After SVB Collapse, Fed and Lawmakers Eye Bank Rules

After SVB Collapse, Fed and Lawmakers Eye Bank Rules

The Federal Reserve is being criticized for the collapse of the Silicon Valley bank, and lawmakers and financial regulation experts are questioning why the regulator failed to identify and stop seemingly obvious risks. Those concerns are prompting a review of how the central bank oversees financial institutions – one that could lead to tougher rules for a number of banks.

In particular, the episode could lead to significant regulatory and oversight changes for institutions – like Silicon Valley Bank – which are large but not large enough to be considered globally systemically important and are therefore subject to stricter supervision and regulation. Smaller banks face less stringent regulations than the largest, which must undergo regular and comprehensive financial health tests and more closely monitor how much readily available cash they have as a buffer in times of crisis.

Regulators and lawmakers are focused both on whether a deregulation push in 2018 during the Trump administration went too far and whether the rules in place are sufficient in a changing world.

While it’s too early to predict the outcome, the shockwaves that the Silicon Valley bank’s demise sent through the financial system and the government’s sweeping response to avoid unleashing a nationwide bank run are adding pressure for a stronger one At sight.

“There are many signs of regulatory failure,” said Kathryn Judge, a financial regulation expert at Columbia Law School, who also noted that it’s too early to draw any firm conclusions. “We need stricter regulations for large regional banks that more accurately reflect the risks these banks can pose to the financial system,” she said.

The call for tighter banking regulations is reminiscent of the aftermath of 2008, when risky bets by big financial firms helped plunge the United States into a deep recession and exposed blind spots in banking supervision. The crisis eventually led to the 2010 Dodd-Frank Act, a reform that ushered in a series of stricter requirements, including far-reaching “stress tests” that test a bank’s ability to weather difficult economic situations.

But some of those rules have been relaxed — or “tailored” — under Republicans. Randal K. Quarles, who served as Fed vice chairman for oversight from 2017 to 2021, enacted bipartisan legislation that relaxed some regulations for small and medium-sized banks and pushed to make day-to-day Fed oversight simpler and more predictable.

Critics have said such changes may have helped pave the way for the problems now plaguing the banking system.

“There’s clearly a problem with oversight,” said Daniel Tarullo, a former Fed governor who helped design and enact many post-2008 banking regulations and is now a professor at Harvard University. “Loss of regulation is something that has worried us for a number of years.”

The Federal Reserve Bank of San Francisco has been responsible for overseeing the Silicon Valley bank, and pundits across the ideological spectrum are wondering why the bank’s mounting risks haven’t been halted. The company grew rapidly, absorbing a large number of depositors from a vulnerable industry: technology. A large proportion of the bank’s deposits were uninsured, which meant customers were more likely to rush to exit in difficult moments, and the bank had not been careful to hedge against the financial risks of rising interest rates.

Making the situation worse, Greg Becker, the chief executive officer of Silicon Valley Bank, was on the board of directors of the Federal Reserve Bank of San Francisco until Friday. The Fed has stated that reserve bank directors are not involved in banking supervision matters.

Finally, questions about banking supervision return to the Fed’s board of directors in Washington – who has played a more prominent role in directing day-to-day banking supervision since the 2008 crisis.

The board has indicated it will take the concerns seriously and has appointed its new vice chairman of the board, Michael Barr, to investigate what happened at Silicon Valley Bank, the Fed announced this week.

“Events surrounding the Silicon Valley bank warrant a thorough, transparent and expeditious review by the Federal Reserve,” Fed Chair Jerome H. Powell said in a statement.

It’s unclear how significant any of the 2018 rollbacks would have been in the Silicon Valley Bank case. Under the original post-crisis rules, the bank, which had less than $250 billion in assets, most likely should have undergone a full Fed stress test sooner, probably later this year. But the rules for stress testing are so complex that even that is difficult to determine with certainty.

“No one can say that none of this would have happened if it wasn’t for the 2018 rollbacks,” Ms Judge said. But “these rules suggest that banks of this scale do not pose a threat to financial stability.”

But the government’s dramatic response to the Silicon Valley bank collapse, which included bailing out uninsured depositors and launching a Fed bailout program, underscored that even the country’s 16th largest bank could require sweeping public action.

Given this, the Fed will once again pay attention to how these banks are treated in terms of both capital (their financial cushion against losses) and liquidity (their ability to quickly convert assets into cash to repay depositors).

