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Before Silicon Valley Bank collapsed, the Fed spotted big problems

WASHINGTON — Silicon Valley Bank’s risky practices were on the Federal Reserve’s radar for more than a year, an awareness that proved insufficient to stem the bank’s demise.

The Fed repeatedly warned the bank that it was in trouble, according to a person familiar with the matter.

In 2021, a Fed review of the growth bank found serious weaknesses in the way it managed key risks. Supervisors at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six subpoenas. Those warnings, known as “matters needing attention” and “matters needing immediate attention,” indicated the company was doing a poor job of ensuring it would have enough cash on hand in case of trouble.

But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was undergoing a full supervisory review, receiving a closer look, and was ultimately rated poor on governance and controls. It was placed under a set of restrictions that prevented it from growing through acquisitions. Last fall, staff members at the San Francisco Federal Reserve met with top company leaders to discuss their ability to access enough cash in a crisis and potential exposure to loss as rates rise. of interest.

It became clear to the Fed that the company was using bad models to determine how its business would do as the central bank raised rates: its leaders assumed that higher interest income would help its financial position substantially as rates rose. but that was ruled out. in step with reality.

In early 2023, Silicon Valley Bank was in what the Fed calls a “horizontal review”, an assessment intended to measure the robustness of risk management. That check identified additional deficiencies, but at that point, the bank’s days were numbered. In early March, he faced a run and failed in a matter of days.

Important questions have been raised about why regulators failed to spot the problems and take action early enough to prevent the fall of Silicon Valley Bank on March 10. Many of the issues that contributed to its collapse seem obvious in retrospect: measuring by value, over 97 percent of their deposits were not federally insured, making it more likely that customers would flee at the first sign of trouble. Many of the bank’s depositors were in the technology sector, which has recently fallen on hard times as higher interest rates hit business.

And Silicon Valley Bank also had a lot of long-term debt that had fallen in market value because the Fed raised interest rates to fight inflation. As a result, it faced huge losses when it had to sell those securities to raise cash to deal with a wave of customer withdrawals.

The Fed has launched an investigation into what went wrong with the bank’s supervision, led by Michael S. Barr, the Fed’s vice president for supervision. The results of the inquiry are it is expected to be released publicly for May 1. Lawmakers are also looking into what went wrong. The House Financial Services Committee has scheduled a hearing on the recent bank collapses by March 29.

The picture that is emerging is of a bank whose leaders failed to plan for a realistic future and neglected looming financial and operational problems, even when raised by Fed supervisors. For example, according to a person familiar with the matter , both internal employees and the Federal Reserve informed company executives about cybersecurity issues, but they ignored the concerns.

The Federal Deposit Insurance Corporation, which took control of the firm, did not comment on its behalf.

Still, the extent of known problems at the bank raises questions about whether Fed bank examiners or the Fed’s Board of Governors in Washington could have done more to force the institution to address the weaknesses. Whatever intervention was made was too small to save the bank, but why remains to be seen.

“It’s a supervisory failure,” said Peter Conti-Brown, a financial regulation expert and Fed historian at the University of Pennsylvania. “What we don’t know is if it was a failure of the supervisors.”

Mr. Barr’s review of the Silicon Valley Bank collapse will focus on some key questions, including why the problems identified by the Fed did not stop after the central bank issued its first set of matters requiring attention. The existence of those early warnings was previously reported by Bloomberg. It will also look at whether supervisors believed they had the authority to escalate the issue and whether they escalated the issues to the Federal Reserve Board level.

The Fed report is expected to reveal information about Silicon Valley Bank that is generally kept private as part of the process of confidential banking supervision. It will also include any recommendations for regulatory and supervisory arrangements.

The bank’s fall and the chain reaction it triggered is likely to result in a broader push for tighter banking supervision. Barr was already conducting a “holistic review” of Fed regulation, and the fact that a bank that was big but not huge could create so many problems in the financial system likely informed the results.

Banks with less than $250 billion in assets are typically barred from the most onerous parts of banking supervision, and that’s been even more true since an “accommodation” law was passed in 2018 during the Trump administration and it was implemented by the Federal Reserve. in 2019. Those changes left smaller banks with less stringent rules.

Silicon Valley Bank was still below that threshold, and its collapse underscored that even banks that are not big enough to be considered globally systemic can cause big problems for the American banking system.

As a result, Fed officials might consider tougher rules for those big, but not huge, banks. Among them: Officials might wonder whether banks with $100 billion to $250 billion in assets should hold more capital when the market price of their bond holdings falls, an “unrealized loss.” Such a change would most likely require a phase-in period, as it would be a substantial change.

But as the Fed works to complete its review of what went wrong at Silicon Valley Bank and propose next steps, it faces an intense political backlash for failing to stop the troubles.

Some of the concerns center on the fact that the bank’s CEO, Greg Becker, served on the board of directors of the Federal Reserve Bank of San Francisco. until March 10. While board members do not play a role in bank supervision, the optics of the situation are bad.

“One of the most absurd aspects of the bankruptcy of the Silicon Valley bank is that its CEO was a director of the very body charged with regulating it,” Senator Bernie Sanders, an independent from Vermont, wrote on Twitter on Saturday, announcing that he would “introduce a bill to end this conflict of interest by banning the CEOs of big banks from serving on Fed boards.”

Other concerns center on whether Jerome H. Powell, the Fed chairman, allowed too much deregulation during the Trump administration. Randal K. Quarles, who was Fed vice chair of supervision from 2017 to 2021, carried out an expansionary 2018 regulatory rollback act that some observers at the time warned would weaken the banking system.

Powell typically defers to the Fed’s vice president of supervision on regulatory affairs, and he did not vote against those changes. Lael Brainard, then a Fed governor and now a top White House economic adviser, voted against some of the adjustments, marking them as potentially dangerous in dissenting remarks.

“The crisis clearly demonstrated that the distress of even large, non-complex banking organizations usually manifests first in liquidity stress and is quickly transmitted through the financial system.” she warned.

Senator Elizabeth Warren, Democrat of Massachusetts, has requested an independent review of what happened at Silicon Valley Bank and has urged that Mr. Powell not get involved in that effort. He “bears direct responsibility for, and has a long history of, failures related to” banking regulation, he wrote in a letter Sunday.

Maureen Farrell contributed reporting.

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