An investigation by the Federal Reserve hammers the “shift in the stance of supervisory policy” that lawmakers initiated in 2018.
WASHINGTON ― After the failure of Silicon Valley Bank in March, Senate Banking Committee member Sen. John Kennedy (R-La.) asked on the Senate floor, “Where were the regulators?”
On Friday, the regulators responded ― with a reminder that Kennedy and other lawmakers told them to go easy on institutions like Silicon Valley Bank.
In a lengthy and highly anticipated report, the Federal Reserve accepted some blame for the bank’s failure, but also noted that thanks to a law Congress passed in 2018, “a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.”
In a preface to the report, the Fed’s top bank supervisor, Michael Barr, said the central bank would consider restoring some of the regulations. President Joe Biden picked Barr last year to replace Randy Quarles, a Donald Trump appointee who was a cheerleader for the 2018 rollback alongside Fed chair Jerome Powell.
Silicon Valley Bank failed after its depositors rushed to withdraw money amid concerns about the bank’s stability ― concerns triggered by the bank’s own belated effort to shore up its risky balance sheet. The bank couldn’t honor the withdrawals and failed, prompting regulators to step in and make all the depositors whole in an effort to prevent runs on other mid-sized institutions.
In its report Friday, the Fed primarily faulted the bank’s management, which it said “took steps to maintain short-term profits rather than effectively manage the underlying balance sheet risks.” The report also faulted Fed supervisors for being slow to act on known warning signs, such as the bank’s exposure to unrealized losses on its assets due to rising interest rates.
But the document emphasized weakened regulations and a hands-off culture among regulators as major culprits in Silicon Valley Bank’s flop.
“This report really is a repudiation of the way Randy Quarles ran supervision and regulation at the Fed during his tenure,” said Todd Phillips, a fellow at the progressive Roosevelt Institute and a former attorney with the Federal Deposit Insurance Corporation, which is another federal bank regulator.
Quarles claimed in a statement on Friday that the report provided “no evidence” for its conclusions.
In 2018, Congress rolled back rules put in place following the Wall Street crash a decade earlier, easing burdens on mid-sized banks so they would lend more freely. The rollback was thoroughly bipartisan, with strong support from Senate Democrats led by Sen. Mark Warner (D-Va.). Experts warned at the time that the decision would increase the risk of bank failures, but most lawmakers said the risks were worth it. Powell and Quarles backed the changes.
The new law exempted financial institutions with less than $250 billion in assets from “enhanced prudential standards,” such as certain stress tests simulating what would happen if the bank faced a run on deposits. (The previous threshold had been $50 billion.)
The law also said regulators could maintain tighter scrutiny on smaller banks if they thought they needed to, an approach the Fed described as “tailoring” regulations on a case-by-case basis. That’s why Kennedy and other members of the Banking Committee have blamed the Fed for dropping the ball.
Barr’s investigation suggests tailoring didn’t work.
“Although the stated intention of these policy changes was to improve the effectiveness of supervision, the changes also led to slower action by supervisory staff and a reluctance to escalate issues,” the report reads.
If it weren’t for the new law and subsequent regulations, according to the report, Silicon Valley Bank “would have been subject to enhanced liquidity risk management requirements, full standardized liquidity requirements… enhanced capital requirements, company-run stress testing, supervisory stress testing at an earlier date, and tailored resolution planning requirements.”
The report also highlighted a culture among supervisory staff, fostered by Quarles, to take it easy on banks.
“In the interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory actions,” the report reads. “There was no formal or specific policy that required this, but staff felt a shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed.”
Sen. Elizabeth Warren (D-Mass.), the foremost critic in Congress of the 2018 law, said on Twitter that the investigation “identifies how the 2018 law that weakened our bank rules and the Fed’s ‘tailoring’ in response were major contributors to SVB’s failure.”
“The Federal Reserve’s report is an unflinching assessment of Silicon Valley Bank’s implosion, demanding the Fed immediately adopt stricter bank oversight and Congress swiftly strengthen bank regulations to prevent another crisis,” Warren said.
Senate Banking Committee chairman Sherrod Brown (D-Ohio), for his part, said bank executives “must testify” before his committee.
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