Home Economy Before the collapse of Silicon Valley Bank, the Fed noticed big problems

Before the collapse of Silicon Valley Bank, the Fed noticed big problems

by SuperiorInvest

WASHINGTON — Silicon Valley Bank’s risky practices have been on the Federal Reserve’s radar for more than a year — and that awareness proved insufficient to stop the bank’s demise.

The Fed has repeatedly warned the bank that it has problems, according to a person familiar with the matter.

In 2021, the Fed’s assessment of the growing bank found serious flaws in how it deals with 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,” indicated the firm was doing a poor job of ensuring it had enough readily available cash on hand in case of trouble.

But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was under full supervision – receiving a closer look – and was ultimately rated inadequate for governance. It was subject to a set of constraints that prevented it from growing through acquisitions. Last fall, San Francisco Fed staff met with the firm’s executives to talk about their ability to access sufficient cash in a crisis and their potential exposure to losses as interest rates rise.

It was clear to the Fed that the firm was using the wrong models to determine how its business would fare when the central bank raised rates: Its leaders assumed that higher interest income would substantially help their financial situation when rates went up, but that was off the mark. in step with reality.

As of early 2023, Silicon Valley Bank was in what the Fed calls “horizontal revision”, an assessment to measure the strength of risk management. That review revealed more flaws – but at that point the bank’s days were numbered. She faced a breakout in early March and failed within days.

Major questions have been raised about why regulators failed to spot problems and take action early enough to prevent Silicon Valley Bank from collapsing on March 10. Many of the problems that contributed to its collapse seem obvious in retrospect: Measuring by value, about 97 percent its deposits were not insured by the federal government, making it more likely that customers would leave at the first sign of trouble. Many of the bank’s depositors were in the technology sector, which has fallen on hard times recently as higher interest rates weighed on business.

And Silicon Valley Bank also held a lot of long-term debt, the market value of which fell when the Fed raised interest rates to fight inflation. As a result, it faced huge losses when it had to sell these securities to raise cash to face a wave of withdrawals from customers.

The Fed launched an investigation into what went wrong with bank supervision, led by Michael S. Barr, the Fed’s vice chairman for supervision. The survey results are it is expected to be publicly released until May 1. Lawmakers are also digging into what went wrong. The House Financial Services Committee has scheduled a hearing on the recent bank collapses of March 29.

The picture that emerges is that of a bank whose leaders failed to plan for a realistic future and neglected looming financial and operational problems even as they were brought to the attention of Fed supervisors. For example, according to a person familiar with the matter, the firm’s executives were briefed on cybersecurity concerns by both internal employees and the Fed — but ignored the concerns.

The Federal Deposit Insurance Corporation, which took control of the firm, did not comment on its behalf.

Still, the extent of the bank’s known problems 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 oversight,” said Peter Conti-Brown, a financial regulation expert and Fed historian at the University of Pennsylvania. “The thing we don’t know is if it was a failure of the superiors.

Mr. Barr’s review of the Silicon Valley Bank collapse will focus on several 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 these initial warnings was Bloomberg reported earlier. It will also look at whether supervisors believed they had the authority to escalate the problem and whether they escalated the problems to the Federal Reserve board level.

The Fed’s report is expected to reveal information about Silicon Valley Bank that is usually kept private as part of the confidential banking supervision process. It will also contain any recommendations for regulatory and supervisory corrections.

The bank’s collapse and the chain reaction it set off are also likely to lead to a wider push for tighter banking supervision. Mr Barr has already been conducting a “holistic review” of Fed regulation, and the fact that a bank that was big but not enormous could cause so many problems in the financial system is likely to inform the results.

Banks with less than $250 billion in assets are typically excluded from the toughest parts of banking supervision — and that’s even more true since the “tailoring” law passed in 2018 during the Trump administration and put in place by the Fed. in 2019. These changes left smaller banks with less stringent rules.

Silicon Valley Bank was still below that threshold, and its collapse highlighted that even banks that are not large enough to be considered globally systemic can cause widespread problems in the US banking system.

As a result, Fed officials could consider tighter rules for these big but not huge banks. Among them: Officials could question whether banks with $100 billion to $250 billion in assets should be required to hold more capital when the market price of their bonds falls — an “unrealized loss.” Such a tweak would most likely require a roll-in period as it would be a substantial change.

But as the Fed works to complete its review of what went wrong at the Silicon Valley Bank and comes up with next steps, it faces heavy political blowback for failing to stop the problems.

Some concerns center on the fact that the bank’s CEO, Greg Becker, sat on the board of the Federal Reserve Bank of San Francisco. until March 10. While board members do not play a role in banking supervision, the optics of the situation are bad.

“One of the most absurd aspects of the failure of a Silicon Valley bank is that its CEO was the head of the same body that was in charge of regulating it,” said Sen. Bernie Sanders, a Vermont independent. he wrote on Twitter announced on Saturday that he would “introduce a bill to end this conflict of interest by banning the CEOs of major banks from serving on Fed boards.”

Other concerns center on whether Jerome H. Powell, the Fed chairman, has allowed too much deregulation during the Trump administration. Randal K. Quarles, who was the Fed’s vice chairman for supervision from 2017 to 2021, implemented a sweeping deregulation law in 2018 that some observers at the time warned would weaken the banking system.

Mr. Powell usually reports to the Fed’s supervisory vice chairman on regulatory matters and did not vote against the changes. Lael Brainard, then the Fed governor and now the White House’s chief economic adviser, voted against some of the adjustments — calling them potentially dangerous in dissenting statements.

“The crisis has clearly shown that the distress of even non-complex large banking organizations generally manifests itself first in a lack of liquidity and quickly transmits the contagion through the financial system,” she warned.

Sen. Elizabeth Warren, Democrat of Massachusetts, yes requested an independent review about what happened at Silicon Valley Bank and urged Mr. Powell not to be involved in the effort. “He has direct responsibility for — and has a long history of failures involving” banking regulation, she wrote in a letter Sunday.

Maureen Farrell contributed reporting.

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