Fed Takes Share Of Blame For SVB Collapse In Closely Watched Review

May 3, 2023
Described as a test of the Dodd-Frank Act, the US Federal Reserve’s independent review of the collapse of Silicon Valley Bank (SVB) has found both managerial and supervisory failures were responsible.

Described as a test of the Dodd-Frank Act, the US Federal Reserve’s independent review of the collapse of Silicon Valley Bank (SVB) has found both managerial and supervisory failures were responsible.

On Friday (April 28), the Fed released its report on its internal review looking at several factors that together contributed to the collapse of SVB.

This included looking into its own role as the primary federal supervisor of the bank.

The report concludes that the bank failure was partly due to “a textbook case of mismanagement” by the bank, as well as the Fed’s failure to quickly adapt its supervisory activity to the rapid growth of SVB.

Consistent with earlier arguments by Democratic lawmakers, the report also blames Trump-era deregulation which lowered supervisory and regulatory requirements regarding capital and liquidity for banks with under $250bn in assets.

A test of an important Dodd-Frank-created role

The investigation was conducted by Fed vice chair for supervision Michael Barr and came after policymakers on both sides of the aisle attacked the Fed, and particularly its chair Jerome Powell, over their failure to act to prevent the collapse.

On March 13, Powell announced that he asked Barr to lead an internal review of the causes of the collapse and gave him six weeks to conclude the investigation.

The idea of an internal review, rather than an independent outside audit, was taken with serious reservations by experts and politicians alike.

Top Democratic Senator Elizabeth Warren said Powell allowed big banks to “boost their profits by loading up on risk [which] directly contributed to these bank failures”.

“For the Fed’s inquiry to have credibility, Powell must publicly and immediately recuse himself from this internal review.”

Non-profit advocacy group Better Markets described this process as “an acid test for the power, authority, and independence” of the vice chair for supervision at the Fed.

That position was “a major reform created by the Dodd Frank Act to address, in part, the many deep and consequential failures of the Fed in the years leading up to the 2008 financial crash”, according to Dennis Kelleher, CEO of Better Markets.

Kelleher said the position of the Fed vice chair for supervision was designed to be both powerful and independent “but the position has never been tested”.

“Until now.”

If the report fails to directly detail actions and specifically identify who at the Fed board contributed to the collapse, then “the report will be a clear indication that the [vice chair for supervision] is subordinate to the chair just like everyone else at the Fed”.

“That will gut a key reform of the Dodd-Frank Act,” Kelleher said.

Shift in Fed’s supervisory culture contributed to the bank's fall

Following the release of the report, however, Kelleher applauded Barr and his team who he claimed did not omit the role of regulators in the bank failures.

“The Fed vice chair for supervision and his team deserve credit for completing a significant review in an inappropriately short period of time,” Kelleher said.

The report does not specifically identify those responsible for the collapse, but instead points to a number of factors.

It highlights a shift in supervisory culture and expectations within the Fed under the direction of the former vice chair for supervision, Randal Quarles, albeit without explicitly naming him.

“No formal or specific policy that required this, but staff felt a shift in culture and expectations from internal discussions and observed behaviour that changed how supervision was executed,” the report says.

“As a result, staff approached supervisory messages, particularly supervisory findings and enforcement actions, with a need to accumulate more evidence than in the past, which contributed to delays and in some cases led staff not to take action,” the report goes on.

It notes that there were 31 open supervisory warnings against SVB when it failed in March, including in core areas such as governance and risk management, but supervisors did not fully appreciate the extent of the vulnerabilities and failed to take steps in time.

“After all, the report in effect says that if you take the cops off the city streets in a high crime neighbourhood, then there’s going to be lots more lawbreaking," Kelleher said.

“It is no mystery how to address these failures: put the regulatory cops back on the finance beat and make sure they have the tools, powers, and authorities necessary to rein in inappropriate risk taking and recklessness."

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