SVB mismanagement shows US Fed must tighten supervision, reconsider Trump’s midsize bank rules

The implosion of Silicon Valley Bank and Signature Bank raises questions about what US Federal Reserve supervisors knew about the firms’ lax risk-management and when they knew it.

These failures also flash a red light for the central bank to stiffen supervision of other mid-sized banks — typically those with $100 billion to $700 billion in assets — and re-evaluate its Trump-era rules that eased regulation of them.

The Biden team is well-positioned to make rule changes, since key players were dissenters or critics of the Trump rollback of the 2010 Dodd-Frank Act. But they are likely to be constrained by a 2018 law passed by the Republican-controlled Congress.

Biden officials who are likely to have input include Michael Barr, the Fed’s regulatory chief who was an architect of the 2010 Dodd-Frank Act; Federal Deposit Insurance Corp. chief Martin Gruenberg; and Lael Brainard, head of the White House’s National Economic Council.

As for the Silicon Valley Bank collapse, its former chief executive, Greg Becker, bears the most immediate responsibility for mismanaging the bank’s deposit outflows while its asset values were declining. He awkwardly sat on the board of the San Francisco Fed at the same time.

The Fed is accountable for oversight of many mid-sized banks, and is certain to be questioned about its supervision at congressional hearings.

“At some point soon, both federal and state supervisors need to explain to the public why liquidity loss from deposit outflows at these banks wasn’t sufficiently tested — if at all — in light of a changing interest rate environment,” said Sarah Bloom Raskin, a Duke law professor who was a Fed governor and deputy Treasury secretary during the Obama administration.

In a statement today, the Fed said Barr, its top regulator, would lead a review of the central bank’s supervision and regulation of Silicon Valley Bank. The review is to be released to the public May 1.

The Fed’s interest rate increases to combat inflation caused a decline in value of SVB assets, which were concentrated in long-term Treasury bonds and mortgage-backed securities. Bond prices fluctuate inversely with their interest rates.

Aaron Klein, the economic studies chair at the Brookings Institution, a left-leaning think tank, was more definitive in pointing a finger at the Fed.

“SVB was allowed by the Federal Reserve, their primary regulator, to build up a massive position on mortgage-backed securities with little to no hedging for interest rates,” said Klein, a former deputy assistant Treasury secretary during the Obama administration.

Fed supervision

Now Fed supervisors, chastened by the narrow aversion of a more widespread crisis so far, are likely to take a tougher tack in their examinations.

“Certainly examiners are going to be looking at banks with significant securities portfolios relative to uninsured deposits, and they will press these banks to raise more long-term funding” while they can, said Lee Reiners, Duke Financial Economics Center policy director and a former New York Fed senior associate.

Bank customers with more than $250,000 in deposits are uninsured by the Federal Deposit Insurance Corp., meaning they aren’t made whole by the government in case of the firm’s collapse.

The Fed and FDIC stepped in last weekend to provide insurance to all SVB and Signature customers, including those with accounts over $250,000. Most accounts in those banks weren't insured. Also, the Fed created a temporary liquidity fund for banks at risk of runs.

Trump-era rules

In 2018, the Republican-controlled Congress, with the backing of then-president Donald Trump, enacted the Economic Growth, Regulatory Relief and Consumer Protection Act. It rolled back parts of the Dodd-Frank Act, loosening liquidity, stress test and resolution standards for small and mid-sized banks.

A year later, the Fed and FDIC implemented the law by going beyond it, easing requirements even further. Leading the charge was the Fed’s top regulator, Randal Quarles, who has been replaced by Barr, the Dodd-Frank Act architect.

“What should happen is that the loosening of regulation that occurred during the last administration should be tightened,” said Brandeis finance professor Stephen Cecchetti.