As the banking sector tries to make sense of the second-biggest bank failure in U.S. history, a debate has emerged over how much blame lies with the bank’s supervisors.
By all accounts, Silicon Valley Bank committed some cardinal sins in banking. It made itself massively vulnerable to rising interest rates, built its balance sheet around deposits that proved to be unreliable and failed to protect itself against what became fairly large bets.
All of which has critics asking: How could this happen under its regulators’ watch?
“Where was everybody? Were they on vacation?” said David H. Stevens, CEO of Mountain Lake Consulting, and a former assistant secretary of housing in the Obama administration.
The Santa Clara, California-based bank was overseen by California banking regulators and the Federal Reserve, which has undertaken a study of any potential shortcomings in its supervision. Those sympathetic to its regulators say hindsight is 20/20, that the issues may not have appeared as dire in real time and that any behind-the-scenes warnings and actions are not yet public.
What’s quickly become clear is that the bank had unique fragilities due to its outsized reliance on uninsured deposits, which exceed the Federal Deposit Insurance Corp.’s $250,000 guarantee.
Those have historically been treated as safe, stable sources of funding, former Fed Vice Chair for Supervision Randal Quarles said in an interview. For that reason, supervisors likely didn’t view the bank’s unrealized losses on bond investments as needing an immediate remedy, such as raising more equity capital, he said.
“The uninsured deposits at SVB behaved differently than uninsured deposits had over the previous 50 years,” Quarles said. “So, both the structure of the regulations and the judgment, experience and expertise of the supervisors would be looking at those and saying, ‘We don’t have a smoldering flame here, notwithstanding the hole that has developed in these highly interest rate sensitive asset portfolios, because of the relative stability of the funding.'”
Quarles and other former supervisors who spoke with American Banker this week argued that it is unlikely that Silicon Valley Bank’s regulators were blind to the issues on the bank’s balance sheet. But how they assessed those risks, what steps they took to address them and how Silicon Valley Bank responded to those actions remains unknown.
“This certainly looks like a supervisory failure, but we don’t know, will probably never know, what was being messaged to the bank by its supervisors in the run-up to this event,” said Cliff Stanford, a regulatory lawyer with firm Alston & Bird and a former counsel on the Federal Reserve Bank of Atlanta’s supervisory team.
The Fed announced Monday that Vice Chair for Supervision Michael Barr will lead a six-week review of the central bank’s supervisory and regulatory actions surrounding Silicon Valley Bank, to determine where its efforts might have fallen short. The Fed has committed to releasing a report on its findings by May 1. Following bank failures, the FDIC’s inspector general also conducts a post-mortem review of the contributing factors.
Until those reports are made public, there is little insight to glean into how examiners dealt with the issues at Silicon Valley Bank. Communications between banks and their regulators are deemed confidential supervisory information, and are kept under lock and key. Some information — such as a bank’s capital adequacy, assets, management capabilities, earnings, liquidity and sensitivity, or CAMELS, rating — is considered so sensitive that it is illegal to make it public.
Banks the size of Silicon Valley, which had more than $200 billion of assets before it was taken over by the Federal Deposit Insurance Corp. last week, frequently have examiners on their premises. They are also subject to regular formal evaluation processes. The California Department of Financial Protection and Innovation, which declined to comment for this article, and the Fed typically alternate conducting full-scope, on-site examinations annually.
The supervisory reviews do not appear to have yielded public concerns. Silicon Valley Bank has not been the subject of a public enforcement action since 1993, when the Fed issued a cease and desist order against the bank and its bank holding company, according to the Fed’s online records. The matter was resolved in 1996.
As recently as June 2021, the Fed wrote that Silicon Valley Bank was “well capitalized and well managed.” The thumbs-up came when the Fed approved the bank’s purchase of Boston Private, a wealth management firm and private bank.
The mid-2021 purchase — when interest rates were low, and the tech sector was booming — coincided with the bank’s massive growth spurt. By last year, Silicon Valley Bank had quadrupled in size from 2018, when the Fed’s reworked framework for regulating larger banks went into effect.
Much of its growth came early in the pandemic, when money flooded into tech companies and found its way into Silicon Valley Bank’s coffers. Its total deposits jumped to $189 billion at the end of last year, up sharply from $64.4 billion at the end of 2021 and far outstripping the industry’s growth.
The bank claimed to serve nearly half the technology- and life science-focused startups in the country last year. Many of those companies kept all of their deposits at the bank, going well above the FDIC’s insured limit.
As those companies saw their funding dry up amid rising interest rates last year, they began increasingly drawing down their deposits. The outflows got so severe that Silicon Valley Bank announced last week it was selling part of its bond portfolio to raise cash, even though it meant absorbing a large hit from selling them prematurely. Investors panicked, depositors pulled their money out, and regulators shut down the bank.
Many experts say the risks at Silicon Valley Bank would have been obvious to regulators familiar with the savings and loan crisis of the 1980s, which claimed hundreds of thrifts that were caught unprepared for the impact of rising interest rates on their long-term loans.
