BPInsights: April 22, 2023

15 Key Questions the Barr SVB Review Should Answer

The Federal Reserve is expected to release its review of the failure of SVB by May 1. Here are 15 key questions the report should answer.

Identification of SVB Weaknesses

1. For the period 2018-2023, what specific risk management policies and processes were examined?  What MRAs, MRIAs, or other supervisory criticisms were issued to SVB, and in what form?  To what extent did these criticisms directly concern the causes of SVB’s eventual failure, including its reliance on uninsured deposits and its significant unhedged interest rate risk, as opposed to other concerns, whether or not directly related to SVB’s financial condition or safety and soundness?  Were these criticisms prioritized in any way?  Did they identify concrete and specific problems and unsafe or unsound practices?  Were these criticisms directed at reducing actual risks to SVB’s financial condition or were they instead directed at change in processes, procedures, and compliance controls? 
2. When and how were these criticisms escalated to senior staff at the FRBSF, the Board’s Division of Supervision & Regulation (BS&R), and/or the Board of Governors? If not, why not?
3. Did the CAMELS ratings assigned to SVB accurately reflect the quality of the bank’s capital, liquidity, management and sensitivity to interest rate risk?  If not, why not?
4. Did SVB’s examiners ever discuss, either with SVB management or with senior staff at the FRBSF or Board BS&R the issuance of a capital directive, safety and soundness order, or cease and desist order aimed at correcting SVB’s weaknesses?  If not, why?

Examiner Resources and Experience

1. What was the average level of supervisory experience of examiners assigned to SVB at various points in time?  How many of these examiners had prior experience supervising an institution similar in size and complexity to SVB?  Did any of these examiners have prior experience supervising a bank with a similar growth rate, reliance on uninsured deposits, and disproportionate investment of assets in long-term securities?  How frequently was SVB’s EIC changed in the years leading up to its failure (i.e., 2018-2023)?
2. How many of the examiners responsible for reviewing SVB’s sensitivity to interest rate risk and its deposit funding strategy had prior private sector experience in interest rate risk management or treasury operations at a financial institution of similar size and complexity to SVB?  How many of the senior staff at the FRBSF or Board BS&R had such experience?
3. Given that SVB experienced significant asset growth in a short period of time, how did the Federal Reserve adjust the scope, frequency and intensity of its examination of SVB?  Did examiners increase the stringency of expectations placed on SVB during the period of its rapid growth?  If so, how and on what sort of a compliance timetable?  What was the prescribed plan to ensure SVB met any heightened requirements, and did SVB in fact meet those requirements in a timely way, and if not, then what sanctions/remediation demands did it face?
4. Did Board members or staff raise concerns about the quality of supervision and the competence of the supervisors at the FRBSF in the years leading up to this episode?
5. SVB disclosed duration and EVE as a measure of interest rate risk, and many have observed that those disclosures would have raised red flags at the OCC and other FRBs. How did practices differ at the FRBSF? Were there other national or state banks in a similar situation, and how did their examiners respond?

Effective Board Governance of SVB Supervision

1. Were reporting, escalation and oversight lines for SVB’s examiners appropriate and clear, as concerns each of (i) senior staff at the FRBSF, (ii) senior staff at Board BS&R, and (iii) the Board of Governors?
2. How and when were SVB’s weaknesses escalated by senior staff of Board BS&R to the Board of Governors’ Committee on Supervision and Regulation?  How often did that Committee discuss SVB during the period 2018 up until SVB’s failure?  To what extent did the Board of Governors’ decision to refrain from appointing a chair of that committee for a nine-month period of time in 2021 and 2022 affect its ability to effectively oversee SVB’s supervision?  Why did it make that decision?  How frequently did the Committee meet from October 2021 to July 2022?  How many governors served on the Committee during this period?  What process governed who could call meetings, set agendas and oversee the work of the Fed’s supervisory function?

