May 30, 2024

Federal Reserve Releases Critical Report on Silicon Valley Bank Collapse

In a rare instance of self-criticism, the Federal Reserve has released a highly critical report on its own supervision and regulation of Silicon Valley Bank (SVB), which collapsed in mid-March, marking the largest bank failure since the 2008 financial crisis. The review, conducted by Michael S. Barr, the Fed’s vice chair for supervision, blamed the Fed overseers for not taking forceful enough action and highlighted weaknesses in regulation and supervision that must be addressed.

The review spanned hundreds of pages and outlined a range of changes to bank oversight and regulation that the Fed will consider in response to the disaster, from stronger deterrents against risk-taking to possible curbs on incentive compensation for executives at poorly managed banks.

The collapse of SVB has brought to light significant weaknesses at the bank that appear to have started and grown progressively worse in plain sight in the years leading up to its demise.

The bank had a large share of deposits above the government’s $250,000 insurance limit, making it vulnerable to uninsured depositors pulling their money at the first sign of trouble. The bank’s leaders also made a big bet on interest rates staying low, which turned out to be a bad one as the Fed raised rates rapidly in a bid to control inflation, leaving the bank facing big losses.

The review’s release highlights the need for systemic change and accountability in the financial industry and the urgency of preventing further disasters.

Barr suggested that an independent body should review the failures of oversight at the bank since he has to continue working with his colleagues at the central bank and might be hesitant to criticize them. The report stopped short of overt finger-pointing, focusing on weaknesses in the overall system of regulation and supervision.

The collapse of SVB demonstrated that a bank’s distress could have system-wide consequences through contagion, even if the firm is not extremely large, highly connected to other financial counterparties, or involved in critical financial services. Banks with bad capital planning, risk management, and governance could face additional capital or liquidity beyond regulatory requirements, and limits on capital distributions or incentive compensation could be appropriate and effective in some cases.

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