BPInsights: April 29, 2023

What’s in the Recent SVB Reports?

The Federal Reserve and the Government Accountability Office each released reports today concerning the failure of Silicon Valley Bank. These reports are likely the first of several reviews to dissect federal regulators’ actions in light of SVB’s failure.

BPI President and CEO Greg Baer released the following statement in response:

We commend both the Federal Reserve and the GAO for releasing reports on SVB’s failure with speed and urgency, and believe it is particularly helpful that the Federal Reserve has made public the underlying supervisory materials related to SVB, given its status as a failed institution. These will assist future investigations greatly as they assess the causes and ramifications of SVB’s failure, including numerous important topics beyond the scope of these initial reports.

Unfortunately, and in contrast to the accurate and objective review of the problems leading to the failure of SVB provided by the GAO’s report, the Federal Reserve’s report lays blame at changes to regulation and supervision made in recent years, when its own examination materials make plain the fundamental misjudgments made by its examination teams over that same period. For example, SVB consistently failed the internal liquidity stress tests it was required to perform, but Fed examiners did not require it to improve its liquidity situation, suggesting that the regulations were fit for purpose, but the examiner response was inadequate. Put simply, there is no provision of S. 2155 that requires examiners to misjudge interest rate risk; the examination materials make clear that nothing in S. 2155 prevented them from properly examining it.

Lastly, we are disappointed that the Fed’s report has proceeded to make policy recommendations without input from the public or Congress and without the benefit of a broader and deeper investigation. Particularly remarkable is a reflexive and largely unexplained demand for higher capital requirements, which no independent observer has identified as playing any material role in SVB’s failure. It is surprising that the Board, whose Reserve Bank clearly made serious mistakes in the supervision of SVB, Moonstone and Silvergate, would not seek external views in proposing a solution to its supervisory mistakes.

A brief overview of the GAO report and its findings is included below:

• The GAO report examines (1) bank-specific factors that contributed to the failures, (2) supervisory actions regulators took leading up to the failures, (3) the basis for the systemic risk determinations Treasury made, and (4) factors the Federal Reserve and Treasury considered to establish and provide credit protection for the Bank Term Funding Program and the use of the program to date.
• Regarding supervisory actions, the report concludes that starting in 2018, regulators identified concerns with Silicon Valley Bank and Signature Bank, but both banks were slow to mitigate the problems, and regulators did not escalate supervisory actions in time to prevent the failures. 
• GAO noted its “longstanding concerns with escalation of supervisory concerns” and recommendations that it made in 2011 that regulators “consider adding noncapital triggers to their framework for prompt corrective action (to help give more advanced warning of deteriorating conditions).”
• GAO also referenced its 2015 report on bank failures, which had concluded that although regulators often identified risky practices early in previous banking crises, the regulatory process was not always effective or timely in correcting the underlying problems before the banks failed.
• GAO intends to conduct future reviews of:
  • FRBSF and FDIC supervisory decision-making;
  • How the Category IV designation affected SVB supervision prior to its March 2023 failure;
  • The Federal Reserve’s, including FRBSF’s, and the FDIC’s decision-making processes for escalating supervisory actions; and
  • Use of the systemic risk exception.

The Federal Deposit Insurance Corporation also published a report on Friday concerning the failure of Signature Bank.

• In contrast to the Fed report, the FDIC report does not cite regulation as a cause of the Signature Bank failure. Instead, it criticizes “poor management” and FDIC examination.
• In particular, supervision in the FDIC New York Regional Office is described as understaffed, slow to address issues and hesitant to address bank shortcomings. The report concludes that supervisors should have downgraded the bank’s management and liquidity ratings far sooner.
• Among other contributing causes, the FDIC points to the bank’s significant exposure to the digital asset industry and failed attempts to pledge ineligible collateral at the discount window.  
• It concludes that the failures of SVB and Signature “and their unprecedented speed” may lead to “changes in regulation and supervision and reevaluating liquidity risk management.”
• The FDIC did not release examination materials. The report includes an appendix that summarizes the supervisory history and examination findings since 2017.

Five Key Things

1. How to Make the ‘Lender of Last Resort’ Function Better

The recent failures of SVB and Signature Bank offer insights into how the government’s lender of last resort function could improve. Making that function more efficient and effective would enhance the stability of the banking system in times of stress and free up more funding for the economy.

• Background: The Federal Reserve and the Federal Home Loan Banks both provide credit to the banking system, with the FHLBs providing ongoing funding and the Fed acting as lender of last resort.
• Why it matters now: The SVB and Signature failures have brought new urgency to policymakers’ tools for preventing bank runs, but there’s an important tradeoff: some of these tools require banks to diverge from their core mission of liquidity transformation (funding illiquid loans with demandable deposits). Liquidity regulations require banks to load their balance sheets with government securities, leaving less room for loans to businesses and households. The largest banks use more than 20 percent of their balance sheets to fund the government rather than the economy.
• The alternative: Instead of buying more and more government debt, banks could instead rely on the Fed’s discount window as a viable option for lending. The discount window suffers from an undeserved stigma – if it was treated as a viable option for banks to use to meet their liquidity needs, the banking system could support more economic growth.
• Different roles: The Fed and the Federal Home Loan Banks play different roles in providing credit to the banking system. In some jurisdictions such as the EU, the central bank provides ongoing funding to commercial banks. But in the U.S., the Fed only lends to meet contingencies or crises – instead, the FHLBs have the government’s conduit to provide ongoing funding to banks. This creates a challenge because FHLBs are ill-suited to be the lender of last resort, and this division of responsibility interferes with the Fed’s ability to play that role.

