US regulators are facing questions over whether they missed signs of mounting problems at Silicon Valley Bank, the tech lender whose implosion last week fomented fears of contagion across the banking sector.
As the government fought to contain the fallout from the failure of SVB — which on Friday was taken over by the Federal Deposit Insurance Corporation after customers withdrew deposits en masse — attention turned to the regulators who oversee the financial system. Many questioned how the country’s 16th-biggest bank was allowed to become so vulnerable. Its collapse was quickly followed by the closure of cryptocurrency sector lender Signature Bank on Sunday.
Former regulators and financial policy experts say it is too soon to know exactly how big a blunder authorities actually made, especially given the enormity of the liquidity shock and the fact that SVB remained well-capitalised amid its failure.
Still “this is a black eye for regulators. Something happened that wasn’t supposed to happen”, said Ian Katz, financial policy analyst at research firm Capital Alpha Partners. “You’re already seeing finger-pointing going on and that is going to continue.”
Shortly after the Federal Reserve announced an emergency lending vehicle on Sunday evening to buttress the banking sector, Gary Gensler, chair of the US Securities and Exchange Commission, warned that the market regulator would “investigate and bring enforcement actions if we find violations of the federal securities laws”.
The Fed was the primary overseer of SVB. California’s state regulator was also a key supervisor given SVB’s state-chartered bank status.
The lender’s collapse has highlighted the “perennial problem” with the US’s “dual banking system”, in which state-chartered banks are subject to both federal and state oversight, said Saule Omarova, professor of law at Cornell University. “Some things might have been lost” in that co-ordination.
While a bank run ultimately brought down the venture capital and start-up community’s go-to lender, experts say some of SVB’s weak spots were glaringly obvious.
Deposits at the bank grew at a blistering pace. Assets totalled $212bn by the end of 2022, compared with just $115bn in 2020. This, said Aaron Klein, former deputy assistant secretary for economic policy at the Treasury department, should have drawn regulators’ scrutiny. Notably, nearly 96 per cent of SVB’s deposits were not covered by the FDIC insurance policy, which guarantees deposits up to $250,000.
For Kathryn Judge, a professor at Columbia University with expertise in financial regulation, another “classic red flag” was the fact that SVB was so reliant on the Federal Home Loan Bank of San Francisco for funding, with $15bn of outstanding loans by the end of 2022 after no loans the year before.
“We consistently see that before banks get in trouble, they struggle to access market-based sources of financing and increase their reliance on the Federal Home Loan Bank System,” said Judge. “That does raise questions over how closely the Fed was following developments at SVB.”
Financial losses had also begun to pile up on account of the bank’s exposure to long-term fixed-rate bonds. That made SVB highly susceptible to a surge in interest rates. The Federal Reserve embarked on one of its most aggressive campaigns to raise interest rates in March last year.
Michael Ohlrogge, associate professor at the New York University School of Law, said SVB’s collapse highlighted “weaknesses in the assumptions that are baked into” bank regulation. SVB’s exposure to interest rate risk contributed to its failure. Yet banks have to maintain little capital to absorb potential losses on mortgage-backed securities issued by US government agencies, he said.
Experts argue SVB’s red flags could have been spotted in advance, if not largely avoided, had lawmakers and regulators not eased rules for smaller lenders in recent years.
The 2018 rollback of the Dodd-Frank act, the biggest deregulatory effort since the 2007-08 financial crisis, exempted some banks with assets of up to $250bn from the Fed’s toughest supervisory measures, including stress tests as well as capital and liquidity requirements. In testimony to the Senate in 2015, Greg Becker, SVB’s chief executive, asked lawmakers to increase the asset threshold below which “significant regulatory burdens” would not apply.
The bipartisan legislation was a cornerstone of Donald Trump’s presidency, but critics warned it would weaken a regulatory apparatus that had been built to avoid future crises.
The Dodd-Frank rollback “definitely reduced the buffer of shareholder funds that banks need to have in order to absorb losses”, said Ohlrogge.
“Had it not been for that, then Silicon Valley Bank would have had a larger buffer . . . it would have been less likely for there to be a run in the first place and in the event of a run it would have lessened any kind of loss that those uninsured depositors are going to be facing.”
Omarova, who testified before the Senate against relaxing regulation for smaller banks, said the 2018 bill “should not have been passed”.
“Congress should really bear a lot of the blame for deregulating precisely at the time when they should have allowed the regulators to implement Dodd-Frank much more vigorously,” she added.
The Fed in 2019 followed suit and approved lighter regulations for all but the biggest banks. A former lawyer in the Fed’s banking regulation and policy group said the decision was predicated on the view that large regional banks were not “systemic” and “don’t need close regulatory and supervisory scrutiny”. “[Last] week has proven definitively that that was wrong,” the lawyer said.
The Federal Reserve declined to comment. The California Department of Financial Protection and Innovation did not immediately respond to a request for comment.
More broadly, SVB’s collapse has highlighted the key ingredient to a stable banking sector: trust.
“Banking is in part a trust game,” said Judge. “It’s trusting the individual institutions, but it’s also trusting the system of supervision and the infrastructure that protects the stability of the system.”
Additional reporting by Antoine Gara in New York
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