Liquidity Planning and Potential Operational Frictions

1. Was SVB prepared to borrow from the Fed’s discount window?  At what point did SVB complete discount window borrowing documents (Operating Circular No. 10)?  If not until days before failure, why hadn’t they been completed earlier? Had SVB ever executed a test borrowing at the discount window, and if not, why not?
2. When did SVB pledge collateral to the discount window, what assets, and what quantity?  Did SVB have a Borrower in Custody agreement with the Reserve Bank so that it could pledge its loans? 
3. Did SVB express interest in the Fed’s Standing Repo Facility?  Why had SVB not signed up for the facility?
4. On Thursday evening prior to SVB’s Friday morning failure, why did the Fed not keep its wire transfer systems open late so that SVB could transfer securities from its custodian to the Fed to secure a discount window loan?

Five Key Things

1. BPI Statement on FSOC Vote

BPI President and CEO Greg Baer released the following statement on Friday on the FSOC vote to update its procedures for nonbank designation: 

“Friday’s FSOC vote to update its procedures for designating nonbank firms systemically important is an important step forward in preserving the stability of the financial system. We have continually made the point that activities with the same risk should have the same regulation, whether at a bank or nonbank. As regulatory pressures continue to push risk out of the banking system, that risk does not go away; rather, it accumulates in places where it is less understood and less regulated. Increasingly, too, while immune from regulation ex ante, shadow banks qualify for federal assistance when there is a crisis. We urge FSOC to be thoughtful and judicious as they consider any potential nonbank designation and ensure that major repositories of systemic risk are overseen appropriately.” 

2. Breaking Down Misunderstandings About Credit Card Late Fees

The CFPB has proposed to cap the safe harbor for credit card late fees at $8. The CFPB touts this change as a money-saver to consumers, but while it’s optically (and politically) appealing, it’s substantively superficial and, in fact, over the long term, the change will lead to higher overall costs for consumers, more constrained access to credit and lower credit scores.

Transparency: Credit card late fees are transparent, have been highly regulated for over a decade and apply equally to all customers that do not pay on time — contrary to the CFPB’s rhetoric about late fees.

Causes and effects: If consumers lack a strong incentive to pay on time, more consumers could pay late, and financial institutions would be forced to take steps to offset the costs associated with rising late payments in order to meet their prudential obligation to manage credit risk. Here are some of the ways the proposal could ultimately harm the consumers it aims to help.

• Higher costs: Consumers over time would see higher up-front costs and tighter credit limits as a result of the likely effects of this proposal. The weakening of late fees’ deterrence effect would drive more delinquencies and credit losses, which would necessitate banks managing credit risk by tightening credit access to customers with more challenged credit profiles and increasing interest rates or other fees. These costs would affect all consumers with credit cards, not just those who pay late.
• System-wide: Aside from raising costs for individual customers, the proposal would expose the whole financial system to a higher risk of credit losses. The necessary safeguards against that risk would also result in consumer harm.

Bottom line: The proposal to limit late fees curtails banks’ ability to manage credit risk and guts a deterrence effect that motivates prudent financial decision-making. The proposal will have unintended harmful consequences for banks’ ability to serve customers across the credit risk spectrum.

Rhetoric vs. reality: To learn about how the reality of credit card fees differs from the CFPB’s rhetoric, check out BPI, ABA and CBA’s infographic here.

3. A Curious Fed Lending Program

Normally, the Federal Reserve is highly transparent about its lending. It maintains a whole website about its discount window lending with descriptions of the programs, background information, their interest rates and other details. It also publishes term sheets and Frequently Asked Questions documents for all its emergency lending programs, such as its new Bank Term Funding Program. So why hasn’t the Fed provided details on its lending to bridge banks created after recent bank failures?

