WASHINGTON — Silicon Valley Bank was growing steadily in 2018 and 2019 — and supervisors at its primary overseer, the Federal Reserve Bank of San Francisco, were preparing it for a stricter oversight group, one in which specialists from around the Fed system would vet its risks and point out weak spots.
But a decision from officials in Washington halted that move.
The Federal Reserve Board — which sets the Fed’s standards for banking regulation — was in the process of putting into effect a bipartisan 2018 law that aimed to make regulation less onerous for small and midsize banks. As the board did that, Randal K. Quarles, the Trump-appointed vice chair for supervision, and his colleagues also chose to recalibrate how banks were supervised in line with the new requirements.
As a result, Silicon Valley Bank’s move to the more rigorous oversight group would be delayed. The bank would previously have advanced to the Large and Foreign Bank Organization group after its assets had averaged more than $50 billion for a year; now, that shift would not come until it consistently averaged more than $100 billion in assets.
The change proved fateful. Silicon Valley Bank did not fully move to the stronger oversight group until late 2021. Its assets had nearly doubled over the course of that year, to about $200 billion, by the time it came under more intense supervision.
By that point, many of the issues that would cause its demise had already begun festering. Those included a customer base heavily dependent on the success of the technology industry, an unusually large share of deposits above the $250,000 limit that the government insures in the event of a bank collapse and an executive team that paid little attention to risk management.
Those weak spots appear to have gone unresolved when Silicon Valley Bank was being overseen the way that small and regional banks are: by a small team of supervisors who were in some cases generalists.
When the bank finally entered more sophisticated supervision for big banks in late 2021, putting it under the purview of a bigger team of specialist bank overseers with input from around the Fed system, it was immediately issued six citations. Those flagged various problems, including how it was managing its ability to raise cash quickly in times of trouble. By the next summer, its management was rated deficient, and by early 2023, intense scrutiny of the bank had stretched to the Fed’s highest reaches.
Big questions remain about why supervisors didn’t do more to ensure that shortcomings were addressed once they became alarmed enough to begin issuing citations. The Fed is conducting an internal investigation of what happened, with results expected on May 1.
But the picture that is emerging is one in which a slow reaction in 2022 was not the sole problem: Silicon Valley Bank’s difficulties also appear to have come to the fore too late to fix them easily, in part because of the Trump-era rollbacks. By deciding to move banks into large-bank oversight much later, Mr. Quarles and his colleagues had created a system that treated even sizable and rapidly ballooning banks with a light touch when it came to how aggressively they were monitored.
That has caught the attention of officials from the Fed and the White House as they sort through the fallout left by Silicon Valley Bank’s collapse on March 10 and ask what lessons should be learned.
“The way the Federal Reserve’s regulation set up the structure for approach to supervision treated firms in the $50 to $100 billion range with lower levels of requirements,” Michael Barr, the Fed’s vice chair for supervision, told lawmakers this week. By the time Silicon Valley Bank’s problems were fully recognized, he said, “in a sense, it was already very late in the process.”
About five people were supervising Silicon Valley Bank in the years before its move up to big-bank oversight, according to a person familiar with the matter. The bank was subject to quarterly reviews, and its overseers could choose to put it through horizontal reviews — thorough check-ins that test for a particular weakness by comparing a bank with firms of similar size. But those would not have been a standard part of its oversight, based on the way the Fed runs supervision for small and regional banks.
As the bank grew and moved up to large-bank oversight, the size of the supervisory team dedicated to it swelled. By the time it failed, about 20 people were working on Silicon Valley Bank’s supervision, Mr. Barr said this week. It had been put through horizontal reviews, which had flagged serious risks.
But such warnings often take time to translate into action. Although the bank’s overseers started pointing out big issues in late 2021, banks typically get leeway to fix problems before they are penalized.
“One of the defining features of supervision is that it is an iterative process,” said Kathryn Judge, a financial regulation expert at Columbia Law School.
The Fed’s response to the problems at Silicon Valley Bank seemed to be halting even after it recognized risks. Surprisingly, the firm was given a satisfactory liquidity rating in early 2022, after regulators had begun flagging problems, Mr. Barr acknowledged this week. Several people familiar with how supervising operates found that unusual.
“We’re trying to understand how that is consistent with the other material,” Mr. Barr said this week. “The question is, why wasn’t that escalated and why wasn’t further action taken?”
Yet the high liquidity rating could also tie back to the bank’s delayed move to the large bank supervision group. Bank supervisors sometimes treat a bank more gently during its first year of tougher oversight, one person said, as it adjusts to more onerous regulator attention.
There was also turmoil in the San Francisco Fed’s supervisory ranks around the time that Silicon Valley Bank’s risks were growing. Mary Daly, the president of the reserve bank, had called a meeting in 2019 with a number of the bank supervisory group’s leaders to insist that they work on improving employee satisfaction scores, according to people with knowledge of the event. The meeting was previously reported by Bloomberg.
Of all the San Francisco Fed employees, bank supervisors had the lowest satisfaction ratings, with employees reporting that they might face retribution if they spoke out or had different opinions, according to one person.
Several supervision officials departed in the following years, retiring or leaving for other reasons. As a result, relatively new managers were at the wheel as Silicon Valley Bank’s risks grew and became clearer.
It’s hard to assess whether supervisors in San Francisco — and staff members at the Fed board, who would have been involved in rating Silicon Valley Bank — were unusually slow to respond to the bank’s problems given the secrecy surrounding bank oversight, Ms. Judge said.
“We don’t have a baseline,” she said.
Even as the Fed tries to understand why problems were not addressed more promptly, the fact that Silicon Valley Bank remained under less rigorous oversight that may not have tested for its specific weaknesses until relatively late in the game is increasingly in focus.
“The Federal Reserve system of supervision and regulation is based on a tailored approach,” Mr. Barr said this week. “That framework, which really focuses on asset size, is not sensitive to the kinds of problems we saw here with respect to rapid growth and a concentrated business model.”
Plus, the 2018 law and the Fed’s implementation of it probably affected Silicon Valley Bank’s oversight in other ways. The Fed would probably have begun administering full stress tests on the bank earlier without the changes, and the bank might have had to shore up its ability to raise money in a pinch to comply with the “liquidity coverage ratio,” some research has suggested.
The White House called on Thursday for regulators to consider reinstating stronger rules for banks with assets of $100 billion to $250 billion. And the Fed is both re-examining the size cutoffs for stricter bank oversight and working on ways to test for “novel” risks that may not tie back cleanly to size, Mr. Barr said this week.
But Mr. Quarles, who carried out the tailoring of the 2018 bank rule, has insisted that the bank’s collapse was not the result of changes that the law required or that he chose to make. Even the simplest rung of supervision should have caught the obvious problems that killed Silicon Valley Bank, he said, including a lack of protection against rising interest rates.
“It was the simplest risk imaginable,” he said in interview.