Washington, D.C. – Bank Policy Institute Senior Fellow Jeremy Newell will testify today before the U.S. House Oversight & Accountability Committee’s Subcommittee on Health Care and Financial Services at a hearing entitled “A Failure of Supervision: Bank Failures and the San Francisco Federal Reserve.” Newell’s testimony offers key takeaways on the Federal Reserve’s supervision of Silicon Valley Bank. The materials that the Fed has published so far depict a supervisory culture that focuses on process at the expense of addressing core financial risks, the testimony states.
“Taken together, the picture that we do have today strongly suggests that the Federal Reserve’s supervision of SVB may have been emblematic of a larger culture of bank supervision that has increasingly lost its way, becoming distracted from its core mission of scrutinizing bank safety and soundness and resembling something more akin to examination-as-management consulting,” Newell said in the testimony. “It also suggests that the reforms that are needed don’t simply involve ‘tougher’ supervision or more rules, but instead a broader structural reform of supervisors’ approach that is aimed at ensuring that examiners are better directing their attention and already-considerable supervisory tools to the kinds of core risks to bank financial integrity that led to SVB’s failure.”
Supervision of SVB emphasized compliance processes, governance and immaterial risks rather than key risks to the bank’s financial integrity. Examiners’ directives – matters requiring attention, or MRAs – failed to prioritize or focus on the risks that ultimately led to SVB’s failure. Supervisors failed to use all the tools at their disposal – for example, they did not enforce important enhanced prudential standards for liquidity and risk management, even though they knew SVB was not meeting those standards. And supervisors oriented much of their activity around rating frameworks designed to be subjective, with the result that SVB’s exam ratings often bore no relationship to its actual risk profile. Further analysis is necessary to diagnose and remedy these serious supervision problems, which the Fed’s recent report on SVB does not meaningfully acknowledge.
- The Fed’s supervisory approach emphasizes process over substance, as suggested by the volume of SVB examiner directives focused on issues like IT risk management and governance.
- A major challenge in oversight of bank supervision is secrecy around the supervisory process. There are sensible reasons for this confidentiality, but it results in a unique asymmetry in which the public generally only hears one side of the story: that of the banking agencies. SVB’s failure presents a rare opportunity to learn about how bank supervision happens in practice and how it can be improved.
Moving forward: Reforms to the Fed’s supervision may warrant consideration:
- Holistic and programmatic changes to appropriately focus supervisory activities, resources, and priorities on risks that are material to the financial integrity of the supervised institution, including greater emphasis on the development of independent examiner views on such risks.
- Review and reform of how the agency uses MRAs, MRIAs and other forms of supervisory criticism, including (i) clear standards that focus those tools on risks that are material to the financial integrity of the supervised institution and (ii) better prioritization by supervisors of required remediation that is consistent with those risks.
- Review and reform of all supervisory ratings systems, including the woefully outdated CAMELS framework, with a view towards making those systems more objective and better focused on risks that are material to the financial integrity of the supervised institution.
- Greater clarity and transparency as to how various authorities for supervisory activities and decisions are allocated to Federal Reserve Bank and Federal Reserve Board staff, respectively, both to the public with respect to general policies and to individual supervised institutions with respect to specific activities and decisions.
- Review of potential enhancements to internal review and oversight of supervisory activities and decisions within the Federal Reserve System.
About Bank Policy Institute.
The Bank Policy Institute (BPI) is a nonpartisan public policy, research and advocacy group, representing the nation’s leading banks and their customers. Our members include universal banks, regional banks and the major foreign banks doing business in the United States. Collectively, they employ almost 2 million Americans, make nearly half of the nation’s small business loans, and are an engine for financial innovation and economic growth.