• The footnote: The cover page of the Fed’s weekly H.4.1 on March 16, 2023 stated: 
  Factors affecting reserve balances of depository institutions (table 1) “other credit extensions” reports loans that were extended to depository institutions established by the Federal Deposit Insurance Corporation (FDIC). The Federal Reserve Banks’ loans to these depository institutions are secured by collateral, and the FDIC provides repayment guarantees.
  
  A footnote to the table, which has also been included in subsequent releases, provides the same information: 
  
  7. Includes loans that were extended to depository institutions established by the Federal Deposit Insurance Corporation (FDIC). The Federal Reserve Banks’ loans to these depository institutions are secured by collateral and the FDIC provides repayment guarantees.
• Unanswered questions: Several things about this lending – which amounts to $173 billion – remain unclear. The Fed has not provided the interest rate, or the collateral.
• Bottom line: Given the sheer size of this lending – more than 3x the peak amount of regular discount window lending in response to COVID and half as much again as the peak amount of such lending during the Global Financial Crisis – it warrants transparency. The upcoming Fed report on recent bank failures should shed light on these critical public policy issues.

4. BPI: Stablecoin Bill Should Not Allow Crypto Firms Access to Fed Accounts

A provision of the draft House stablecoin bill that would allow nonbank stablecoin issuers Fed account access raises significant financial stability and other concerns, BPI said in a letter to leaders of the House Financial Services Committee this week. Fed account access would increase systemic risk by allowing nonbank stablecoin issuers to back their stablecoins with central bank money and access the payments system without the strong safeguards and supervision that apply to banks, the letter said.

• Recent events: The letter cited the Fed’s recent decision to deny crypto firm Custodia’s request for a master account due to several key risks. “Indeed, in light of the collapse of FTX and a long list of other crypto firms, the case for linking the crypto universe, of which stablecoins are a necessary part, to the Federal Reserve appears to have diminished significantly,” the letter said.
• Financial crime: The draft legislation would also pose money laundering and illicit finance risks – it is crucial that stablecoin issuers be held to the same BSA/AML/sanctions requirements and standards as insured banks, the letter said.
• Context: The Committee’s Subcommittee on Digital Assets, Financial Technology and Inclusion held a hearing this week to discuss potential stablecoin legislation.

5. What Went Wrong at SVB? BPI’s John Court Joins Bankshot Podcast

BPI General Counsel John Court joined American Banker’s Bankshot podcast to discuss key factors behind recent bank failures. Other banks took steps to manage their balance sheets as interest rates rose, Court noted – but SVB was slow to make such adjustments. “I think that is basically what led to their downfall, was their lack of proactively managing their balance sheet to account for these risks,” he said. Other participants in the podcast episode this week were Karen Petrou of Federal Financial Analytics, Brookings’ Aaron Klein, ICBA’s Rebeca Romero Rainey and Columbia Law professor Kathryn Judge.

• Tailoring: Tailoring is the wrong target for blame in the SVB collapse, Court said. It’s “certainly politically expedient for certain people to blame that tailoring for the … losses at Silicon Valley and its failure,” he said. “I don’t think anybody’s done the work yet and looked at the review.” Court rebutted suggestions that if the liquidity coverage ratio had applied to banks with assets between $100-250 billion, that would have mitigated SVB’s problems. “I don’t think that’s true at all.”
• Supervision: Aaron Klein said there was a contradiction between the Fed opting not to apply enhanced prudential standards to SVB and yet invoking the systemic risk exception to rescue depositors. The SVB failure was a clear management failure, and “it seems that it’s also an examination failure and a supervisory failure,” Court said. The problems that caused SVB’s failure were “bank management 101 and bank examiner 101 types of things,” he said.
• Ships in the night: Silvergate Bank, which went out of business just ahead of SVB’s failure, is a “critical part of this story, if only because these two ships were passing in the night, but they are very different ships,” Court said. Silvergate catered to the nonbank crypto industry – stablecoin issuers and other crypto firms – and it was also fast-growing. But Silvergate acted more responsibly – they “recognized that their business model was not long-term durable and they actually engaged in a voluntary liquidation and dissolution, where they were actually able to pay their depositors back and wind themselves down in a way that posed no risk to the FDIC and had little to no role for the government.” The timing was unfortunate: the market may have been confused or alarmed by SVB releasing its plan to deal with its balance sheet risks shortly after Silvergate’s liquidation announcement, Court said.

