and unlike 2008, the FED and the U.S. Government cannot afford to bail out Loans, Mortgages, Commercial Mortgage Backed Securities and Residential Mortgage Backed Securities. All of those will crash out of existence this time.
Get ready for it.
Mr. Kulak, just who other than disaster crazies would buy long-term bonds during a zero-interest-rate policy in effect, plus inflating the money supply where future value of the dollar might be lower? With that and other problems, few really have sympathy and I’m already tired of a lot of overdoing of some banks getting themselves in trouble for this or that reason not associated with us ordinary folks. It wasn’t “bare-knuckle” stuff, but inept and self-serving, or so they thought with everything they did. It didn’t end up to their benefit(s).
Meanwhile, only insured deposits should have been paid, only to the $250,000 limit, nothing over the limit, nothing whatsoever for uninsured deposits. As a few critics were immediate to say, when the feds bailed out all, they established a precedent that likely becomes a new consistent policy, and already certainly many people expect everything to be paid every time from now on.
“Mr. Kulak, just who other than disaster crazies would buy long-term bonds during a zero-interest-rate policy in effect, plus inflating the money supply where future value of the dollar might be lower?”
Obviously, an incompetent risk manager. I have not read an explanation behind the justification of buying low interest long term bonds in an obviously non-transitory inflationary environment when short term ones were paying like 1% less. I remember that time well as I was looking to refinance two apartment buildings because it didn’t take a genius to know the CARES Act was going to trigger inflation and the only chemo the FED knows is raising interest rates. My original lending bank wouldn’t return my calls as they had the prepay hanging over my head and why do anything at such a time, so I bit the bullet and paid the prepay and subsequent origination fee to switch one of the loans. Not wanting to lose the entire business the original lender extended the term on the remaining loan to nine years (at a lower rate!). I think they were stunned I was willing to pay a five figure prepay to get away from them and I wrote long emotional letters pointing out their lack of ethics in ghosting me. If I were that lender, I would have let me walk – but I guess it’s not their money. No way would I have taken on a new note in the threes for that long knowing rates would be 7%-8% in a year or two. But it is hard to know what is going on inside the bank politics wise. Worked out for us bigly.
“Meanwhile, only insured deposits should have been paid, only to the $250,000 limit, nothing over the limit, nothing whatsoever for uninsured deposits.
I originally shared that sentiment, however, was this “moral hazard” the depositors doing or the bank? You could say depositors should preform perfect due diligence on their banks or they should spread out deposits $250K a bank. However, if you only make them $250K whole, you will have more runs on smaller banks from large depositors (millions per account) to the top banks (maybe first and second largest) as they would be the safest (or only safe) ones left. All these smaller banks would then be insolvent and things may very well be worse. Keep in mind, the FED pressure these banks to push their fractional lending out to 90%, as that is a huge driver of the economy.
JUst an Observation,
MORAL HAZARD APPLIES TO INVESTMENTs NOT REGULAR BANK ACCOUNTS.
A person having a checking or savings account is not subject to MORAL HAZARD.
This really shows how little many people understand the differences between LOAND, MORTGAGES, COMMERCIAL MORTGAGE BACKED SECURITIES, and RESIDENTIAL MORTGAGE BACKED SECURITIES.
Those are subject to MORAL HAZARD, not checking and savings accounts. Why can’t the people here understand the difference?
——- Blocked ———-
no one cares what you say or think
get a job and pay your bills
then maybe if you’re good
you can get a seat at the adult table
——- Blocked ———-
Just an Observation,
Well here we go again, instead of a constructive conversation you just insult those that prove the point?
In any event the Fed has said by the end of the year it will raise rates by .5%. No cuts until at least 2024
It also warned that credit tightening has to occur in order to prevent more rate hikes. This is going to force a lot of businesses to pay what they earn, and not rely on credit.
You all should watch PBS Frontline “Age of Easy Money”, it validates most of what I have been saying for years. Especially the use of free loans to buy back stocks to inflate the stock markets.
No innovation, no real product growth, and fake overvaluation of existing properties and services is going to continue to force the market down.
And you can complain and insult me all you want it won’t change reality.
This is fun.