The investigation is ongoing, but Vice Chairman of the Federal Reserve Board of Supervision Michael Barr is aware of it. “The bankruptcy of the SVB [Silicon Valley Bank] it’s a book case of bad management,” read the advance he released this Monday about the first intervention he will make when he appears before the Senate this Tuesday. Barr comes to Capitol Hill amid questions about whether the central bank has made oversight mistakes that have led to a banking crisis threatening the economy.
The strange thing is that according to Barr’s story, the supervisors had accurately identified the company’s problems. “We have to ask ourselves why the bank could not fix and address the issues we identified in a timely manner. It’s not the job of supervisors to fix the problems identified, it’s the job of the bank’s management and board of directors,” said the Fed’s vice president.
In 2021, as the bank grew and became more important, it was transitioned into a more rigorous oversight group with constant contact and oversight of solvency, liquidity and cybersecurity risks, Barr explains. At the end of 2021, the supervisory authorities identified deficiencies in the bank’s liquidity risk management. There were six red flags (‘regulatory findings’) related to the Bank’s liquidity stress testing, contingency funding and liquidity risk management. In May 2022, regulators released three additional findings related to ineffective oversight of the board, deficiencies in risk management and the bank’s internal audit function.
In the summer of 2022, regulators downgraded the bank’s management rating to fair and gave the bank’s governance and controls a poor-1 rating. These ratings mean that the bank was not ‘well managed’ and was subject to growth constraints. In October 2022, regulators met with the bank’s senior management to raise concerns about the bank’s interest rate risk profile, and in November 2022, Barr said, regulators gave the bank a supervisory conclusion on the management of interest rate risk.
The collapse of the bank, step by step
That oversight didn’t prevent the bank’s demise, which Barr sums up concisely. The Fed Vice President explains that the SVB has a concentrated business model serving the technology sector and venture capital. Also that it has grown very quickly, tripling the size of its assets between 2019 and 2022. In the early stages of the pandemic and as the technology sector boomed, SVB saw significant deposit growth. The bank invested the proceeds from these deposits in longer-term securities in order to increase returns and profits.
However, “the bank has not effectively managed the interest rate risk of these securities or developed effective tools, models and metrics to measure interest rate risk,” Barr said. “At the same time, the bank failed to manage the risks of its liabilities,” he adds. These liabilities consisted largely of deposits from venture capital firms and the technology sector, which were highly concentrated and could be volatile.
Since these companies often have no operating income, they hold large bank balances to cover payroll and pay for operating expenses. “These depositors were connected through a network of venture capital firms and other links, and when tensions began, they essentially acted together to launch a bank run,” says the Federal Reserve Vice Chairman.
“The bank waited too long to address its problems and, ironically, the steps it eventually took to strengthen its balance sheet triggered a flight of uninsured depositors that led to bankruptcy,” adds Barr.
The vice-president of the Federal Reserve recalled that on Wednesday, March 8, the SVB announced that it had realized a loss of $1.8 billion in a sale of securities to raise liquidity and was planning a capital increase. Uninsured depositors interpreted these measures as a sign that the bank was in trouble. “They were focused on the bank’s balance sheet and didn’t like what they saw,” says Barr.
Talk of a deposit leak began on social media, and uninsured customers (with balances in excess of $250,000) were withdrawing funds at an extraordinary rate, attracting more than $40 billion as of Thursday, March 9th deposits from the bank. On Thursday evening and Friday morning, the company said it expects even larger outflows that day. The bank did not have enough cash or guarantees to withstand these extraordinary and rapid outflows and went bankrupt on Friday, March 10, Barr summarizes. Panic gripped the remaining depositors of the SVB, who saw their savings at risk and that their companies were at risk due to the bankruptcy of the financial institution, with which the authorities acted to avoid contagion, guaranteeing all of the company’s deposits.
supervision and regulation
Barr self-critically acknowledges that the size thresholds used by the central bank may not always be a good indicator of risk, particularly when a bank has a non-traditional business model. But he concedes that this bank’s uniqueness and focus on the tech sector isn’t everything, as its downfall was ultimately caused by banking’s well-known poor management of interest rate and liquidity risks.
“Our review raises several questions: How effective is the supervisory approach in identifying these risks? Having identified risks, can supervisors distinguish risks that pose a significant threat to a bank’s safety and soundness? Do supervisors have the necessary tools to mitigate security and resiliency threats? Do the culture, policies, and practices of the board and Fed banks support regulators in using these tools effectively?” says Barr.
The Federal Reserve is not only examining what went wrong with oversight after the shortcomings were discovered, but also whether tighter regulation (like before Donald Trump’s 2018 counter-reform) could have prevented this crisis. At this point, it seems to indicate that not much would have changed with the previous law.
Looking ahead, Barr believes efforts need to be redoubled to improve the resilience of the banking system. And he proposes concrete measures: “It is important that we propose and apply the final reforms of Basel III that better reflect commercial and operational risks in our measurement of banks’ capital needs. Additionally, in line with our advance notification of the proposed rulemaking, we plan to propose a long-term debt requirement for large non-G-SIBs to have a buffer of loss-absorbing resources to support their stabilization and a non-systemic solution represents a risk. We need to improve our multi-scenario stress testing to capture a broader range of risks and uncover channels of contagion, as we have seen in the recent series of events. We also need to consider changes to our liquidity standards and other reforms to improve the resilience of the financial system,” he concludes.
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