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Post-mortems begin on Silicon Valley Bank failure

The law kept SVB off the too-big-to-fail list

Rep. Brad Sherman, D-Calif., said any stress test “worthy of the name stress test” would have caught SVB's condition before its failure.
Rep. Brad Sherman, D-Calif., said any stress test “worthy of the name stress test” would have caught SVB's condition before its failure. (Bill Clark/CQ Roll Call file photo)

President Joe Biden on Monday said he would ask Congress and regulators to strengthen regulations on small banks such as Silicon Valley Bank, boosting scrutiny of a bipartisan 2018 law that eased the requirements for such banks.

Biden’s remarks to reassure depositors, taxpayers and the markets early Monday came after three financial regulators decided Sunday to guarantee deposits at both Santa Clara, Calif.-based SVB and New York City-based Signature Bank, including those above the $250,000 limit for coverage by the Federal Deposit Insurance Corporation. A fee assessed on banks would cover losses to the fund, the regulators said.

And lawmakers and others began examining whether SVB’s failure resulted from the relaxed requirements, poor regulatory oversight or bad management, or some combination of the three.

The Federal Reserve said Vice Chair for Supervision Michael S. Barr will review the supervision and regulation of SVB and the Fed will release his report by May 1. “The events surrounding Silicon Valley Bank demand a thorough, transparent, and swift review by the Federal Reserve,” said Chair Jerome H. Powell in a statement.

Biden’s Monday remarks sharpened scrutiny of the 2018 law, which had already come under attack from some Democrats after the run on SVB and the shuttering of Signature by New York state regulators. Biden and the regulators said their moves didn’t amount to a bailout; depositors would be protected, but shareholders and some debt holders would not. They also removed the banks’ management.

“During the Obama-Biden administration, we put in place tough requirements on banks, like Silicon Valley Bank and Signature Bank, including the Dodd-Frank law, to make sure that a crisis we saw in 2008 would not happen again,” Biden said, referring to the 2010 law. “Unfortunately, the last administration rolled back some of these requirements. I’m going to ask Congress and the banking regulators to strengthen the rules for banks to make it less likely this kind of bank failure would happen again.”

Bigger buffer? More scrutiny?

The 2018 law raised the threshold at which a bank would be considered too big to fail to $250 billion from $50 billion. Banks considered systemically important under the 2010 financial overhaul law were required to keep more capital on hand, undergo stress tests and produce a “living will” that would provide for orderly dissolution. Even though the law kept SVB off the systemic risk list, regulators nevertheless cited that risk to justify the action Sunday. 

The 2018 law took effect just as SVB was moving above the $50 billion asset threshold. With $209 billion in assets at the end of last year, according to the FDIC, the bank would have been subject to enhanced requirements before passage of the 2018 law, and closer scrutiny, including Fed stress testing. 

Rep. Brad Sherman, D-Calif., said regulators missed the mismatch between assets and liquidity needs at SVB because Congress limited their visibility into banks of that size.

“It took these medium and large institutions and caused them to be regulated pretty much as if they were small,” Sherman said in an interview. “As a result, the folks in Silicon Valley took risks that I can’t imagine they would have gotten away with under the other program.”

Sherman said Congress should repeal the 2018 law. 

As SVB’s assets jumped about 270 percent since 2018, its total shareholders equity rose about 210 percent, reducing the buffer that might have helped the bank withstand the crisis. 

Centrist Democrats in Congress were among those who supported the 2018 change. Sens. Mark Warner of Virginia and Jon Tester of Montana voted for the bill, introduced by Sen. Michael D. Crapo, then the Senate Banking chairman.

Crapo, R-Idaho, was not impressed by Biden’s call to revisit the 2018 legislation. “Calling for more regulation is a distraction that will not solve for failed basic supervision,” Crapo said in a statement Monday. “The bipartisan S. 2155 right-sized regulation for financial institutions and preserved protections to ensure the safety and soundness of our financial system. This event was a basic supervisory oversight failure of poor financial risk management strategies.”

Some lawmakers were unwilling Monday to defend the 2018 law, but even some who opposed it at the time were skeptical that higher capital requirements would have made a difference. They noted that SVB’s money was tied up in traditionally low-risk assets. Its problem was a mismatch between depositors having an immediate claim on their money and the bank’s investments on long-term bonds. 

Robert Hockett, a Cornell Law School professor, said he opposed the 2018 law but that it had little impact in the SVB case because the bank had invested assets in U.S. Treasury bonds, typically considered safe, low-risk assets.

“I do think there might be a touch of opportunism,” Hockett said of Democrats’ criticism.

The steep rise in interest rates during 2022 left SVB with long-term Treasurys worth less on the market than their face value. When the bank had to sell off assets to meet withdrawal demands of its customers, it had to sell those Treasurys at a loss. 

“The irony here is that they did exactly what we would want them to do,” Hockett said in an interview. “You don’t get much more boring than industrial loans by an industrial bank on the one hand, and then investing the surplus in U.S. Treasury securities that are considered so safe that they get a zero risk weighting in all of the risk-based systems of capital regulation.

“It might have been the case that had there been enhanced prudential regulation that somebody might have told SVB, ‘Look, you’ve got to hedge against the interest rate risk,'” he said. “But I don’t know that that would have happened.”

Fed stress tests put the biggest banks through a range of economic scenarios to see whether they could withstand them. The central bank said last month that 23 banks would this year be tested against “a severe global recession with heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets.”

Such a recession scenario would typically imply lower interest rates rather than the rising rates that caught SVB.

But Sherman said the stress test requirements would have caught the interest rate risk. “Any stress test worthy of the name stress test would have caught [it],” he said.

Bartlett Naylor, financial policy advocate for Public Citizen, agreed that increased supervision would have caught the risk even if higher capital requirements did not. 

“Under enhanced supervision, regulators would have taken a sterner position about how heavily they are exposed to those kinds of Treasurys, that they’re not rolling them over a little faster and buying the higher yielding Treasurys,” Naylor said in an interview. “They locked in low rates for a long period of time.”

Republicans, meanwhile, said regulators already have the tools they need.

“At this time, it is important to remain levelheaded and look at the facts — not speculation — when assessing the right path forward,” House Financial Services Chairman Patrick T. McHenry, R-N.C., said in a statement. “I have confidence in our financial regulators and the protections already in place to ensure the safety and soundness of our financial system.”

Ryann DuRant, a spokesperson for Senate Banking ranking member Tim Scott, R-S.C., said regulators missed the signs on SVB. 

“SVB’s failure is the result of mismanagement and failed supervision,” DuRant said in a statement. “Regulators said SVB was ‘idiosyncratic.’ If that’s the case, how did they miss the idiosyncrasies and the risk? If this is such an outlier in the system, why wasn’t action taken? Regulators failed to do their job with regards to SVB, and if regulators can’t do their job with what the law gives them now, why is giving them more regulations the better route?”

The Federal Reserve separately on Sunday also announced the Bank Term Funding Program, which for one year would ensure that other banks have the cash on hand to cover customer withdrawals. The program would lend money to banks, credit unions and other qualifying depository institutions using high-quality assets held by the institutions, such as Treasurys, agency debt or mortgage-backed securities, as collateral at par. The Fed was effectively telling the market that it would value some securities above their market value.

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