WASHINGTON — The Silicon Valley bank’s risky practices have been on the Federal Reserve’s radar for more than a year — awareness that proved insufficient to halt the bank’s demise.
The Fed has repeatedly warned the bank of problems, according to a person familiar with the matter.
In 2021, a Fed review of the growing bank found serious weaknesses in dealing with key risks. Officials at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six subpoenas. These alerts, known as “matters requiring attention” and “matters requiring immediate attention,” indicated that the firm had done a poor job of ensuring it had enough readily accessible cash in case of trouble.
But the bank hasn’t fixed its vulnerabilities. By July 2022, Silicon Valley Bank was under a full supervisory review – it was under scrutiny – and was eventually found to be deficient on governance and controls. It was subjected to a series of restrictions that prevented it from growing through acquisitions. Last fall, San Francisco Fed officials met with senior executives at the company to discuss their ability to access enough cash during a crisis and a potential risk of losses as interest rates rise.
The Fed realized that the company was using poor models to determine how its business would fare if the central bank raised interest rates: Its leaders assumed that higher interest income would significantly improve their financial condition as interest rates rose, but that was out step with reality.
In early 2023, Silicon Valley Bank was undergoing what the Fed calls a “horizontal review,” an assessment designed to measure the strength of its risk management. Other shortcomings were identified during this review – but by this time the bank’s days were numbered. In early March, it faced an onslaught and failed within days.
Big questions have been raised about why regulators failed to identify problems and take action early enough to prevent Silicon Valley Bank’s March 10 sinking. Many of the problems that contributed to its collapse seem obvious in retrospect: By value, about 97 percent of its deposits were uninsured by the federal government, making customers more likely to run away at the first sign of trouble. Many of the bank’s depositors were from the technology sector, which has been going through a rough patch lately as higher interest rates weighed on the business.
And the Silicon Valley Bank also held a lot of long-term debt, the market value of which had fallen as the Fed hiked interest rates to fight inflation. As a result, it suffered huge losses selling these securities to raise cash to meet a wave of customer withdrawals.
The Fed, led by Michael S. Barr, the Fed’s vice chairman for oversight, has launched an investigation into what went wrong with the bank’s oversight. The results of the investigation are expected to be released by May 1st. Lawmakers are also investigating what went wrong. The House Financial Services Committee has scheduled a March 29 hearing on the recent bank failures.
The picture is emerging of a bank whose executives have failed to plan for a realistic future and neglected looming financial and operational problems, even when approached by Fed regulators. For example, according to a person familiar with the matter, company executives have been briefed on cybersecurity issues by both internal staff and the Fed — but the concerns have been ignored.
The Federal Deposit Insurance Corporation, which has taken control of the company, did not comment on its behalf.
Still, the magnitude of the known problems at the bank raises the question of whether the Fed’s bank auditors or the Fed’s Board of Governors in Washington could have done more to force the institution to address weaknesses. Whatever intervention was staged was insufficient to save the bank, but why remains to be seen.
“It’s a regulatory failure,” said Peter Conti-Brown, a financial regulation expert and Fed historian at the University of Pennsylvania. “What we don’t know is whether it was a failure by supervisors.”
Mr. Barr’s review of the Silicon Valley bank collapse will focus on a few key questions, including why the problems identified by the Fed didn’t stop after the central bank issued its first set of matters requiring attention. The existence of these initial alerts was previously reported by Bloomberg. It also examines whether regulators believed they had the authority to escalate the issue and whether they took the issues to the Federal Reserve Board level.
The Fed’s report is expected to reveal information about Silicon Valley Bank that is normally kept secret as part of the confidential banking regulatory process. It will also include any recommendations for regulatory and regulatory fixes.
The bank’s demise and the chain reaction it triggered should also lead to a broader push for stricter banking supervision. Mr. Barr already conducted a “holistic review” of Fed regulation, and the fact that a bank that was big but not huge could cause so many problems in the financial system is likely to affect the results.
Typically, banks with less than $250 billion in assets are barred from the most onerous parts of banking supervision — and that’s even more so since a “tailor-made” law passed during the Trump administration in 2018 and implemented by the Fed in 2019. These changes left smaller banks with less strict rules.
Silicon Valley Bank was still below that threshold, and its collapse underscored that even banks not large enough to be considered globally systemically important can cause widespread problems in the American banking system.
As a result, Fed officials may consider tightening rules for these large but not giant banks. Among them: Officials could ask whether banks with assets of $100 billion to $250 billion need to hold more capital if the market price of their bond holdings falls — an “unrealized loss.” Such an optimization would most likely require a phase-in-phase as it would be a significant change.
But as the Fed works to complete its review of what went wrong at Silicon Valley Bank and propose next steps, it faces a major policy backlash for failing to fix the problems.
Some of the concerns center on the fact that the bank’s chief executive officer, Greg Becker, sat on the board of directors of the Federal Reserve Bank of San Francisco until March 10. While board members play no part in banking supervision, the optics of the situation are poor.
“One of the most absurd aspects of the Silicon Valley bank’s failure is that its CEO was a director of the same body responsible for regulation,” Senator Bernie Sanders, a Vermont independent, wrote on Twitter Saturday, announcing that he it will “Introduce a bill to end this conflict of interest by banning CEOs of big banks from sitting on Fed boards.”
Other concerns revolve around whether Fed Chairman Jerome H. Powell allowed too much deregulation during the Trump administration. Randal K. Quarles, who served as Fed vice chairman from 2017 to 2021, implemented a regulatory rollback bill in 2018 in a sweeping manner that some observers at the time warned would weaken the banking system.
Mr. Powell normally reports to the Fed’s vice chairman on regulatory matters, and he did not vote against these changes. Lael Brainard, then Fed governor and now a top White House economist, voted against some of the changes — and in dissenting statements, flagged them as potentially dangerous.
“The crisis has clearly shown that the distress of even non-complex large banking organizations generally first manifests itself as liquidity stress and quickly transmits contagion through the financial system,” she warned.
Senator Elizabeth Warren, a Massachusetts Democrat, has asked for an independent review of what happened at Silicon Valley Bank and urged that Mr. Powell not be involved in the effort. He “has direct responsibility for – and has a long list of – failures in banking regulation,” she wrote in a letter Sunday.
Maureen Farrell contributed coverage.