On April 28, both the Federal Reserve and the Federal Deposit Insurance Corporation issued self-assessments of their regulatory oversight leading up to the closings of Silicon Valley Bank and Signature Bank. At the time of their failures, Silicon Valley Bank and Signature Bank were the second- and third-largest bank failures in U.S. history, with total assets of $209 billion and $110 billion, respectively.
The Federal Reserve Bank of San Francisco was the primary federal regulator for Silicon Valley Bank, while the FDIC was the primary federal regulator for Signature Bank. (READ MORE: Silicon Valley Bank Got Woke, Went Broke)
Shortly after the closings of Silicon Valley Bank and Signature Bank, the Federal Reserve and the FDIC made commitments to the relevant House and Senate committees to provide internal reviews of their regulatory supervision of the two banks leading up to their demise. On April 28, the two regulators issued separate reports with their assessments of the causes behind the failures of Silicon Valley Bank and Signature Bank. Each report provided valuable insights into each regulator’s view of the circumstances leading to the failures. However, as the regulators have responsibility for the safety and soundness of the banks under their supervision, their reports must be viewed with the awareness that they have an inherent self-interest in what they report.
Considering the content and conclusions of each report, both the Federal Reserve and the FDIC accepted at least some responsibility for the ultimate need to shut down each bank. However, each report also clearly puts most of the blame on the management of each bank.
The Federal Reserve’s report on Silicon Valley Bank, “Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank,” outlined four primary conclusions as follows:
- Silicon Valley Bank’s board of directors and management failed to manage their risks.
- Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.
- When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.
- The Board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.
The FDIC’s report, “FDIC’s Supervision of Signature Bank,” put almost all of the blame for Signature Bank’s failure on the bank’s management and very little on itself as the primary regulator. In its report, the FDIC provided the following comments in its executive summary:
Causes of the Failure
The primary cause of SBNY’s failure was illiquidity precipitated by contagion effects in the wake of the announced self-liquidation of Silvergate Bank, La Jolla, California (Silvergate), on March 8, 2023, and the failure of Silicon Valley Bank, Santa Clara, California (SVB), on March 10, 2023, after both experienced deposit runs. However, the root cause of SBNY’s failure was poor management. SBNY’s board of directors and management pursued rapid, unrestrained growth without developing and maintaining adequate risk management practices and controls appropriate for the size, complexity and risk profile of the institution. SBNY management did not prioritize good corporate governance practices, did not always heed FDIC examiner concerns, and was not always responsive or timely in addressing FDIC supervisory recommendations (SRs).
SBNY funded its rapid growth through an overreliance on uninsured deposits without implementing fundamental liquidity risk management practices and controls. Additionally, SBNY failed to understand the risk of its association with and reliance on crypto industry deposits or its vulnerability to contagion from crypto industry turmoil that occurred in late 2022 and into 2023. Although fallout from the liquidation of Silvergate and the failure of SVB was unprecedented and unfolded rapidly, SBNY’s poor governance and inadequate risk management practices put the bank in a position where it could not effectively manage its liquidity in a time of stress, making it unable to meet very large withdrawal requests.
The FDIC’s Supervision
The FDIC conducted a number of targeted reviews and ongoing monitoring, issued Supervisory Letters and annual roll-up reports of examination (ROEs), and made a number of SRs to address supervisory concerns. In retrospect, FDIC could have escalated supervisory actions sooner, consistent with the Division of Risk Management Supervision’s (RMS) forward-looking supervision concept. Additionally, examination work products could have been timelier and communication with SBNY’s board and management could have been more effective.
Since the release of the above reports from the Federal Reserve and the FDIC, other assessments from credible independent groups have also been issued. These groups include the Bank Policy Institute, the American Enterprise Institute, and the U.S. General Accountability Office. Their assessments place far more responsibility on the Federal Reserve and the FDIC for the demise of Silicon Valley Bank and Signature Bank. The critical assessments made by each group are summarized below.
The Bank Policy Institute’s May 8 report, “A Failure of (Self-) Examination: A Thorough Review of SVB’s Exam Reports Yields Conclusions Very Different From Those in the Fed’s Self Assessment,” is highly critical of the Federal Reserve’s report on Silicon Valley Bank. It states that the Federal Reserve ignored important issues in its report. Here is an excerpt of the Bank Policy Institute’s report with its key conclusions:
In contrast to the Federal Reserve’s own assertion that its supervisory mistakes were primarily a function of insufficiently stringent supervision and regulation under prior leadership, we conclude that these materials tell a very different story — namely, one of:
- A misguided supervisory culture heavily focused on compliance processes and governance and not actual risk to safety and soundness;
- Reliance on an MRA (Matters Requiring Attention) apparatus that lacked prioritization or appropriate focus;
- A failure to enforce important prudential rules that were clearly applicable; and
- Use of supervisory rating frameworks that were, by design, grounded in little more than examiner judgment.