Watch: The CFPB’s Irresponsible Rhetoric on Credit Card Late Fees

In Case You Missed It

The First Twitter Bank Run? Study Explores Social Media Bank Effects

A recent economic paper by J. Anthony Cookson (University of Colorado at Boulder) and others explores the effects of social media on bank run risk. The paper is particularly relevant after the SVB collapse, which House Financial Services Committee Chair Patrick McHenry (R-NC) described as “the first Twitter-fueled bank run.” The paper shows that social media amplifies bank run risk factors: “During the run period, we find the intensity of Twitter conversation about a bank predicts stock market losses at the hourly frequency. This effect is stronger for banks with bank run risk factors,” the paper’s abstract says. “At even higher frequency, tweets in the run period with negative sentiment translate into immediate stock market losses.”

CFPB Breach Exposed Confidential Consumer, Firm Data

A major CFPB email breach, in which a former staffer forwarded records to a personal email account, included 250,000 consumers’ personal information as well as confidential supervisory information about dozens of firms, according to the Wall Street Journal. The CFPB reported this incident to Congress in late March but it only became public this week.

• Lawmaker scrutiny: Financial Services Committee Chair Patrick McHenry (R-NC), Oversight Subcommittee Chair Bill Huizenga (R-MI) and Senate Banking Committee Ranking Member Tim Scott (R-SC) have decried the breach, saying it raises concerns about the CFPB’s ability to safeguard consumers’ personal information.

OCC’s Hsu: Open Banking Could Shape Bank Supervision

The evolution of “open banking”, or consumer-authorized financial data sharing, could shape the OCC’s bank supervision, Acting Comptroller Michael Hsu said in a recent speech. The impacts of open banking could intersect with the OCC’s mission of ensuring banks maintain safe, sound and fair operations, Hsu said.

• Key themes: Hsu noted that authentication processes, secure data transmission protocols, limitations on sharing and receiving data and other controls may need to be strengthened. He also said accountability challenges could arise when mistakes occur, and observed that consumers could face risks as the set of players in the financial data space proliferates. Banks have expanded from handling customers’ money to also handling their financial data, he observed.
• Where it is now: The OCC’s supervision in this area, to date, has focused on banks’ compliance with the Gramm-Leach-Bliley Act, which established stringent standards for data privacy in banking.
• Where it’s going: The OCC stood up the Office of Innovation in 2016, recently rebranding it as the Office of Financial Technology. This suggests that the agency is honing its focus on technology issues.
• The risks of speed: Fast-moving deposits are in focus among regulators lately as a variable in the SVB run. Hsu noted that while data portability is empowering for consumers, it could increase liquidity risk of banks’ retail deposits. Banks will likely respond by taking steps to retain customers, which could increase the “stickiness” of those deposits, but Hsu signaled he is monitoring that digital transition.
• Security: Hsu called for banks to be vigilant about information security and cyber threats amid an increase in consumer-authorized data sharing.
• Separation: Hsu warned about blurring the lines between banking and commerce, particularly as data aggregators and fintechs play prominent roles in open banking and as Big Tech firms get into financial services.

Bowman: CBDC Could Disrupt Banking System

Federal Reserve Governor Michelle Bowman laid out the potential benefits and risks of a U.S. CBDC in a speech this week. A poorly designed CBDC could disrupt the banking system, harm consumers and businesses and threaten financial stability, she said. “There are significant risks in adopting a CBDC that cannibalizes rather than complements the U.S. banking system,” Bowman said. A CBDC that pays interest at comparable or better rates than deposits and other safe assets could reduce the funds available to lend and increase in the cost of capital across the economy, she said. “Likewise, we need to consider the effect on bank stability, and the potential of even more rapid bank runs, in a world where there are fewer constraints on the volume and velocity of payments.”

