Perspective on Risk - March 28, 2023 (The Supervision of SVB)
I’m heading out the door for my flight to Egypt, but wanted to get this out so it isn’t stale.
The Supervision of SVB
Fed Vice Chair for Supervision Michael S. Barr provided written testimony on the SVB failure. Reading this, and recognizing he will put the best spin possible on the Fed’s efforts, I am actually fairly impressed by my former FRBSF and Board colleagues. They were on the issues, made the timely and tough call on the ratings, put the onus on management, and supervisors were connected to senior policymakers.
Connecting Monetary Policy & Bank Supervision
I Stand Corrected - I has previously written than it appeared there was a breakdown between the supervision and monetary policy wings of the Fed.
In mid-February 2023, staff presented to the Federal Reserve's Board of Governors on the impact of rising interest rates on some banks' financial condition and staff's approach to address issues at banks. Staff discussed the issues broadly, and highlighted SVB's interest rate and liquidity risk in particular. Staff relayed that they were actively engaged with SVB but, as it turned out, the full extent of the bank's vulnerability was not apparent until the unexpected bank run on March 9.
So the Board was aware. Maybe the process wasn’t proactive enough, or maybe the bureaucracy resulted in a delay in presentation, but the key point is that the connection DID exist.
I read this paragraph as admitting they weren’t proactive enough:
As I said a few months ago with regards to capital, we must be humble about our ability—and that of bank managers—to predict how a future financial crisis might unfold, how losses might be incurred, and what the effect of a financial crisis might be on the financial system and our broader economy.
There Was a Timely Downgrade
In the summer of 2022, supervisors lowered the bank's management rating to "fair" and rated the bank's enterprise-wide governance and controls as "deficient-1." These ratings mean that the bank was not "well managed" and was subject to growth restrictions under section 4(m) of the Bank Holding Company Act
Some other observations:
The Fed upped the level of supervision as SVB rapidly grew. This appears pretty timely.
In 2021, as the bank grew rapidly in size, the bank moved into the large and foreign banking organization, or LFBO, portfolio to reflect its larger risk profile and was assigned a new team of supervisors. LFBO firms between $100 billion and $250 billion are subject to some enhanced prudential standards but not at the level of larger banks or global systemically important banks (G-SIBs).
The examiners appear to have hit many of the right issues six to twelve months in advance:
Liquidity Risk Management
Near the end of 2021, supervisors found deficiencies in the bank's liquidity risk management, resulting in six supervisory findings related to the bank's liquidity stress testing, contingency funding, and liquidity risk management.
Not entirely clear, though, if they hit on the volatile nature of SVB’s deposits.
Interest Rate Risk Management
In October 2022, supervisors met with the bank's senior management to express concern with the bank's interest rate risk profile and in November 2022, supervisors delivered a supervisory finding on interest rate risk management to the bank.
And let’s remember that it was AFTER this that SVB decided to no longer hedge its interest rate risk position.
Risk Management and Internal Audit Deficiencies
In May 2022, supervisors issued three findings related to ineffective board oversight, risk management weaknesses, and the bank's internal audit function.
See you in a few weeks.