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Compliance & Risk

Fed plans broad revamp of bank oversight in wake of SVB collapse

· 5 minute read

· 5 minute read

After the failure or forced sale of several smaller, regional banks, the Federal Reserve is looking at how it could better monitor these banks and protect consumers

The Federal Reserve issued a detailed and scathing assessment on late last month of its failure to identify problems and push for fixes at Silicon Valley Bank (SVB) before the U.S. lender’s collapse, promising tougher supervision and stricter rules for banks.

In what Fed Vice Chair for Supervision Michael Barr called an “unflinching” review of the U.S. central bank’s supervision of SVB, the Fed said its oversight of the Santa Clara, California-based bank was inadequate and that regulatory standards were too low. “SVB’s failure demonstrates that there are weaknesses in regulation and supervision that must be addressed,” Barr said in a letter accompanying a 114-page report, which also was supplemented by confidential materials that are typically not made public.

While it was the regional bank’s own mismanagement of basic risks that was at the root of SVB’s downfall, the Fed said, supervisors of SVB did not fully appreciate the problems, delaying their responses to gather more evidence even as weaknesses mounted, and failed to appropriately address certain deficiencies when they were identified. At the time of its failure, SVB had 31 unaddressed citations on its safety and soundness, triple the number its peers in the banking sector had, the report said.

One particularly effective change the Fed could make on supervision would be to put risk mitigation methods in place quickly in response to serious capital, liquidity, or management issues, a senior Fed official said, adding that such increased capital and liquidity requirements also would have bolstered SVB’s resilience.

Barr said that as a consequence of the failure, the central bank will reexamine how it supervises and regulates liquidity risk, beginning with the risks of uninsured deposits.

Regulators shut SVB on March 10 after customers withdrew $42 billion on the previous day and queued requests for another $100 billion the following morning. The historic run triggered massive deposit outflows at other regional banks that were seen to have similar weaknesses, including a large proportion of uninsured deposits and big holdings of long-term securities that had lost market value as the Fed raised short-term interest rates.

New York-based Signature Bank failed two days later (the Federal Deposit Insurance Corporation release its review of that collapse the same day as the Federal Reserve’s assessment of SVB), and the Fed and other U.S. government authorities moved to head off an emerging crisis of confidence in the banking sector with an emergency funding program for otherwise healthy banks under sudden pressure and guarantees on all deposits at the two banks.

Supervision headcount fell

Before the twin bank failures in March, banking regulators had focused most of their supervisory firepower on the very biggest U.S. banks that were seen as critical to financial stability. The realization that smaller banks are capable not only of causing disruptions in the broader financial system but of doing it at such speed has forced a banking regulators to rethink their position.

“Contagion from the failure of SVB threatened the ability of a broader range of banks to provide financial services and access to credit for individuals, families, and businesses,” Barr said. “Weaknesses in supervision and regulation must be fixed.”

In its report, the Fed said that between 2018 to 2021 its supervisory practices shifted, and there were increased expectations for supervisors to accumulate more evidence before considering taking action. The staff interviewed as part of the Fed’s review reported pressure during this period to reduce burdens on firms and demonstrate due process, the report said.

Barr signaled in his accompanying letter that this situation would change. “We need to develop a culture that empowers supervisors to act in the face of uncertainty,” he said.

Between 2016 and 2022, as assets in the banking sector grew 37%, the Fed’s supervision headcount declined by 3%, according to the report. As SVB itself grew, the Fed did not step up its supervisory game quickly enough, the report showed, allowing weaknesses to fester as executives left them unaddressed, even after staff finally did downgrade the bank’s confidential rating to “not-well-managed.”

The Fed is looking at linking executive compensation to fixing problems at banks designated as having deficient management so as to focus executives’ attention on those problems, a senior Fed official said in a briefing.

One thing the report did not do was place any blame at the feet of San Francisco Fed President Mary Daly, with a senior Fed official telling reporters that regional Fed bank presidents do not engage in nor have responsibility for day-to-day supervision of banks in their regions.

While the fallout from the failures of SVB and Signature themselves may have subsided, the ripple effects continue. The forced sale on May 1 of San Francisco-based First Republic Bank after its deposit outflows following the SVB and Signature collapses exceeded $100 billion shows that smaller, regional banks may not be out of the proverbial woods yet.

This blog post was written by Chris Prentice & Hannah Lang, both of Reuters News; with additional reporting by Ann Saphir.

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