To learn more, including some policy recommendations, click here.

2. House Oversight Panel Opens SVB Probe Into San Francisco Fed

The House Committee on Oversight and Accountability has launched an investigation into the San Francisco Fed’s handling of the Silicon Valley Bank failure, according to Bloomberg. The probe, disclosed in a letter on Thursday from the panel’s chairman to San Francisco Fed President Mary Daly, adds to scrutiny of the SF Fed’s supervision of the collapsed bank. The lawmakers requested documents and material by May 11, including the names of lead examiners overseeing SVB. The Matters Requiring Attention against SVB demonstrated that the San Francisco Fed knew by the end of 2022 about the high percentage of uninsured deposits at the bank, the lawmakers wrote, according to Bloomberg. The letter follows a separate request of documents from the San Francisco Fed by Sen. Ted Cruz (R-TX) and Rep. Jim Jordan (R-OH) this week.

3. NY Fed Adjusts ON RRP Terms to Close Counterparty Backdoor

The Federal Reserve Bank of New York this week announced a change to the terms of the overnight reverse repurchase agreement (ON RRP) facility that prohibits counterparty eligibility for funds organized for a single investor. The revision also clarifies that financial stability and ensuring bank safety and soundness are factors considered when evaluating ON RRP counterparties.

• Implications: The update will effectively close a backdoor that risky firms, including crypto or stablecoin firms, could have exploited to gain Fed access. The eligibility changes clarified that “SEC registered 2a-7 funds that, in the sole judgment of the New York Fed, are organized for a single beneficial owner, or exhibit sufficient similarities to a fund so organized, generally will be deemed ineligible to access reverse repo operations.” This update appears to address the risks identified in a BPI blog post in January.

4. Tarullo, Raskin on SVB’s Supervision

Former leading policymakers Daniel Tarullo and Sarah Bloom Raskin offered their views on SVB supervision and regulation at a Peterson Institute for International Economics event this week. Tarullo served as the Fed governor leading supervisory efforts in the wake of the Global Financial Crisis, and Raskin is a former Fed governor and deputy Treasury secretary. The event took place before the Fed’s SVB supervision report was released. Here are some key takeaways from their remarks.

• Supervisory failure: “This was a very significant supervisory failure. Even if you think regulation had been inadequate, or if you thought it was adequate … this was big,” Tarullo said. If gaps in supervision necessitated more stringent regulations for regional banks, the pressure on those banks’ business model warrants consideration, Tarullo suggested. Raskin observed “a lack of urgency in escalating this through the supervisory channels.” “There is a sequencing of enforcement and that sequencing appears to have been missing in this case,” she said. Tarullo said that SVB grew rapidly, in contrast with the typical gradual phase-in to a more stringent supervisory bucket. “When you’ve got a bank sort of blowing through the levels of different supervisory portfolios very quickly, there’s no preparatory time, there’s no time to get used to things.”
• Calibration: Supervision allows regulation to be calibrated in a way that enables banks to intermediate in the economy, he noted. “If it turns out that we can’t rely on supervision, then we do have to think about tighter regulation and what the tighter regulations would mean for the viability of the medium-sized regional bank model, which I think is already under some strains because of the growing importance of economies of scale.”
• Regulatory outlook: “There’s been a lot of attention, almost an obsession, with trying to see if you can trace back a particular deregulatory action, either in the 2018 legislation or the 2019 Fed reg, to the failure of SVB,” Tarullo said. “I think it kind of misses the point.” He noted that under the 2018 legislation, the Fed can ramp up scrutiny on banks between $100-250 billion in assets.
• Unique environment? Any regulatory changes would depend on whether supervisors can be relied upon and whether the factors behind SVB’s demise are idiosyncratic or broader, Tarullo said. He noted some unusual phenomena in the backdrop of the failure, such as high levels of pandemic-era deposits and rapidly rising interest rates. “To what extent did the failures of SVB and Signature … reflect the confluence of a set of conditions that are likely to be non-persistent, and if that’s the case, the implication would be that maybe we don’t need major regulatory changes,” Tarullo said. “If, on the other hand, these are seen to be less idiosyncratic and more a canary in the coal mine kind of situation, then of course, we’d need to be thinking about major regulatory changes.”
• Pushed into the shadows: “Every time we tighten regulation for very good reasons, whether for large banks, medium-sized banks or small banks, there’s some bleeding out of the regulated system into the shadow banking system,” Tarullo said. “If we’re going to proceed down a path of tighter regulation for the banks, particularly the medium-sized banks, we need to be aware of both the risks from shadow banking, but also the competition being provided.”
• Deposits: Tarullo called for the Fed to release more information about large bank deposits. Raising the deposit insurance threshold, for example, to $1 million, wouldn’t necessarily preclude bank runs, and considering blanket deposit insurance shouldn’t be taken lightly, he said.

