The Federal Reserve’s bank supervisors informed Silicon Valley Bank’s management as early as the fall of 2021 of risks stemming from its unusual business model, a top Fed official said Tuesday, but the bank’s managers failed to take the steps necessary to fix its problems.
The Fed official, Michael Barr, the nation’s top banking regulator, said during a Senate Banking Committee hearing that the Fed is considering whether stronger bank rules are needed to prevent a similar bank failure in the future.
“Supervisors had rated the bank at a very low rating,” Barr said. “At the holding company level it was rated deficient, which is also clearly not well-managed.”
The timeline that Barr laid out for when the Fed had alerted Silicon Valley Bank’s management to the risks it faced is earlier than the central bank has previously said the bank was on its radar screen.
Tuesday’s hearing is the first formal congressional inquiry into the March 10 collapse of Silicon Valley Bank and the subsequent failure of New York-based Signature Bank, the second- and third-largest bank failures in U.S. history.
The failures set off financial tremors in the U.S. and Europe and led the Fed and other government agencies to back all deposits at the two banks, even though nearly 90 per cent of both banks’ deposits exceeded the $250,000 insurance threshold. The Fed also established a new lending program to enable banks to more easily raise cash if needed.
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Late Sunday, the Federal Deposit Insurance Corp. said that resolving the two banks, including reimbursing depositors, would cost its insurance fund $20 billion, the largest such impact in its history. The FDIC plans to recoup those funds through a levy on all banks, which will likely be passed on to consumers.
Sen. Sherrod Brown, the Ohio Democrat who leads the committee, suggested that Silicon Valley Bank’s failure and the government’s rescue of its depositors, which included wealthy venture capitalists and large tech companies, had caused “justified anger” among many Americans.
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“I understand why many Americans are angry _ even disgusted _ at how quickly the government mobilized, when a bunch of elites in California were demanding it,” Brown said.
Silicon Valley’s deposits grew rapidly and were heavily concentrated in the high-tech sector, which made it particularly vulnerable to a downturn in a single industry. It had bought long-term Treasurys and other bonds with those funds.
The value of those bonds fell as interest rates rose. When the bank was forced to sell those bonds to repay depositors as they withdrew funds, Silicon Valley absorbed heavy losses and couldn’t repay all its customers.
Barr said the Fed’s review of what happened with Silicon Valley will consider whether stricter regulations are needed, including whether supervisors have the tools needed to follow up on their warnings. The Fed will also consider whether tougher rules are needed on liquidity _ the ability of the bank to access cash _ and capital requirements, the level of funds held by the bank.
“A review will consider whether the supervisory warnings were sufficient and whether supervisors had sufficient tools to escalate,” Barr said. “I anticipate the need to strengthen capital and liquidity standards for firms over $100 billion,” which would have included SVB.
Fed Chair Jerome Powell has said he will support any regulatory changes that are proposed by Barr.
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Last September, before the banks’ collapse, Barr had said he was conducting a “holistic review” of the government’s capital requirements. He suggested that he might support toughening those requirements, which prompted criticism from the banking industry and Republican senators.
Barr also said in prepared remarks that the Fed will review whether a 2018 law that weakened stricter bank rules also contributed to the financial turmoil.
“SVB’s failure is a textbook case of mismanagement,” Barr said.
Martin Gruenberg, chairman of the FDIC, and Nellie Liang, the Treasury undersecretary for domestic finance, also testified Tuesday. On Wednesday, all three will testify to a House committee.
Gruenberg said the FDIC, which insures bank deposits, and the Fed and Treasury, took steps to protect the two banks’ depositors to prevent a broader bank run, in which customers would swiftly withdraw their funds and can cause even healthy banks to buckle.
“I think there would have been a contagion,” Gruenberg said, “and I think we would have been in a worse situation today.”
Gruenberg said in his testimony that the top 10 depositors at Silicon Valley held $13.3 billion in their accounts. That is an enormous figure that reflects the wealth of many of its customers, which included large companies such as Roku, the streaming video company, which held about $500 million in an SVB account.
Democratic senators charged that the failures can be attributed, to some extent, to the 2018 softening of the stricter bank regulations that were enacted by the 2010 Dodd-Frank law.
The 2018 law exempted banks with assets between $100 billion to $250 billion _ Silicon Valley’s size _ from requirements that it maintain sufficient cash, or liquidity, to cover 30 days of withdrawals. It also meant that banks of that size were subject less often to so-called “stress tests,” which sought to evaluate how they would fare in a sharp recession or a financial meltdown.
Simon Johnson, an economist at the Massachusetts Institute of Technology who co-wrote a book about the 2008-2009 financial crisis, said he believed the 2018 regulatory rollback “contributed to a big relaxation of supervision and fed into this lackadaisical attitude around Silicon Valley Bank.”
But Steven Kelly, senior research associate at the Yale program on financial stability, said he believed that Silicon Valley Bank’s business model was so flawed that requiring it to hold more liquidity wouldn’t have helped it withstand the lightning-fast bank run that toppled it. On Thursday, March 9, depositors _ many of them operating swiftly, using smart phones _ withdrew $42 billion, or 20% of its assets, in a single day.
“You’re never going to write liquidity regulations that are strict enough to prevent that, when there’s a run on a fundamentally unviable bank,” Kelly said.
The Fed has come under harsh criticism by groups advocating tighter financial regulation for failing to adequately supervise Silicon Valley Bank and prevent its collapse, and Barr will likely face tough questioning by members of both parties.
As recently as mid-February 2023, Barr says in his prepared testimony, Fed staffers told the central bank’s board of governors that rising rates were threatening the finances of some banks and highlighted, in particular, the risk-taking at Silicon Valley Bank.
“But, as it turned out,” Barr says, “the full extent of the bank’s vulnerability was not apparent until the unexpected bank run on March 9.”
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AP Economics Writer Paul Wiseman contributed to this report.
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