“They got caught in the classic squeeze that took down the savings & loans in the 1980s,” Stevens said. “Their depositors were large corporate clients demanding yield and higher interest rates on their account, versus average depositors who get paid nothing and tend to keep their money at a bank.”
Stevens and others said these large, uninsured corporate depositors should have been considered “hot money,” prone to flee at a moment’s notice, as many of them did last week.
Ultimately, the bank saw $42 billion of deposit requests in less than two days, as depositors whipped themselves into a panic by exchanging messages on social media, Slack and email about their concerns over the bank’s liquidity.
“The Fed really never had probably considered or severely underestimated how quickly everybody starts to text each other, phone each other, message each other and immediately start saying: ‘Oh my god, this is horrible. We’re gonna take our money out,'” said Mayra Rodríguez Valladares, a bank consultant and managing principal at MRV Associates.
The size and speed of the run was unprecedented, but some experts said it was predictable, given the Fed’s clear messaging around raising interest rates to quell inflation. Had supervisors encouraged Silicon Valley to better hedge its rate risk exposures, the bank could have avoided the liquidity crunch that triggered the bank run, said Ted Tozer, the former president of Ginnie Mae.
“Regulators got complacent,” said Tozer, who is now a nonresident fellow at the Urban Institute’s Housing Finance Policy Center. “We go from one crisis to another, and it’s incredible to me that examiners have forgotten about the 1980s when we went through a similar interest rate rise to crush inflation.”
Others said guarding against interest rate risk should be a first-order concern for banks’ chief financial officers and risk managers. Regulators have not issued specific warnings about interest rate risks this past year, but it is a standard part of their guidance.
“The examiners at the FDIC and the states are constantly preaching to banks about interest rate risk, the dangers of it and how to be prepared for it,” said Alfred A. DelliBovi, chairman of $8.5 billion-asset Flushing Bank, in Uniondale, New York. “It’s in the hymnal, they all say you have to watch out for interest rate risk.”
Banks that fall short on heeding that guidance, or raise other concerns, can get formal warnings from Fed examiners in their routine reviews. But those fixes can take some time to be finalized, and the timing of the spark that sets off a failure is often unpredictable, said Mark Williams, a Boston University professor and former Fed supervisor.
He pointed to a brand-new example: the Swiss bank Credit Suisse teetering on the brink of failure on Wednesday despite years of clear mismanagement and public regulatory concern.
“Claims that ‘Well, regulators missed it,’ that probably is not quite accurate, because of the time it takes, once a rating is provided, for the remedy to occur,” Williams said. “What sped up this whole problem, of course, was that we had an incredibly aggressive depositor run.”
In the days since the failures of Silicon Valley Bank and Signature Bank in New York, a political debate has emerged over whether changes to bank regulation guidelines are in order.
Specifically, many Democrats on Capitol Hill have called for rolling back some of the reforms implemented by the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act, which applied the strictest rules to banks with more than $250 billion of assets, instead of those with $50 billion or more.
Todd Phillips, an independent consultant and former FDIC lawyer, said the law loosened critical protections for institutions of Silicon Valley’s size. But it also sent a message to bank supervisors to avoid “pushing too hard on any of these mid-sized banks,” Phillips said.
Quarles, who oversaw the Fed’s implementation of that law, said none of the changes instituted on his watch would have played a clear role in preventing the failure of Silicon Valley Bank. He noted that the bank’s reliance on deposits — even uninsured ones — would have satisfied even the highest liquidity coverage ratio requirements and would have been deemed sufficient under a stress test.
Quarles argued that broad changes to capital rules are not necessary, but said that some specific exam features, including the treatment of uninsured deposits, which currently are treated as between 90% and 95% as secure as their insured counterparts, are worth revisiting.
“Even though I don’t believe that anything that happened calls for a change in anything we did, I think it raises questions going forward about issues that have not been on the agenda before, particularly this uninsured deposits issue,” Quarles said.
Former Fed Governor Dan Tarullo, the agency’s former regulatory head, said in an interview with Marketplace that he expects the Fed’s internal review to reveal which shortcomings belong solely to Silicon Valley Bank and which were driven by the “lighter touch” supervisory approach initiated during the Trump administration.
“I suspect that it’s a combination of the two,” Tarullo said. “But, given the signals that the Fed was sending, you know, in the last several years, I believe that part of it is just the ‘Don’t be too tight in your supervision, you need to find legal problems before you tell the banks to change what they were doing.'”
While all of the lessons to be drawn from last week’s events are not yet clear, many in the industry agree that the bank’s demise could have been avoided.
“I have enough faith in the regulatory system to believe that the bank examiners probably would have spotted this issue and talked to management about it,” said Konrad Alt, co-founder of the advisory firm Klaros and a former senior deputy at the Office of the Comptroller of the Currency. “[The real question is] whether their response was appropriately calibrated to the magnitude of the problem, and I think the fact that the bank has failed spectacularly kind of answers the question.”
Kate Berry contributed to this report.