• Financial inclusion: Bowman discussed the potential benefits of a CBDC, such as potentially speeding up interbank transactions in wholesale markets, and noted that some have suggested CBDC could enhance financial inclusion. But she expressed some skepticism about that particular benefit: The small percentage of the U.S. population that is unbanked might not trust the government, and unbanked households may not have mobile phones or internet access. “While there has been important research on these barriers to adoption, including consumer attitudes and technology requirements, policymakers also need to consider whether there are other means to improve financial inclusion, such as alternatives for making the distribution of government benefits more efficient and effective like promoting financial literacy.”
• Guardrails: “It would be irresponsible to undermine the traditional banking system by introducing a CBDC without appropriate guardrails to mitigate these potential impacts on the banking sector and the financial system,” Bowman said.
• Digging deeper: Bowman called for the Fed to continue researching potential implications of a CBDC.
• Bottom line: “From my perspective, there could be some promise for wholesale CBDCs in the future for settlement of certain financial market transactions and processing international payments,” Bowman said. “When it comes to some of the broader design and policy issues, particularly those around consumer privacy and impacts on the banking system, it is difficult to imagine a world where the tradeoffs between benefits and unintended consequences could justify a direct access CBDC for uses beyond interbank and wholesale transactions.”

The Crypto Ledger

The SEC this week charged crypto trading platform Bittrex and its cofounder with allegedly operating an unregistered national securities exchange, broker and clearing agency. Meanwhile, SEC Chair Gary Gensler testified on Capitol Hill for an oversight hearing, where he faced criticism from House Republicans over his crypto crackdown. Here’s what else is new in crypto.

• Europe: The European Union’s Markets in Cryptoassets (MiCA) legislation gained final parliamentary approval this week. The legislation has been in the works for three years. It would be the first large-scale attempt to regulate crypto on the Continent.
• Swift to SBF – “I knew you were trouble when you walked in”: Taylor Swift was one of the few celebrities to do her due diligence on collapsed crypto exchange FTX, according to a lawyer suing celebrity FTX promoters.

EU Debate on ‘Digital Euro’ Moves (At Least Temporarily) from Theory to Reality

As reported by CoinDesk this week:

During a Wednesday debate, members of the European Parliament raised concerns over privacy, state control and the role of banks, and some are starting to wonder if the project is worth pursuing at all. “There’s one central question which hasn’t yet been credibly answered, which is what is the added value …. What can I do with a digital euro that I can’t do with current payment options?” asked Markus Ferber, economic spokesperson for the center-right European People’s Party. “As long as there’s no answer to this question, there’s going to be a great deal of skepticism.” That view appears to be shared by some in the center-left Socialists and Democrats grouping, the next biggest in the chamber. “The question we have to ask is why are we doing it, and with what goal,” said French lawmaker Aurore Lalucq. “We’re jumping onto the digital bandwagon because it’s fashionable, and trying to deliver it with forceps … I think you need to be extremely careful.”

BPI’s Mamula Discusses Financial Data Sharing at FDATA Panel

BPI’s Sarah Mamula participated in a panel discussion this week on data privacy and consumer financial data sharing. The discussion comes as the CFPB is working on rules implementing Section 1033 of the Dodd-Frank Act, which directs the agency to set requirements on how consumers’ data may be shared and handled by financial firms. It also comes after Chairman Patrick McHenry (R-NC) introduced and passed legislation to modernize requirements in the Gramm-Leach-Bliley Act through the House Financial Services Committee, which, if enacted, would add stringent privacy standards on the banking industry. Consumer data sharing rules should preserve the security of consumers’ financial information, Mamula said at the panel. It’s essential that all companies handling customers’ sensitive financial information, such as data aggregators, be subject to strong regulation and supervision, she said. Mamula also noted the welcome inclusion of a federal preemption provision in the Data Privacy Act that Chairman McHenry passed in HFSC. That provision will enable one uniform standard to be applied throughout the United States, easing the path for financial institutions to protect their customers’ privacy under clear, consistent rules.

