Fed’s self-scrutiny starts off on the wrong foot

Federal Reserve building is pictured in Washington
The Federal Reserve building is pictured in Washington, U.S., on March 19, 2019. REUTERS/Leah Millis/File Photo

NEW YORK, March 22 (Reuters Breakingviews) - The collapse of Silicon Valley Bank came as a shock to many of its customers and investors. It ought not to have surprised the Federal Reserve, though. Central bank staff had flagged in January that the tech-adjacent lender was at risk of possible cash shortages. The Fed is now investigating how its supervision of SVB could have been better. But it’s a stretch to think the institution, with its tangled, partly centralized structure, can conduct a warts-and-all review.

Compared with its global counterparts, the Fed is a many-headed beast. There’s the Board of Governors in Washington, led by Chair Jay Powell and his fellow governors. One of them, supervisory tsar Michael Barr, is leading the SVB review that will report by May 1. Then there are the regional Reserve Banks – in SVB’s case the San Francisco Fed – that act as main contacts and supervisors in the field. The local teams do most of the legwork on specific firms. But deciding whether a bank passes muster is a wider team effort.

It’s an intricate process, to put it mildly. Banks with assets worth $100 billion or more face elaborate reviews, which involve a body called the Large and Foreign Banking Organization Management Group. This includes both representatives from the Board of Governors and the regional Reserve Banks. Local teams submit their findings and propose separate ratings annually for capital, liquidity and governance, which are vetted by this cross-Fed group. Each bank is also scrutinized by a dedicated analyst at the Board of Governors.

SVB, which had nearly $200 billion of assets at the end of 2022, was subject to this process. It was an unusual member of its cohort because of its rapid growth and skew towards technology firms. It was also unusual in its risks. SVB had racked up large holdings of long-dated government bonds that tumbled in value as interest rates rose. As customers drew out cash to meet their own needs, SVB sold these assets, triggering losses. When it tried to raise capital, depositors, most of whom had balances beyond the level the government guarantees in a bank failure, panicked. That sparked a wider and ongoing crisis of confidence in the banking system.

It was a lack of liquidity that ultimately felled SVB. And while the timing couldn’t have been foreseen, several weaknesses had been, according to a person familiar with the situation. SVB was rated in 2022 as having satisfactory liquidity management, but with half a dozen outstanding “matters requiring attention” and “matters requiring immediate attention,” according to a person familiar with the situation. Those aren’t incompatible with a bank being rated satisfactory, as long as they can be fixed without material changes, and don’t persist for a long time.

By the beginning of 2023, a presentation San Francisco Fed staff made available to the LFBO Management Group flagged SVB’s unrealized securities losses, weaknesses in its management of interest rate risk, and its vulnerability to dwindling cash at tech firms and their backers. Local watchdogs knew SVB had issues, but representatives from the Board of Governors did too. The Fed declined to comment.

True, it’s not obvious the central bank could have done much about this in the time it had. Supervisors had previously noted, and reflected to the Fed group, which vets bank ratings, that SVB had made progress in tackling some of its weaknesses. But the dispersed flow of information within the Fed about the bank’s troubles poses a problem in attributing accountability for supervision and ratings. More awkwardly, the factors that helped to fell SVB go right to the top of the Fed: Powell had backed a lighter regulatory touch, including less onerous liquidity hurdles, for banks with assets below $250 billion. That’s another reason the agency he heads is an imperfect arbiter for determining what went wrong.

The Fed’s communications with banks it supervises are generally not visible to the outside world. The central bank doesn’t even acknowledge the existence of the LFBO Management Group on its public-facing website. That’s odd, because such cross-cutting groups help reinforce the idea that the Fed is trying to ensure consistency. They exist in part as a line of defense against local examiners developing blind spots over the lenders they supervise.

Rather than just investigate itself, the Fed board could learn from the companies it regulates. Wells Fargo (WFC.N), for example, brought in a law firm to run an independent review after discovering employees had created millions of fake customer accounts to hit sales targets. The bank later lost its chief executive and several board members, and is still wrestling with its cultural issues. Nonetheless, the outside probe showed that directors were serious about diagnosing the problem.

For the Fed, it would be easier to get a more objective view. It already has an independent conduct cop, the Office of the Inspector General, which swooped in to inspect stock trades by officials, including Powell, during the Covid-19 pandemic. Bringing in the OIG to unpick the SVB saga would be a first step to determining not just who knew what, but whether its supervision processes need an overhaul. It’s unrealistic to think the Fed will never make mistakes in overseeing banks. It can at least respond to them transparently.

Follow @johnsfoley on Twitter

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)


The U.S. Federal Reserve said on March 13 that it would conduct a review into its supervision of failed lender Silicon Valley Bank. Vice Chairman for Supervision Michael Barr is leading the review, and results will be publicly released by May 1.

SVB was part of the Fed’s “Large and Foreign Banking Organization” supervisory regime, which covers firms with more than $100 billion of assets. Eight of the biggest firms, including JPMorgan and Bank of America, are overseen through a separate “Large Institution” program.

Editing by Peter Thal Larsen and Amanda Gomez

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