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Home Newsbytes

Post-mortem reports on bank failures highlight supervisory missteps, call for changes

April 28, 2023
Reading Time: 3 mins read
Post-mortem reports on bank failures highlight supervisory missteps, call for changes

Federal Reserve supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity, and the bank experienced “a textbook case of mismanagement,” Federal Reserve Vice Chairman for Supervision Michael Barr said today in his long-awaited report on the institution’s failure. He also pointed to previously adopted regulatory tailoring standards that he said impeded effective supervision, though the report itself acknowledged that in the case of SVB, “higher supervisory and regulatory requirements may not have prevented the firm’s failure.”

As the Fed looks to make changes to its current framework for bank supervision and regulation, one focus should be to improve “the speed, force and agility of supervision,” Barr said. He noted that SVB grew rapidly but that under current rules, there was a “slow transition” period for when it would have received heightened supervision as a larger bank. “Within our supervisory structure, we should introduce more continuity between the portfolios, so that as a bank grows in size and changes its supervisory portfolio, the bank will be ready to comply with heightened regulatory and supervisory standards more quickly, rather than providing a long transition to comply with those heightened standards,” he said.

Barr also suggested higher capital or liquidity requirements for banks that “can serve as an important safeguard until risk controls improve, and they can focus management’s attention on the most critical issues.” As for regulation, the Fed plans to revisit its tailoring framework, particularly for banks with more than $100 billion in assets, Barr said, which will include revisiting the current approach to stress testing.

The Fed will also reevaluate how it supervises and regulates liquidity risk, starting with uninsured deposits, and how to improve its capital requirements. Finally, the Fed should consider setting tougher minimum standards for executive incentive compensation programs and ensure banks comply with the existing compensation standards, Barr said.

FDIC, GAO cite poor management, regulator shortcomings

The FDIC also issued a report citing management failures and excessive exposure to the volatile crypto sector as reasons for the collapse of Signature Bank, which failed shortly after SVB. The FDIC report identified matters for further study, including the need for more examiner guidance on supervising banks that are overly reliant on uninsured deposits.

While the Fed and FDIC reports placed much of the blame on mismanagement by the bank and the current regulatory framework, a report by the Government Accountability Office—also issued today—took a more pointed stance on the supervisory failures that led to the collapse of both SVB and Signature Bank in March, noting that supervisors failed to escalate their concerns about the banks’ management of risk related to deposits in the months preceding the failures.

The agency noted that from 2019 to 2021, total assets at SVB and Signature grew by 198% and 134% respectively, which far exceeded the 33% median deposit growth of a group of 19 banks of similar size. The two banks relied on uninsured deposits to support that growth, with SVB affected by rising interest rates and Signature having exposure to crypto markets.

The Federal Reserve Bank of San Francisco downgraded SVB in June 2022 and began enforcement action in August, which was not finalized before the bank failed, GAO said.  The FDIC took multiple actions took address supervisory concerns related to Signature’s liquidity and management but did not substantially downgrade the bank until the day before it failed. The GAO said it had previously warned banking regulators that their supervisory approach had potential cracks of the kind that both banks fell through.

“GAO has longstanding concerns with escalation of supervisory concerns, having recommended in 2011 that regulators consider adding noncapital triggers to their framework for prompt corrective action (to help give more advanced warning of deteriorating conditions),” the agency said. “The regulators considered noncapital triggers, but have not added them to the framework, thus missing a potential opportunity to take early action to address deteriorating conditions at banks.”

Nichols: Failures not representative of banking sector health

In response to the reports, ABA President and CEO Rob Nichols noted ABA “take[s] any bank failure seriously, and we will review the findings and proposed policy changes in these reports carefully, including where the conclusions may differ. At the same time, we urge policymakers to refrain from pushing forward new and unrelated regulatory requirements that could limit the availability of credit and the ability of banks of all sizes to meet the needs of their customers and communities when these reports suggest that existing rules were sufficient.”

“Finally, we want to highlight what these reports also make clear: the failures of these individual institutions reflect the unique circumstances at these banks and do not reflect the overall health and vitality of the U.S. banking sector,” Nichols added.

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