Category: Financial Services

Recapping the Federal Reserve SVB Review: What Happened and What’s Next

By Keaghan Ames, Vice President, Financial Services Practice

The collapse of Silicon Valley Bank (“SVB”) in March was at a minimum correlated with a series of chain reactions, including the failing of several other banks. For many, uncertainty about the particular details around how SVB failed resulted in certain doubts about the resiliency of several regional banks, including First Republic’s, and their ability to hold deposits and navigate fixed income markets.

Seven weeks later, the Federal Reserve (“the Fed”) recently announced the results of their review on the failure of SVB (“the review”). Each of these findings brings with them vastly different implications for the market and the continued national attention on medium-sized/regional banks ($100 billion- $250 billion in assets). The Federal Reserve made four findings. While the first three findings are readily understood and anticipated, the fourth finding will be the topic of discussion in Washington in the weeks to come.

1. Silicon Valley Bank’s board of directors and management failed to manage their risks.
2. Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.
3. When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.

SVB’s inability to manage interest rate risk and scale its risk management framework with the growth of the bank was widely known prior to the Fed’s review. However, some of the risk-metrics around SVB were startling, specifically three facts: (a) 94% of the deposits at SVB were uninsured comparative to 41% among its other large banking organization (LBO) peers; and, (b) SVB actively removed interest-rate hedges beginning in early 2022, as rates were being raised by the Federal Reserve and, (c) beginning in Q4 of 2021, the unrealized losses on SVB’s investment portfolio securities continued to grow in the billions of dollars.

On the regulatory and supervisory side, the Senate Banking Committee and House Financial Services Committee hearings in late March revealed that the Fed and FDIC were aware of a number of these risk management deficiencies, including a lack of interest rate risk management upon the part of SVB. The review also confirms that the regulators did not fully extend the growth of these risks (i.e., the same scaling issue that SVB’s management had). There were also several delays by the Fed, including seven-months to develop an enforcement action related to some of SVB’s deficiencies and failing to take any material supervisory actions following significant rating downgrades in the 2022 Capital, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk (CAMELS) and Large Financial Institution (LFI) ratings.

4. The Board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA)[1] and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.

FRB Vice Chair for Supervision Barr made clear in the recent congressional hearings, well in advance of the conclusion of the Federal Reserve’s review, that he anticipated significant regulatory and supervisory changes as a result of SVB’s failure. Though the first three findings confirm that the SVB management and Federal Reserve supervisory teams failed to act in a prudent and/or expedited fashion, the report still suggests that the tailoring reform, implemented under S.2155 (i.e., EGGRCPA), contributed to the collapse of SVB. Specifically, SVB “may have more proactively managed its liquidity and capital positions or maintained a different balance sheet composition” but for the reform from tailoring. (emphasis added)

Many within the beltway believe that the Federal Reserve will use this “may have” as a justification to take actionable regulatory reform for regional and foreign banks. As far as anticipated reactions, industry and congressional policymakers will have a difficult time reconciling the notion that the deficiencies with SVB’s risk management and with the Federal Reserve’s supervisory teams should lead to further regulatory and supervisory reform for the entire banking sector. Particularly when that reform could lead to another one-size-fits-all regulatory approach that will ultimately squeeze medium sized banks and hinder competition in the banking sector.

Next Steps

Prior to the collapse of SVB, the regulators were already rumored to be increasing capital requirements on banks through the U.S. implementation of Basel III, a global overhaul of bank capital standards. The review seems to indicate that the Federal Reserve will finalize the Basel III reform and conduct a series of other reforms including rolling back the tailoring reform under S.2155 (EGRRCPA).

Congressionally, there will likely be more hearings. We anticipate Chair McHenry (R-NC) of the House Financial Services Committee, his top lieutenants, and several members of Congress on a bi-partisan basis will be hard pressed to support rolling back the tailoring reform, particularly in the current economic environment. Traditionally, the Fed’s Vice Chair for Supervision has testified before the Senate Banking Committee and House Financial Services Committee in May so it’s quite possible that the Hill will have an opportunity to speak with Vice Chair Barr in the near future.

[1] The Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) is also known by its bill number: S.2155.