US regulators released a set of reports Friday examining the March failures of Silicon Valley Bank and Signature Bank that spread the blame between bank managers who underestimated risks to supervisors from the Federal Reserve and FDIC who could have done more to press for changes.
The report from the Fed, which was Silicon Valley Bank's primary regulator, also cited a set of federal bank regulations that were loosened at the end of last decade. Fed Vice Chair of Supervision Michael Barr recommended Friday that some of these rules need to change, as a result of the failure.
They include tougher capital and liquidity standards for mid-sized banks, tougher executive compensation standards as well as changes to how the Fed tests for a lender's management of interest-rate risk.
The Fed "failed to take enough forceful action" with Silicon Valley Bank, Barr said in a letter released by the Fed, and the bank's failure "demonstrates that there are weaknesses in regulation and supervision that must be addressed," suggesting that rules implemented in 2019 that lessened regulations on banks with $100 billion or more in assets will be revisited.
The FDIC in its report about Signature Bank said the "root cause" of the New York lender's failure was "poor management" but that the FDIC "could have escalated supervisory actions sooner" and been more "forceful."
A crucial week ahead
The March 10 and March 12 seizures of Silicon Valley Bank and Signature Bank triggered panic across the banking system that is still unfolding seven weeks later as San Francisco lender First Republic (FRC) fights for its survival after losing more than $100 billion in deposits. US officials are coordinating talks to save the regional bank, Reuters reported Friday, but CNBC reported that a seizure by regulators seems increasingly likely.
The reports also arrive ahead of another crucial week for the Fed with policymakers set to meet in Washington on Tuesday and Wednesday to decide on another possible interest rate increase. Fed Chair Jerome Powell will surely face questions at a Wednesday press conference about the findings in Friday’s report.
The review also prompted more bipartisan scrutiny of how the Fed handled Silicon Valley Bank's meltdown.
Republican Patrick McHenry (R-NC) called it “a thinly veiled attempt to validate the Biden Administration and Congressional Democrats’ calls for more regulation,” while Sen. Elizabeth Warren (D-MA) added that the report showed Powell "failed in his responsibility."
In his response to both reports, Sen. Sherrod Brown (D-OH said “those involved in these failures owe the American people an explanation.”
Slowly, then all at once
Silicon Valley Bank's demise unfolded slowly over a matter of years, then all at once. Its end came two days after disclosing it would take a $1.8 billion loss on the sale of some bonds that had fallen in value because of rising interest rates and would look to raise an additional $2.25 billion in capital to bolster its balance sheet.
More than $40 billion was pulled from the bank on March 9, coinciding with the failed capital raise which ultimately doomed the bank.
The Fed said Silicon Valley Bank had no developed "sufficient contingent funding capacity" to survive such a run.
A longer-term problem was that the bank's "core risk-management capacity failed to keep up with rapid asset growth, which led to steady deterioration of its financial condition in 2022 and into March 2023" as rates rose.
Between 2019 and 2021, Silicon Valley Bank’s total assets tripled from $71 billion to $211 billion.
Management, according to the Fed, even masked some of the bank's true risks after failing its own internal liquidity stress tests and breaching its long-term interest rate risk limits. The bank, the Fed said, changed risk-management assumptions around liquidity shortfalls and exposure to rising interest rates "rather than fully addressing the underlying risks."
The Fed admits its own supervisors made plenty of mistakes, too. They gave Silicon Valley Bank management a confidential supervisory rating of "satisfactory" from 2017 through 2021 "despite repeated observations of weakness in risk management." Its liquidity was also rated "strong" during this period and thus subject to less stringent reviews.
More complications emerged in 2021 when the Fed moved Silicon Valley Bank into a new category requiring tougher oversight of bigger banks. The San Francisco branch of the Fed established a new team of 20 people, up from the previous eight assigned to the bank.
Because current regulations allow for a transition period to those higher standards, it took time for this new group to make its assessments. It wasn't until November 2022 that this new group arrived at a plan to downgrade another confidential rating of the firm's sensitivity to market risk. But Silicon Valley Bank failed before that downgrade could be finalized or issued.
The delay meant the bank "effectively continued to operate below supervisory expectations for more than a year despite its growing size and complexity." The situation "likely warranted a stronger supervisory message in 2022."
One of Signature's big problems, according to the FDIC report, was its reliance on uninsured depositors and its dependence on the cryptocurrency industry during a period of growth.
It also developed a concentration of very large depositors. Approximately 60 clients held deposit account balances in excess of $250 million, representing about 40 percent of total deposits. Digital asset-related deposits alone represented 27 percent of total deposits at year-end 2021.
Four separate depositors, each comprised greater than 2 percent of total assets, together held 14 percent of total assets. Three of these depositors were digital asset-related clients.
When the FDIC raised concerns about the deposit concentrations, it said "management did not heed the FDIC’s concerns." Instead, managers said their close relationship with large clients made them less likely to leave. By the end of 2022, uninsured deposits were 90% of all deposits.
It was not prepared for the shock of a large depositor run even on March 9, when a short seller claimed that 25 percent of Signature's deposits were related to the cryptocurrency sector, and into the morning of March 10. Management, according to the FDIC, fervently maintained that Signature was "not like WaMu or IndyMac," referring to two banks that went down during the 2008 financial crisis.
"Bank management failed to acknowledge the severity of the problem until a run started" in the afternoon, FDIC said. Deposit withdrawals equaled 20% of total deposits, and Signature scrambled to cover pending wire requests.
By the afternoon of March 12, outgoing wires for the next day had increased to $7.9 billion. Based on a best-case scenario, FDIC determined Signature had $3 billion in liquidity available.
Regulators decided to seize it that evening, 53 hours after the fall of Silicon Valley Bank.