5. Stablecoin Risk Fears Come Full Circle

Circle stablecoin USDC has plummeted to about a $30.7 billion market cap from a peak of more than $56 billion last year. The coin’s market cap has plunged about $13 billion since the bank failures in March, according to Bloomberg. Crypto firms are pressing U.S. policymakers for legislation. “It’s a critical moment here in the US and, as I like to say, it’s really a moment for Congress to step up,” Circle CEO Jeremy Allaire said in the Bloomberg piece. He also said “We are seeing a huge amount of concern globally about the US banking system,” and “we are seeing concern about the regulatory environment in the US.” Allaire appears to be missing the massive stablecoin run right in front of his eyes and blaming recent banking system stress for crypto woes.

In Case You Missed It

The Crypto Ledger

The Republican-led draft stablecoin bill circulating in Congress this week would create a path for insured bank subsidiaries and nonbanks to receive federal approval to become payment stablecoin issuers. State approved entities also could become such issuers, according to Bloomberg. The draft bill focuses on “payment stablecoins” used as a medium of exchange and does not include algorithmic stablecoins like TerraUSD, whose collapse ignited a crypto panic last year. One key question is how any stablecoin bill will handle Fed account access for nonbank stablecoin issuers, which could put the financial system at risk. Unlike the Waters draft, the current proposal would not explicitly give nonbank stablecoin issuers Fed accounts. Here’s what else is new in crypto.

• Binance pressure: Crypto giant Binance faces regulatory scrutiny on multiple fronts, and CEO Changpeng Zhao has hired new attorneys as legal pressures intensify. “The legal threats have converged to create the most precarious moment in Binance’s history,” the New York Times reported in a recent piece. “Criminal charges against Mr. Zhao or his company could set off mass panic in the crypto markets, which are reeling from the FTX exchange’s collapse last year and the arrest of the firm’s founder, Sam Bankman-Fried. Binance is several times larger than FTX was, processing tens of billions of dollars in trades every day.”
• Coinbase strikes back: Coinbase filed a lawsuit against the SEC to push the regulator to establish new rules for crypto securities. The lawsuit marks a new stage in the legal standoff between the agency and the crypto exchange, which reportedly faces an upcoming SEC enforcement action.
• End of a voyage: Binance.US terminated its deal to buy bankrupt Voyager Digital’s assets. Reasons for the termination were unclear, but the move comes at a time of intense regulatory scrutiny of Binance and the links between the global crypto exchange and its supposedly separate U.S. structure.

CFPB Ex-Staffer in Email Breach was Examiner

The former CFPB staffer responsible for the data breach containing confidential supervisory information and sensitive consumer information was an examiner working in supervision, according to a recent Law360 piece. The former employee forwarded confidential supervisory information on 45 firms and identifying information for more than 250,000 consumer accounts. The breach is drawing criticism from members of Congress. According to a financial services attorney in a different Law360 piece, the incident is “a tremendous blow to the credibility of the bureau.”

EU Takes Step Toward New Resolution Framework

The European Commission recently adopted a proposal to modify the EU’s resolution framework, with a focus on mid-sized and smaller banks. The updates aim to preserve financial stability and ensure that taxpayers do not bear losses from bank failures. The framework would tap “deposit guarantee schemes” in a bank failure after a bank uses up its internal loss absorbing capacity and only for banks that were “already earmarked for resolution in the first place,” according to a European Commission factsheet. “The proposed rules will allow authorities to fully exploit the many advantages of resolution as a key component of the crisis management toolbox,” the factsheet said.

• Deposit insurance: The deposit insurance limit of 100,000 euros per eligible depositor per bank remains, but the new proposal would harmonize standards across the EU; extend depositor protection to public entities like schools and city governments and client money deposited in certain types of funds; and protect temporarily high bank account balances in situations “linked to specific life events” like inheritances.
• Next steps: The legislation will be discussed next by the European Parliament and Council.

Central Banks Getting Up from the Floor

A recent Bank for International Settlements speech by Claudio Borio lays out the costs of central banks using “floor” systems (abundant reserves systems) to set interest rates. Returning to scarce reserve, or “corridor”, systems may have several benefits, he suggests. The costs of floor systems may take time to appear and become obvious; implementation challenges of corridor systems may be overestimated; and there is no need to wait for the central bank balance sheet to shrink before moving in that direction, Borio says. “A useful guiding principle is that its size should be as small as possible, and its composition as riskless as possible, in a way that is compatible with the central bank fulfilling its mandate effectively,” he says of central bank balance sheets. The speech cites a BPI note entitled “The Fed is stuck on the floor: here’s how it can get up.”

Wells Fargo Unveils Partnership for Creating Inclusive Communities

Wells Fargo and the T.D. Jakes Group this week announced a 10-year partnership aimed at creating inclusive communities for people of all income levels. Wells Fargo has committed up to $1 billion to fund a range of community development projects as part of the initiative.