Fed Slams Its Own Oversight of Silicon Valley Bank in Post-Mortem

WASHINGTON — The Federal Reserve released a sweeping and highly critical report on Friday examining why its own supervision and regulation of Silicon Valley Bank failed to address risks that ultimately led to its collapse in mid-March, a crash that was the largest bank failure since the 2008 financial crisis.

The review — conducted by Michael S. Barr, the Fed’s vice chair for supervision — blamed Fed overseers for failing to “take forceful enough action.” Mr. Barr also stated that the bank’s failure demonstrated “weaknesses in regulation and supervision that must be addressed.”

He added that “regulatory standards for SVB were too low, the supervision of SVB did not work with sufficient force and urgency, and contagion from the firm’s failure posed systemic consequences not contemplated by the Federal Reserve’s tailoring framework.”

The review spanned hundreds of pages and painted a picture of a bank that grew rapidly in size and risk with limited intervention from supervisors who missed obvious problems and moved slowly to address the ones they did recognize. And it outlined a range of changes to bank oversight and regulation — from stronger deterrents against risk-taking to possible curbs on incentive compensation for executives at poorly managed banks — that the Fed will consider in response to the disaster.

The post-mortem is a rare instance of overt self-criticism from the Fed, and it comes as the aftershocks of Silicon Valley Bank’s collapse continue to shake the American financial system. First Republic Bank, a regional lender that required a cash infusion from other large banks as nervous customers pulled their deposits and fled, remains imperiled.

Mr. Barr’s review was announced on March 13, just after Silicon Valley Bank’s failure and the government’s sweeping announcement on March 12 that it would protect the bank’s large depositors, among other measures to shore up the banking system. That same weekend, the federal government also shuttered a second institution, Signature Bank. The Federal Deposit Insurance Corporation, which was the primary supervisor for Signature, will release its own report later on Friday.

Yet attention has focused heavily on Silicon Valley Bank, both because it failed earlier and because significant weaknesses at the bank appear to have started and grown progressively worse in plain sight in the years leading up to its demise.

The bank had a large share of deposits above the government’s $250,000 insurance limit. Uninsured depositors are more likely to pull their money at the first sign of trouble to prevent losing their savings, making that a major vulnerability for Silicon Valley Bank. The bank’s leaders also made a big bet on interest rates staying low, which turned out to be a bad one as the Fed raised rates rapidly in a bid to control inflation. That left the bank facing big losses and helped to bring it to its knees — leading to a rapid failure that spooked depositors at other banks across the country.

“Contagion from the failure of S.V.B. threatened the ability of a broader range of banks to provide financial services and access to credit for individuals, families, and businesses,” Mr. Barr said.

Mr. Barr was a major architect of intensified bank regulations in the wake of the 2008 crisis. He was nominated to his job by President Biden and took office in July 2022 — toward the end of Silicon Valley Bank’s life. Given that, much of his review reflected on supervision under his predecessor, Randal K. Quarles, the Trump-appointed vice chair for supervision in that office from 2017 to October 2021.

The report itself was produced by regulatory and financial experts within the Fed system who were not involved in the bank’s oversight. They had full access to supervisory documents and internal communications, and had the ability to interview relevant Fed staff, according to the release.

The findings suggested that supervisors failed to fully understand how much risk Silicon Valley Bank was taking. Fed supervisors flagged issues at the bank, but it did not catch them all or follow up on them intensively enough. The bank’s management was rated satisfactory from 2017 through 2021, despite repeated observations of risk taking, the report found.

Silicon Valley Bank had 31 open supervisory findings when it failed in March 2023, about three times the number at its peers, based on the Fed’s report.

The review said it was hard to identify precisely what caused the foot-dragging, but pointed to a culture that focused on consensus and to supervisory changes that happened during the Trump administration and under Mr. Quarles.

“Staff felt a shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed,” the report said.

Even as Silicon Valley Bank expanded and amassed bigger risks, resources dedicated to its oversight actually declined, the report said: Scheduled hours dedicated to the firm’s supervision fell more than 40 percent from 2017 to 2020. Resources dedicated to bank oversight across the Fed system were also limited. From 2016 to 2022, head count in Fed system’s supervisory staff fell even as banking sector assets grew, the report said.

Mr. Barr raised a number of immediate considerations that should be focused on — and changes that should be made — in the wake of Silicon Valley Bank’s collapse.

“The combination of social media, a highly networked and concentrated depositor base, and technology may have fundamentally changed the speed of bank runs,” Mr. Barr wrote, noting that social media enabled a rapid run on the bank.

The regulation and supervision tweaks Mr. Barr suggested included a renewed look at how the Fed carries out oversight for banks of different sizes, including a review of “tailoring” rules enacted during the Trump administration that made oversight less onerous for many small and midsize banks.

Mr. Barr’s report said that the Fed would re-evaluate a range of rules for banks with $100 billion or more in assets — for which the rules were relaxed. Those banks faced looser oversight because they were not deemed “systemic,” but the collapse of Silicon Valley Bank has underlined that even smaller banks can have big implications.

The episode demonstrated that a bank’s distress could have systemwide consequences through contagion — where concerns about one firm spread to other firms — “even if the firm is not extremely large, highly connected to other financial counterparties, or involved in critical financial services,” Mr. Barr said in his review.

Banks with bad capital planning, risk management and governance could also face “additional capital or liquidity beyond regulatory requirements,” the report said, suggesting that “limits on capital distributions or incentive compensation could be appropriate and effective in some cases.”

And Mr. Barr’s overview suggested that a broader set of banks should take into account gains or losses on their security holdings when it comes to their capital — money that can help a bank get through a time of crisis. That would be a major departure from how the rules are currently set, and Mr. Barr underlined that changing such standards would require a rule-making process that would take time.

“I agree with and support” the “recommendations to address our rules and supervisory practices, and I am confident they will lead to a stronger and more resilient banking system,” Jerome H. Powell, the Fed chair, said in a release accompanying Mr. Barr’s report.

The report stopped short of overt finger-pointing. It did not name or implicate specific individuals who had failed to properly account for risks in the case of Silicon Valley Bank, instead focusing on weaknesses in the overall system of regulation and supervision.

And some outside the Fed have suggested that the failures of oversight at the bank need to be reviewed by an independent body, because Mr. Barr has to continue working with his colleagues at the central bank and might be hesitant to criticize them.

“We need someone with some independence to dig in,” Jeff Hauser, director of the Revolving Door Project, said ahead of the release.

Mr. Barr suggested that he would be open to such a follow-up.

“We welcome external reviews of S.V.B.’s failure, as well as congressional oversight, and we intend to take these into account as we make changes to our framework of bank supervision and regulation,” Mr. Barr said in his statement.