WASHINGTON — Jerome H. Powell will likely face more than the usual questions about the Federal Reserve’s latest interest rate decision on Wednesday. The central bank president will almost certainly wonder how and why his institution failed to prevent problems at Silicon Valley Bank before it was too late.
The collapse of the Silicon Valley Bank, the biggest bank failure since 2008, prompted increased scrutiny by the Fed as many wondered why the bank’s vulnerabilities were not fixed in time. time.
Many of the bank’s weaknesses, in hindsight, seem obvious to regulators at the Fed. A large portion of its deposits exceed the $250,000 insurance limit, making depositors more likely to flee at the first sign of trouble and leaving the bank vulnerable to withdrawals.
The bank has also grown rapidly and its depositors are heavily focused on the volatile technology industry. It holds a lot of long-term bonds, which will lose market value when the Fed raises interest rates, as it has done over the past year. However, the bank has done little to protect itself against the increase in borrowing costs.
Governor at the Fed Council in Washington allow the bank to merge with a small bank in June 2021, after the first warning signs appeared and just a few months before the Fed supervisors in San Francisco release start a series of warnings about the company’s poor risk management. In 2022, the Fed repeatedly reported problems to executives and banned the company from growing through acquisitions.
But the Fed did not react decisively enough to prevent the bank’s problems from leading to its demise, a failure that has destabilized the rest of the American financial system.
Mr. Powell may face a number of questions: What happened? Did the checkers at the Federal Reserve Bank of San Francisco not mark the risk strongly enough? Did the Fed’s board fail to monitor the noted weakness? Or is that lapse a sign of a broader problem — that is, do existing rules and oversight make it difficult to quickly address critical flaws?
The Fed has was announced a review of the bank’s collapse, with the investigation set to end May 1.
“The events surrounding Silicon Valley Bank require thorough, transparent, and expeditious review by the Federal Reserve,” Mr. Powell said in a statement last week.
Congress is also planning to dig into what happened, with committees in both the Senate and House scheduled to hear next week about the recent bank crash.
Investors and financial regulation experts raced to find out what happened even before those investigations were over. Silicon Valley Bank has a business model that makes it unusually vulnerable to a wave of rapid withdrawals. Even so, if its demise is evidence of a blind spot in the way banks are supervised, the weaknesses could be more widespread throughout the banking system.
Daniel Tarullo, a former Fed governor who oversaw regulation after 2008 and is now one, said: “The failure of the SVB didn’t just make people question, ‘Oh, are the other banks in the loop? similar situation that they might be in danger?’” a professor at Harvard. “It’s also a wake-up call to look at banks in general.”
Politicians have has begun to blame. Some Democrats have criticized the regulatory restrictions passed in 2018 and taken into effect by the Fed in 2019 as weakening the system, and they have criticized Mr. Powell for not stopping it. get them.
At the same time, some Republicans have staunchly tried to blame the San Francisco Fed, arguing that the explosion did not necessarily lead to tougher regulations.
“Obviously there’s a lot we don’t know,” said Lev Menand, who studies money and banking at Columbia Law School.
Understanding what happened at Silicon Valley Bank requires understanding how banking supervision works — and especially how it has evolved since the late 2010s.
Different US regulators oversee banks differently, but the Federal Reserve authoritative on large joint stock banks, state-owned member banks, foreign banks operating in the United States, and some regional banks.
The Fed’s board of governors, made up of seven politically appointed officials, is responsible for shaping regulations and setting the basic rules governing banking supervision. But day-to-day supervision of the banks is carried out by supervisors at the Fed’s 12 regional banks.
Before the 2008 financial crisis, those semi-private sector affiliates had a lot of decision-making power when it came to banking supervision. But after that crisis, the regulator was run more centrally outside of Washington. The Dodd-Frank Act created a new role for one of the Fed’s governors – vice president of banking supervision – giving central bank checkers around the country a formal and clear boss. than.
The idea is to make banking supervision tighter and more secure. Dodd-Frank also beefed up capital and liquidity requirements, forcing many banks to control risk and keep easy-to-mine funds on hand, while holding regular stress tests to check their health. for the biggest banks.
But by the time the Fed’s first official supervisory vice chair was confirmed in 2017, the regulatory pendulum had swung back in the opposite direction. Randal K. Quarles, a pick for President Donald J. Trump, took office, pledging to ease banking rules that, in particular, many Republicans consider too burdensome.
“After the first wave of reforms, and with the benefit of experience and reflection, some improvements will certainly be relevant,” Mr. Quarles said. at his confirmation hearing.
Some of those improvements come directly from Congress. In 2018, Republicans and many Democrats passed a law That gentle rule on small banks. But the law did more than just free up community banks. It also raised floor where more stringent banking rules began, amounting to $250 billion in assets.
Mr. Quarles push the relief further. For example, banks with assets between $250 billion and $700 billion are allowed to refuse to calculate unrealized losses — the change in the market value of old bonds — from their capital calculations. While that didn’t matter in the case of SVB, given that the bank was below the $250 billion threshold, several Fed officials at the time warned that that and other changes could making the banking system more vulnerable.
Lael Brainard, who was then Fed governor and now directs the National Economic Council, warned in a dissenting opinion that “the predicament of the major banking institutions is not even complicated.” complexity often manifests first as liquidity stress and spreads rapidly through the financial system.”
Other Fed officials, including Mr. Powell, voted for the changes.
It is not clear what any adjustment means for the case of Silicon Valley Bank. The bank would most likely have faced a stress test earlier if those changes had not been made. However, those annual reviews rarely examine the interest rate risk that could sabotage the company.
Some have cited another change by Mr. Quarles as potentially more consequential: He is trying to make day-to-day banking supervision more predictable, leaving less work for individuals to control. check.
While Mr. Quarles says he has failed to change oversight much, those both inside and outside the Fed system argue that his mere shift of focus could make sense.
That ethos may be why supervisors feel they can’t do more, said Peter Conti-Brown, a financial regulation expert and Fed historian at the University of Pennsylvania. here.
Mr. Quarles, who stepped down from his post in October 2021, rejected the argument that he made changes to oversight that caused growing weaknesses at Silicon Valley Bank. .
“I gave up my position as vice president of oversight a year and a half ago,” he said.
Fed supervisors began to seriously warn of Silicon Valley Bank’s problems in the fall of 2021, after the bank had grown and faced a more sweeping review. That process resulted in six citations, often referred to as “things to look out for,” that spur executives to action. Add deficiencies have been identified in early 2023, just before the failure.
A key question, Mr. Menand said, is “will supervisors be content to spot problems and wait for them to be fixed?”
But he noted that when it comes to “giving the big shots” — supporting stern warnings by law enforcement — supervisors are, in many ways, dependent on the Fed Board in Washington. If the bank’s management thinks it’s hard for the Board of Directors to respond to their shortcomings, that may make them less interested in fixing the problems.
Banks often have issues that are alerted by their custodians, and those concerns are not always immediately addressed. In a rating system that examines capital planning, liquidity risk management, governance and controls, consistently only about half of large banking institutions scored “satisfactory” on all three.
But after the collapse of the Silicon Valley Bank, the way banking supervision is carried out at the Fed may see some changes. Michael Barr, who was appointed by President Biden as vice chairman of Fed oversight, had been doing a “comprehensive review” of banking supervision even before the failure. Either that or looking at what happened at SVB now is more likely to lead to tighter controls, especially at the big banks in the region.
Mr. Conti-Brown said: “There are many transferable currencies. “I think it could be a general error and it’s part of the design of the system.”
