Watchdog report finds flaws in Fed’s supervision of SVB

Federal Reserve supervisors failed to adjust their approach to Silicon Valley Bank as the institution grew in size, and they failed to scrutinize the risk of rising interest rates on the bank’s investment portfolio, the Fed’s Office of Inspector General concluded in a new report on the central bank’s handling of SVB in the leadup to its failure.

The OIG cited several factors leading to SVB’s failure, including a large concentration in uninsured deposits, weak risk management and ineffective public communications. However, it noted that the San Francisco Fed and Fed itself had conducted several examinations of SVB and identified various weaknesses in its business model. Despite their findings, neither downgraded the bank’s CAMELS composite and certain component ratings until August 2022, the OIG said. The report also noted that Fed senior officials considered removing former SVB CEO Greg Becker from the San Francisco Fed board after discussions to downgrade the bank’s ratings, but decided against it “to avoid revealing confidential supervisory information and potentially signaling to the market the bank’s declining condition.”

The report identified three issues with the Fed’s supervision. First, its supervisory approach did not evolve as SVB grew and increased in complexity. Second, the Fed failed to transition SVB from a regional bank supervisory portfolio to a large bank portfolio. Third, examiners didn’t closely scrutinize the risk of rising interest rates on SVB’s investment securities portfolio.

The report included seven recommendations for how the Fed could improve its supervisory processes. Among them, the OIG suggested the central bank assess its current regional bank supervision framework and determine whether adjustments need to be made based on a supervised institution’s size and complexity. Also, the Fed should take measures to tailor supervisory plans for regional banks to better promote “a timely focus on salient risks” and develop a means to more quickly transition institutions from regional bank supervision to large bank supervision, the OIG said.