Taken together, these four supervisory failures point the way to clearly needed supervisory reforms that the report barely discusses, and that Vice Chair Barr’s “key takeaways” from the report do not even acknowledge.
The American Enterprise Institute hosted a special panel discussion event on May 9 titled “Addressing the Underlying Causes of the Banking Crisis of 2023.” AEI economist and senior fellow Paul Kupiec delivered introductory commentary on the failures of Silicon Valley Bank and Signature Bank. Kupiec’s comments were very critical of the Federal Reserve and the FDIC for how they acted as regulatory supervisors of Silicon Valley Bank and Signature Bank.
Kupiec criticized the Federal Reserve’s decision under the Biden administration to impose climate change as a risk factor in the stress tests required of systemically important banks. This new focus on climate change risk resulted in a neglect of more obvious risks to monitor, such as interest rate risk and liquidity risk with an extraordinarily high number of uninsured deposit balances.
Kupiec was especially critical of the FDIC’s failure to react to the clear interest rate risk and liquidity risk at Signature Bank as its primary regulator, but also as the secondary regulator of Silicon Valley Bank behind the Federal Reserve Bank of San Francisco. The Silicon Valley Bank case was a situation for which the FDIC’s backup regulatory authority was intended, but there is no evidence that the FDIC attempted to push for corrective actions as it should have when the Federal Reserve Bank of San Francisco failed to take action.
Another important point made by Kupiec was the strange disregard for the use of the “Orderly Liquidation Authority” as provided for in the Dodd-Frank Act in the case of the failure of a systemically important bank. Both Silicon Valley Bank and Signature Bank were deemed to be systemically important by the federal regulators after being closed, yet the Orderly Liquidation Authority was apparently never even considered as an option. This leads to the question of why the Orderly Liquidation Authority, considered an integral part of the Dodd-Frank Act to prevent “too big to fail” bailouts, was disregarded when the time came to utilize it.
The U.S. Government Accountability Office provided its own independent assessment of the federal regulatory oversight of Silicon Valley Bank and Signature Bank in its report “March 2023 Bank Failures—Risky Business Strategies Raise Questions About Federal Oversight,” which was issued on April 28. Here is a summary of the key findings in the GAO report:
What went wrong with federal oversight and response?
We’ve looked at bank failures before, notably during the 2007-2009 financial crisis—which saw the largest bank failure in U.S. history (Washington Mutual). Both then and now, we’ve found that although regulators often identified risky practices early, the regulators’ corrective actions either didn’t work or came too late to prevent failure.
For example, we found that the Fed voiced concerns about how SVB was managing liquidity—cash and assets that can be easily turned into cash to meet outflows—in August 2021, while still providing the bank with an overall “satisfactory” rating. By late June 2022, the Fed downgraded SVB’s rating, and in August 2022, the Fed issued a supervisory letter informing the bank of its intent to initiate enforcement action focusing on correcting the management and liquidity issues that ultimately resulted in the bank’s failure. But efforts to take the enforcement action were not finalized to allow regulators to complete additional examinations of the bank.
Signature Bank also received a “satisfactory” rating between December 2018 and December 2021, while FDIC took numerous supervisory actions to address liquidity and management risks at the bank. FDIC had not completed its 2022 examination documents for Signature Bank at the time of its failure in March 2023. FDIC staff told us they were considering escalating supervisory actions in 2022. But these actions wouldn’t have taken effect until the second quarter of 2023. On March 11, the day before Signature Bank was closed, FDIC downgraded the bank’s rating and notified the bank of its intent to pursue an enforcement action.
As described above, the GAO report indicates that both the Fed and the FDIC were delinquent in taking enforcement actions that both regulators identified in 2022. Additionally, the FDIC had not completed its 2022 examination documents when Signature Bank was forced to close in March 2023.
Since the failure of Silicon Valley Bank and Signature Bank, another large bank, First Republic Bank, has been closed. With $229 billion in assets at its closing on May 1, First Republic Bank surpasses Silicon Valley Bank as the second-largest bank failure in U.S. history. This latest bank failure raises more concerns about the safety and soundness of the U.S. banking system.
The detailed assessments of the failures of Silicon Valley Bank and Signature Bank by reputable, independent groups such as the Bank Policy Institute, the American Enterprise Institute, and the Government Accountability Office, point to deficiencies in federal regulatory oversight separate from the poor management of the failed banks.
This warrants congressional consideration for a fresh assessment of the entire federal financial regulatory system, including a reevaluation of the mission, legal mandates, and administrative powers of the Federal Reserve and all other federal financial regulators, such as whether they are more of a detriment than a benefit to an efficient and stable financial system.
Steve Dewey is a retired federal financial regulator and managing director of the Bastiat Society of Washington, DC (www.aier.org/chapter/bastiat-society-of-dc). He is also founder of GeoFinancial Trends, LLC (www.geofinancialtrends.org) and writes on Substack (stevedewey.substack.com).
The Fed Has More Than a ‘Credibility’ Problem