Vice Chairman of Federal Oversight Michael Barr told the Senate Banking Committee on Tuesday that he anticipates the need to strengthen capital and liquidity rules for some regional banks in the wake of the Silicon Valley bank’s dramatic collapse.
His admission came during an exchange with Democratic Sen. Elizabeth Warren, who pressed Barr, FDIC Chairman Martin Greenberg and Undersecretary of the Treasury Nellie Liang to acknowledge the need for tougher action to prevent such failures in the future. Warren said the Fed has the authority to hold between $100 billion and $250 billion in bank assets to stricter standards. The Silicon Valley bank had $209 billion when regulators seized it on March 10, becoming the second largest bank failure in US history.
“I foresee the need to enhance capital and liquidity standards for banks by more than $100 billion,” Barr said in response to Warren.
The comments were the strongest indication yet that the top Fed official responsible for overseeing banks favors a rewrite of rules governing regional lenders that were relaxed at the end of the last decade. Those changes in 2018 and 2019 freed financial institutions the size of Silicon Valley’s bank from some of the stricter requirements imposed in the aftermath of the 2008 financial crisis, a downturn that pushed the banking system to the brink.
One of the major modifications was the Fed’s decision to Exempting banks with assets between $100 and $250 billion from maintaining a standardized “Liquidity Coverage Ratio” It is designed to show whether the lender has enough high-quality liquid assets to survive the crisis. Another decision was to allow most SMEs to opt out of deducting paper losses on bonds from key regulatory capital levels. Silicon Valley Bank was among the banks that benefited from these two changes.
Lawmakers pressed Barr repeatedly on Tuesday over whether he believed the Fed had failed to do its job as supervisor in the Silicon Valley bank case. “By all accounts, it looks like our regulators fell asleep at the wheel,” said Senator Tim Scott, the top Republican on the committee.
Barr argued that the bank’s downfall was instead “a typical case of bank mismanagement”. He, Gruenberg, and Liang pointed to management errors such as a high percentage of uninsured deposits as well as huge portfolio losses. Their testimony came just one day after First Citizens announced a deal to acquire the Silicon Valley bank Loans and deposits from the FDICwho has been in charge of the bank since March 10.
Bank’s fall was swift. It happened just two days later DisclosuresIt will take a $1.8 billion loss on the sale of some depreciated bonds due to higher interest rates and will look to raise an additional $2.25 billion in capital to boost its balance sheet. More than $40 billion was withdrawn from the bank on March 9, coinciding with the failed capital raise that eventually wiped out the bank.
Barr said the Silicon Valley bank “failed because its management failed to adequately address obvious interest rate risks and articulate liquidity risks.”
Barr said he first became aware of the interest rate risks the Silicon Valley bank was taking in the middle part of last month, when Federal Reserve staff made a presentation that highlighted the bank as part of a larger discussion about such risks across the system. He said staff had indicated that they were in the middle of a review and were expected to return to the bank soon on the matter.
“It was the first time I was told about the interest rate risk of Silicon Valley Bank,” he said.
According to his testimony, Fed supervisors first found deficiencies in the bank’s liquidity risk management near the end of 2021, resulting in six supervisory findings related to the bank’s liquidity stress testing, emergency financing, and liquidity risk management. In May 2022, the supervisors released three findings related to ineffective board oversight, weaknesses in risk management, and the bank’s internal audit function.
In October 2022, the supervisors met with the bank’s senior management to express their concern about the bank’s interest rate risk profile. The following month, the supervisors delivered a supervisory conclusion on the management of interest rate risk to the bank.
As it turns out, the full extent of the bank’s weakness wasn’t apparent until the bank’s unexpected rally on March 9th. Barr told lawmakers on Tuesday that by the evening of March 9, more than $42 billion had left the bank, as early as the morning. On March 10, the bank expected the outflow to be “much larger,” it said. “A total of $100 billion was due to go out the door that day.” It was taken over hours later.
Many lawmakers wanted to know why the FDIC couldn’t find a private buyer for the Silicon Valley bank sooner. Scott said that “better private sector engagement with faster action” would have eased investor concerns surrounding regional banks.
The FDIC’s Gruenberg said that one of the bids he received over the weekend after the failure was not valid because the company’s board of directors had not signed off on the bid, and the second bid was more costly to the FDIC than an outright liquidation of the Silicon Valley bank’s assets.
On March 12, Treasury Secretary Janet Yellen, with recommendations from the Fed and the FDIC, approved systemic risk exceptions for the failures of Silicon Valley and New York’s Signature Bank, enabling the FDIC to underwrite all deposits of both banks. This guarantee is backed by the FDIC’s Deposit Insurance Fund, which is funded by ratings from all the banks.
Republican Sen. Cynthia Loomis said she worries that banks in her home state of Wyoming may end up paying for these collapses with higher FDIC ratings. Gruenberg said community banks could be excused from the higher payments. “We have some discretion here and we’ll look into that,” Groenberg said.
Loomis told Barr that the Fed has the power to change the way it supervises banks the size of Silicon Valley and it can do so now. “I can’t think of another additional rule, regulation or law that you need,” she said. Sen. Tom Tillis, another Republican, warned that any changes that increase requirements for banks “by default” could hamper institutions that haven’t engaged in the same risky practices as Silicon Valley’s bank.
Barr and Gruenberg both agreed that the rules for banks with assets of less than $250 billion that were put in place in 2019 will be closely reviewed. In fact, Gruenberg voted against them in 2019 when he was on the FDIC board. “Do you still think it was a bad idea?” Warren asked him on Tuesday.
“I do,” Gruenberg said.
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