Before Silicon Valley Bank collapse, Federal Reserve spotted big problems

A 2021 review found serious weaknesses

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 stop the bank’s demise.

The Fed repeatedly warned the bank that it had problems, according to a person familiar with the matter.

In 2021, a Fed review of the growing bank found serious weaknesses in how it was handling key risks. Supervisors at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six citations. Those warnings, known as “matters requiring attention” and “matters requiring immediate attention,” flagged that the firm was doing a bad job of ensuring that it would have enough easy-totap cash on hand in the event of trouble.

But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was in a full supervisory review — getting a more careful look — and was ultimately rated deficient for governance and controls. It was placed under a set of restrictions that prevented it from growing through acquisitions. Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose.

It became clear to the Fed that the firm was using bad models to determine how its business would fare as the central bank raised rates: Its leaders were assuming that higher interest revenue would substantially help their financial situation as rates went up, but that was out of step with reality.

By early 2023, Silicon Valley Bank was in what the Fed calls a “horizontal review,” an assessment meant to gauge the strength of risk management. That checkup identified additional deficiencies — but at that point, the bank’s days were numbered. In early March, it faced a run and failed within a matter of days.

Major questions have been raised about why regulators failed to spot problems and take action early enough to prevent Silicon Valley Bank’s March 10 downfall. Many of the issues that contributed to its collapse seem obvious in hindsight: Measuring by value, about 97% of its deposits were uninsured by the federal government, which made customers more likely to run at the first sign of trouble. Many of the bank’s depositors were in the technology sector, which has recently hit tough times as higher interest rates have weighed on business.

And Silicon Valley Bank also held a lot of long-term debt that had declined in market value as 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 meet a wave of withdrawals from customers.

The Fed has initiated an investigation into what went wrong with the bank’s oversight, headed by Michael S. Barr, the Fed’s vice chair for supervision. The inquiry’s results are expected to be publicly released by May 1. Lawmakers are also digging into what went awry. The House Financial Services Committee has scheduled a hearing on recent bank collapses for March 29.

Sen. Elizabeth Warren, DMass., on Sunday called on Congress to lift the federal insurance levels for bank deposits above $250,000, a week after the Biden administration announced it would protect all depositors at Silicon Valley Bank, regardless of how much money they had in the failing institution.

Currently, the Federal Deposit Insurance Corporation, or FDIC, insures only up to $250,000 in deposits at banks. On CBS’s “Face the Nation,” Ms. Warren, a member of the Senate Banking Committee and a commercial and bankruptcy law expert, suggested raising that figure to anywhere from $2 million to $10 million.

“Small businesses need to be able to count on getting their money to make payroll, to pay the utility bills,” she said. “Nonprofits need to be able to do that. These are not folks who can investigate the safety and soundness of their individual banks. That’s the job the regulators are supposed to do.”

The picture that is emerging is one of a bank whose leaders failed to plan for a realistic future and neglected looming financial and operational problems, even as they were raised by Fed supervisors. For instance, according to a person familiar with the matter, executives at the firm were told of cybersecurity problems both by internal employees and by the Fed — but ignored the concerns.

The extent of known issues 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 weaknesses. Whatever intervention was staged was too little to save the bank, but why remains to be seen.

“It’s a failure of supervision,” said Peter ContiBrown, an expert in financial regulation and a Fed historian at the University of Pennsylvania. “The thing we don’t know is if it was a failure of 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 did not stop after the central bank issued its first set of matters requiring attention. The existence of those initial warnings was reported earlier by Bloomberg. It will also look at whether supervisors believed they had authority to escalate the issue, and if they raised the problems to the level of the Federal Reserve Board.

The Fed’s report is expected to disclose information about Silicon Valley Bank that is usually kept private as part of the confidential bank oversight process. It will also include any recommendations for regulatory and supervisory fixes.

The bank’s downfall and the chain reaction it set off is also likely to result in a broader push for stricter bank oversight. Mr. Barr was already performing a “holistic review” of Fed regulation, and the fact that a bank that was large but not enormous could create so many problems in the financial system is likely to inform the results.

Typically, banks with fewer than $250 billion in assets are excluded from the most onerous parts of bank oversight — and that has been even more true since a “tailoring” law that passed in 2018 during the Trump administration and was put in place by the Fed in 2019. Those changes left smaller banks with less stringent rules.

Silicon Valley Bank was still below that threshold, and its collapse underlined that even banks that are not large enough to be deemed globally systemic can cause sweeping problems in the American banking system.

“It’s a failure of supervision. The thing we don’t know is if it was a failure of supervisors.”

— Peter Conti-Brown, financial regulation expert and a Fed historian, University of Pennsylvania