- Key insight: Three years after the collapse of Silicon Valley Bank, a new report on the bank failure reminds us that the conditions leading to its failure were made possible by decisions made by the central bank’s board.
- What’s at stake: The new report’s emphasis on supervision leaves unanswered how the decisions of governors who supported weaker rules, including Bowman and Powell, contributed to SVB’s vulnerability.
- Forward look: The public does not need another Dickens-length novel about what happened at SVB. Three of the most obvious fixes are straightforward: Require banks with over $100 billion in assets to reflect unrealized losses on their available-for-sale securities in capital, apply the full liquidity coverage ratio to them, and subject them to the annual stress test that includes scenarios capturing interest-rate risk.
Last month, a consulting firm hired by Federal Reserve Board Vice Chair for Supervision Michelle Bowman publicly released its preliminary report on why Silicon Valley Bank failed. It runs over 300 pages, and the firm says additional reports and recommendations are planned through 2027. The report revisits events already covered by the Federal Reserve’s 2023 review, the Government Accountability Office‘s examination and the Fed’s Inspector General report. While policymakers devote yet more time and money to relitigating SVB’s collapse to reassign blame, the very policies that enabled its failure remain on the books, notwithstanding extensive evidence of their important role in SVB’s failure.
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The basic facts of SVB’s failure are undisputed. The bank held too many long-dated Treasuries and mortgage-backed securities that lost substantial value after the Federal Reserve raised interest rates. It also had an unstable and highly concentrated deposit base that was over 90% uninsured. Yet the board’s rules still allow a bank with SVB’s size and risk profile to exclude unrealized losses on available-for-sale securities from regulatory capital, remain exempt from the full liquidity coverage ratio requirement, and only undergo the Fed’s stress testing every other year, after a multiyear transition period.
Two of the exemptions that hastened SVB’s collapse were created by the board’s 2019–2021 deregulation referred to as “tailoring rules.” The third exemption allows banks to exclude unrealized gains and losses on available-for-sale securities from regulatory capital. While it predates tailoring, in 2019 the board further narrowed the recognition requirement to generally cover banks with at least $700 billion in assets or $75 billion in cross-jurisdictional activity. Under the prior rule, the Fed’s own prior review conceded that SVB would have had to recognize those losses beginning in 2021. The deregulation tailoring project was championed by then-Chair Jerome Powell, then-Vice Chair for Supervision Randal Quarles and then-Governor Michelle Bowman.
Bowman’s presentation of the latest SVB retrospective argues that Congress’ 2018 deregulation law mandating additional tailoring did not cause supervisory delays. Her focus on supervision ignores the more important question: whether the board’s decision to go beyond the 2018 deregulation law’s directive to weaken regulatory safeguards made SVB more vulnerable to failure. Recall that when Congress raised the threshold for automatic enhanced prudential standards from $50 billion to $250 billion in assets, it left the board ample discretion to apply capital, liquidity, and stress testing requirements to banks between $100 billion and $250 billion (SVB had approximately $212 billion in assets when it failed). The board, led by Powell and Quarles with Bowman’s support, chose a substantially weaker framework, buying into the misguided view at the time that these mega-regional banks (those between $100 billion and $700 billion in assets) were somehow being harmed by post-2008 crisis rules.
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The latest report focuses primarily on whether Fed supervisors should have used their discretion to crack down on SVB. But that focus misses the more important story: While career Fed supervisors could have acted sooner and harder on SVB, a significant share of the responsibility for the conditions that enabled SVB’s failure lies with the Fed governors who decided to adopt much weaker rules in the first place. Rules — which by design apply automatically — do not depend on an examiner’s judgment. Once the governors removed those key rules for the mega-regional banks through “tailoring,” every missing protection had to be rebuilt by examiners one large bank at a time, and taking action required defending their directives up the chain to Washington. Career examiners were left to apply bank-specific safeguards within an institution whose top leadership had just affirmatively weakened its most important and effective rules.
Bowman herself acknowledged that a stress test scenario incorporating rising interest rates and fair-value securities losses could have exposed SVB’s vulnerability as early as late 2021. That is the key lesson of SVB: Large banks require both strong regulation and strong supervision because each is a backstop for the other. Strong rules can carry a bank through a period of weak or ineffective supervision because they are binding without an examiner having to identify, escalate, and negotiate a fix. For example, had the governors not removed the liquidity coverage ratio requirement for banks like SVB, it would have faced the full liquidity coverage ratio requirement and quarterly public disclosure of its ratio. The Fed’s own analysis and other independent researchers found that SVB’s liquidity fell short of the liquidity coverage ratio requirement — creating a vulnerability that a binding requirement and public scrutiny could have pushed the bank to preemptively address.
Similarly, strong supervision can sometimes catch what the rules miss. When both are weakened at a large, complex bank, the predictable result is what occurred with SVB. Tailoring weakened the first backstop — the rules — for banks like SVB. The Fed’s supervisory failures removed the second. The new report’s emphasis on supervision leaves unanswered how the decisions of governors who supported weaker rules, including Bowman and Powell, contributed to SVB’s vulnerability.
Everyone in Washington knows that the failure of a mega-regional bank can create a banking crisis. Although the Fed has proposed expanding recognition of unrealized securities losses in capital, that reform remains unfinished and accompanies broader proposed reductions in capital requirements. With a few dissenting exceptions, the board has pursued lower capital requirements for the largest banks and mega-regional banks, changes to stress testing that would weaken it through procedural hurdles, and a multiyear review that reads as an effort to exonerate the officials who championed the deregulation tailoring project. SVB’s board and management were primarily responsible for its failure. Regulation and supervision exist to constrain precisely the risks that bank leaders fail to manage.
The public does not need another Dickens-length novel about what happened at SVB. Three of the most obvious fixes are straightforward: Require banks with over $100 billion in assets to reflect unrealized losses on their available-for-sale securities in capital, apply the full liquidity coverage ratio to them, and subject them to the annual stress test that includes scenarios capturing interest-rate risk.
The vice chair for supervision’s consultant promises more reports in 2027. The board should not wait for them because it already knows what to do. The question is whether Fed governors would rather engage in a blame-game and fight about the last failure or take obvious action to prevent the next one.
