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Weekly Column: Setting The Record Straight On Recent Bank Failures And What We Should Be Focused On

Silicon Valley Bank’s (SVB) collapse was due to massive inflation followed by spiking interest rates and mismanagement that led to a liquidity event, not a capital shortfall.

A combination of excessive spending, skyrocketing inflation, rising interest rates, mismanaged interest rate risk, failed supervision and management, and a social media-fueled bank run led to recent bank failures.  As Congress and regulators analyze what went wrong, one thing is clear: S. 2155’s targeted reforms did not contribute to bank failures.  

The Economic Growth, Regulatory Relief and Consumer Protection Act (S. 2155) was the most significant piece of regulatory reform legislation for community financial institutions in nearly a decade.  In addition to right-sizing regulation, it included provisions to help creditworthy borrowers obtain mortgages, allowed more small business owners to get loans, and included important consumer protections for victims of fraud, seniors and veterans.  The bill passed the Senate with a bipartisan, filibuster-proof majority and was signed into law in May 2018.

Regarding recent bank failures, the Bank Policy Institute explains: “Federal Reserve rate increases triggered large unrealized losses, which in turn undermined confidence in the banks.  Then, because an unusually large portion of their deposits were uninsured, a run by those depositors caused each bank’s failure.  At SVB, panic was exacerbated by the fact that many companies that were lending customers of the bank had been required to hold all their deposits there, and so were at mortal risk in the event that the bank failed. . . . Interest rate risk management is generally addressed through supervision and not regulation, and thus was unaffected by regulatory tailoring under S. 2155.”   

S. 2155 did not take away the Federal Reserve’s ability to properly monitor and supervise Silicon Valley Bank. 

SVB was subject to stringent capital standards, was required to provide a monthly liquidity report to the Federal Reserve, and was also required to conduct quarterly liquidity stress tests, as well as liquidity risk management. 

The bank was very well capitalized--with ratios roughly twice as high as requirements--but had risk management defects.  SVB was exposed to liquidity risk as its investments in long-term government securities were funded by short-term deposits, and interest rate risk from holding fixed-rate assets as inflation soared and interest rates moved higher. 

At a recent Banking Committee hearing, Federal Reserve Vice Chairman for Supervision Michael Barr confirmed the Fed had substantial discretion under S. 2155 to tailor rules, and that SVB was well capitalized.

There is no substitute for robust supervision and risk management.

News articles suggest banking regulators, supervisors and third parties found serious weaknesses in how SVB was handling key risk as interest rates were rising.  The San Francisco Federal Reserve expressed concern with the bank’s interest rate risk management last fall; a third-party review of the bank in early 2022 warned the bank’s risk controls were “substantially below” its peers; and the bank was without a Chief Risk Officer for much of 2022, to name a few. 

By mid-2022, it should have been clear to anyone looking at SVB’s investment portfolio that they were holding unrealized losses as the Federal Reserve continued to increase interest rates.  While we do not yet know what happened in the first few months of 2023, we need to know: 

  • Why SVB management failed to manage its interest rate risk of assets and liabilities;
  • Whether bank examiners at SVB raised interest rate risk concerns with SVB’s investment portfolio; and
  • Why corrective steps were not taken earlier to avoid the bank run that occurred after SVB announced it has sold assets to meet a liquidity crisis. 

While we wait to learn more in the coming weeks, one thing is clear: S. 2155 is not the scapegoat the President and political commentators are looking for.