For example, there could be pressure to lower the threshold at which the stricter rules start to apply. As a result of the 2018 law, some of the stricter rules now come into effect when banks have $250 billion in assets.

Another focus will be the content of stress tests. While banks used to be run through a “negative” scenario that included creative and unexpected shocks to the system – including the occasional rise in interest rates like the one that afflicted the Silicon Valley bank – this scenario ended with the deregulation push.

A rate shock will be included in this year’s stress test scenarios, but the larger question of what risks are reflected in those tests and whether they are sufficient will likely get another look. Many economists had assumed that inflation and interest rates would remain low for a long time – but the pandemic has turned that on its head. It now seems clear that banking regulators made the same flawed assumption.

Many people would have been wrong about the staying power of low interest rates, and “that includes regulators and supervisors who should be thinking, ‘What are the possibilities and what are the scenarios?'” said Jonathan Parker, Sloan’s chief financial officer MIT School of Management.

And there’s also a bigger challenge that the current episode has revealed: Several financial experts said the run on the Silicon Valley bank was so severe that more capital would not have saved the institution. Part of his problem was his huge share of uninsured deposits. These depositors ran fast amid signs of weakness.

This could draw more attention from Congress and regulators as to whether deposit insurance needs to be expanded further or whether the number of uninsured deposits held by banks needs to be limited. And it could take a closer look at how uninsured deposits are treated in banking supervision – those deposits have long been considered unlikely to run fast.

In an interview, Mr. Quarles dismissed the idea that the changes made under his oversight helped hasten the collapse of Silicon Valley Bank. However, he acknowledged that they raised new regulatory issues – including how to deal with a world where technology enables very fast bank runs.

“Certainly none of this is due to anything we changed,” said Mr. Quarles. “You had this perfect flow of imperfect information that really increased the speed and intensity of this run.”

In the days following the collapse, some Republicans focused on the failings of regulators at the Fed, while many Democrats focused on the aftershocks of deregulation and possible misconduct by bank executives.

“All the regulators had to do was read the reports that the Silicon Valley bank filed and they would have seen the problem,” Sen. John Kennedy, a Louisiana Republican and member of the Senate Banking Committee, said.

In contrast, two Senate Democrats — Elizabeth Warren of Massachusetts and Richard Blumenthal of Connecticut — sent a letter to the Justice Department and the Securities and Exchange Commission on Wednesday, urging authorities to investigate whether senior executives were involved in the collapse of the Silicon Valley bank involved failed to meet their regulatory responsibilities or violated laws.

Ms. Warren also introduced legislation this week, co-sponsored by about 50 Democrats in the House and Senate, that would re-impose some of the Dodd-Frank requirements that were reversed in 2018, including regular stress tests.

Senator Sherrod Brown, an Ohio Democrat and chair of the Banking Committee, told reporters he intends to hold a hearing to investigate what happened “as soon as we can.”

Mr. Barr, who joined the Fed last summer, was already reviewing a number of Fed regulations to see if they were suitably strict — a reality that had led to intense lobbying as financial institutions resisted stricter oversight.

But the episode could make those counter-efforts more challenging.

Late Monday, the Bank Policy Institute, which represents 40 major banks and financial services firms, emailed journalists a list of its positions, including claims that the failures of Silicon Valley Bank and Signature Bank were “primarily caused by a failure of management and oversight” rather than regulation” and that the panic surrounding the collapses proved how resilient big banks were to stress, as they were largely unaffected.

The trade group also emailed those talking points to Congressional Democrats, but other trade groups, including the American Bankers Association, have remained silent, according to a person familiar with the matter.

“We share President Biden’s confidence in the nation’s banking system,” said a spokesman for the American Bankers Association. “Every American should know that their accounts are safe and their deposits are protected. Our industry will work with administration, regulators and Congress to continue to build that trust.”

The fallout could also thwart attempts by big banks to roll back regulations they say are inefficient. The biggest banks wanted the Fed to stop forcing them to hold cash equivalents of what they believe to be safe-haven securities like US Treasuries. But Silicon Valley Bank’s failure was caused in part by its decision to keep much of depositors’ money in longer-dated US Treasuries, which fell in value as interest rates rose.

“This definitely underscores why it’s important that there be some capital requirement for government-backed securities,” said Sheila Bair, a former chair of the Federal Deposit Insurance Corporation.

Catie Edmondson contributed to the coverage.

Jeanna Smialek and Emily Flitter