Regulatory Recap: Bank Earnings

After recent bank failures, deposits took top billing as a focus for bank investors in recent first-quarter earnings calls. But regulatory issues also received some attention. Here’s a roundup of regulatory takeaways from recent earnings calls.

Basel on the horizon

Several bank leaders previewed the upcoming Basel Finalization changes’ expected effects on their business.

• “We do expect higher capital from Basel IV, effectively,” JPMorgan Chase CEO Jamie Dimon said on the bank’s earnings call.
• “We still believe that there is plenty of capital amongst the large banks, and if capital requirements were to increase for the large banks by their regulators it would exacerbate any credit tightening that might go on,” Citi CEO Jane Fraser said. She alluded to the “quantity and quality of activity in the shadow banking industry. It does not benefit from the same regulatory frameworks and protections for participants, and I, amongst others, fear that more activity getting driven into it, if the banking capital requirements increase, will be to the detriment of system strength and stability.”

Other questions centered on stress testing.

• “Our ability to predict the [stress capital buffer] ahead of time from running our own process is actually quite limited,” JPMorgan CFO Jeremy Barnum said.
• “There’s a lot of capital changes that are likely to occur from a regulatory standpoint,” U.S. Bank CEO Andrew Cecere said on the bank’s earnings call. The bank is hoping for more clarity on that “in the second half of the year,” he said.

Potential regulatory changes
Bank executives also discussed potential post-SVB regulatory adjustments, such as a potential change in how banks account for their securities holdings, long-term debt requirements for large regionals or stress tests that reflect high interest rate environments.

• Citi’s Fraser said “we hope that there will be a thoughtful and a targeted approach to any changes in the regulatory and capital framework and that they address the root causes of what actually happened here, and what happened is a combination of macro impacts from the sharp rapid rate increases and some idiosyncratic situations, namely a lack of proper asset and liability management at a small handful of banks.” Fraser added that “we don’t see these issues as pervasive throughout the broader banking industry, but the events certainly highlight the importance of prudent asset and liability management.”
• Dimon suggested there could be limitations on held-to-maturity securities, “maybe more TLAC for certain type-size banks, and more scrutiny on interest rate exposure, and stuff like that,” he said.
• It’s “very likely that they will incorporate a higher rate environment into the CCAR process,” U.S. Bank CFO Terry Dolan said. The bank is continuing to reduce the volatility of Accumulated Other Comprehensive Income to rising interest rates, he said. Policymakers are currently considering proposing TLAC requirements for large regional banks, and they might also increase the level of the stress capital buffer or change aspects of the LCR, Dolan said.
• When asked about potential elimination of the AOCI filter, M&T Bank CFO Darren King said “it won’t surprise me if that’s a change that happens, but I think we’re well covered and well prepared should that play itself out.” On TLAC, “that’s really a longer-term change. I think when you look at what’s happening in the industry right now,” King said. “Most organizations have been increasing their use of wholesale funding and bank notes which ultimately will help with TLAC as it plays itself out.”
• PNC’s Robert Reilly said “we anticipate that we will be subject to a total loss absorbing capacity requirement in some form and at some point, with a reasonable phase-in period. Importantly, as our borrowed funds continue to return to a more normalized level, we would expect to be compliant through our current issuance plans under existing TLAC requirements.” On potential elimination of the AOCI filter, PNC CEO William Demchak said “they may well do that”, and said “I would hope that they would have a more holistic look as they do in Europe on measuring balance sheet risk to interest rates.”

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