Question for the Fed: What went wrong with bank oversight?
WASHINGTON — Jerome Powell is likely to face more than the typical questions today about the Federal Reserve’s latest interest rate decision. The central bank chair, who meets the media after the conclusion of the Fed’s latest meeting, will almost certainly be grilled about how and why his institution failed to stop problems at Silicon Valley Bank before it was too late.
The collapse of Silicon Valley Bank, the largest bank failure since 2008, has prompted intense scrutiny of the Fed’s oversight as many wonder why the bank’s vulnerabilities were not promptly fixed.
Many of the bank’s weaknesses seem, in hindsight, as if they should have been obvious to its regulators at the Fed. An outsize share of its deposits were over the $250,000 insurance limit, making depositors more likely to flee at the first sign of trouble and leaving the bank susceptible to runs.
The bank had also grown rapidly, and its depositors were heavily concentrated in the volatile technology industry. It held a lot of long-term bonds, which lose market value when the Fed raises interest rates, as it has over the past year. Still, the bank had done little to protect itself against an increase in borrowing costs.
Governors at the Fed Board in Washington allowed the bank to merge with a small bank in June 2021, after the first warning signs had surfaced and just months before Fed supervisors in San Francisco began to issue a volley of warnings about the company’s poor risk management. In 2022, the Fed repeatedly flagged problems to executives and barred the firm from growing through acquisition.
But the Fed did not react decisively enough to prevent the bank’s problems from leading to its demise, a failure that has sent destabilizing jitters through the rest of the American financial system.
Powell is likely to face several questions: What went wrong? Did examiners at the Federal Reserve Bank of San Francisco fail to flag risks aggressively enough? Did the Fed’s board fail to follow up on noted weaknesses? Or was the lapse indicative of a broader problem — that is, did existing rules and oversight make it difficult to quickly address important flaws?
The Fed has already announced a review of the bank’s
collapse, with the inquiry set to conclude by May 1.
“The events surrounding Silicon Valley Bank demand a thorough, transparent and swift review by the Federal Reserve,” Powell said in a statement last week.
Congress is also planning to dig into what went awry, with committees in both the Senate and House planning hearings next week on the recent bank collapses.
Investors and experts in financial regulation have been racing to figure out what went wrong even before the conclusion of those inquiries. Silicon Valley Bank had a business model that made it unusually vulnerable to a wave of rapid withdrawals. Even so, if its demise is evidence of a blind spot in how banks are overseen, then weaknesses could be more broadly spread throughout the banking system.
“The SVB failure has not only gotten people asking the question, ‘Gee, are other banks in similar enough circumstances that they could be in danger?’ ” said Daniel Tarullo, a former Fed governor who oversaw post-2008 regulation and who is now a professor at Harvard. “It’s also been a wake-up call to look at banks generally.”
Politicians have already begun assigning blame. Some Democrats have blasted regulatory rollbacks passed in 2018, and put into effect by the Fed in 2019, for weakening the system, and they have pointed a finger at Powell for failing to stop them.
At the same time, a few Republicans have tried to lay the blame firmly with the San Francisco Fed, arguing that the blowup shouldn’t necessarily lead to more onerous regulation.
“There’s a lot, obviously, that we don’t know yet,” said Lev Menand, who studies money and banking at Columbia Law School.
Different regulators oversee different banks, but the Federal Reserve has jurisdiction over large bank holding companies, state member banks, foreign banks operating in the United States and some regional banks.
Fed supervisors began to flag Silicon Valley Bank’s problems in earnest in the fall of 2021, after the bank had grown and faced a more extensive review. That process resulted in six citations, often called “matters requiring attention,” which are meant to spur executives to act. Additional deficiencies were identified in early 2023, shortly before the failure.
A critical question, said Menand, is “were the supervisors content to spot problems and wait for them to be remediated?”
But he noted that when it came to “bringing out the big guns” — backing up stern warnings with legal enforcement — supervisors must, in many ways, rely on the Fed Board in Washington. If bank leadership thought the Board was unlikely to react to their deficiencies, it might have made them less keen to fix the problems.
In the wake of Silicon Valley Bank’s collapse, how bank oversight is performed at the Fed could be in for some changes.
Michael Barr, whom President Joe Biden appointed as the Fed’s vice chair for supervision, was carrying out a “holistic review” of bank oversight even before the failures. Either that or the review of what happened at SVB is now more likely to end in tighter controls, particularly at large regional banks.
“The events surrounding Silicon Valley Bank demand a thorough, transparent and swift review by the Federal Reserve.”
Jerome Powell, Fed chairman