After SVB Collapse, Fed and Lawmakers Eye Bank Rules

The Federal Reserve is facing criticism over Silicon Valley Bank’s collapse, with lawmakers and financial regulation experts asking why the regulator failed to catch and stop seemingly obvious risks. That concern is galvanizing a review of how the central bank oversees financial institutions — one that could end in stricter rules for a range of banks.

In particular, the episode could result in meaningful regulatory and supervisory changes for institutions — like Silicon Valley Bank — that are large but not large enough to be considered globally systemic and thus subject to tougher oversight and rules. Smaller banks face lighter regulations than the largest ones, which go through regular and extensive tests of their financial health and have to more closely police how much easy-to-tap cash they have to serve as a buffer in times of crisis.

Regulators and lawmakers are focused both on whether a deregulatory push in 2018, during the Trump administration, went too far, and on whether existing rules are sufficient in a changing world.

While it is too early to predict the outcome, the shock waves that Silicon Valley Bank’s demise sent through the financial system, and the sweeping response the government staged to prevent it from inciting a nationwide bank run, are clearly intensifying the pressure for stronger oversight.

“There are a lot of signs of a supervisory failure,” said Kathryn Judge, a financial regulation expert at Columbia Law School, who also noted that it was too early to draw firm conclusions. “We do need more rigorous regulations for large regional banks that more accurately reflect the risks these banks can pose to the financial system,” she said.

The call for tougher bank rules echoes the aftermath of 2008, when risky bets by big financial firms helped to plunge the United States into a deep recession and exposed blind spots in bank oversight. The crisis ultimately led to the Dodd-Frank law in 2010, a reform that ushered in a series of more stringent requirements, including wide-ranging “stress tests” that probe a bank’s ability to weather severe economic situations.

But some of those rules were lightened — or “tailored” — under Republicans. Randal K. Quarles, who was the Fed’s vice chair for supervision from 2017 to 2021, put a bipartisan law into effect that relaxed some regulations for small and medium-size banks and pushed to make day-to-day Fed supervision simpler and more predictable.

Critics have said such changes could have helped pave the way for the problems now plaguing the banking system.

“Clearly, there’s a problem with supervision,” said Daniel Tarullo, a former Fed governor who helped shape and enact many post-2008 bank regulations and who is now a professor at Harvard. “The lighter touch on supervision is something that has been a concern for several years now.”

The Federal Reserve Bank of San Francisco was in charge of overseeing Silicon Valley Bank, and experts across the ideological spectrum are questioning why growing risks at the bank were not halted. The firm grew rapidly and took on a large number of depositors from one vulnerable industry: technology. A large share of the bank’s deposits were uninsured, making customers more likely to run for the exit in a moment of trouble, and the bank had not taken care to protect itself against the financial risks posed by rising interest rates.

Worsening the optics of the situation, Greg Becker, the chief executive of Silicon Valley Bank, was until Friday on the board of directors at the Federal Reserve Bank of San Francisco. The Fed has said reserve bank directors are not involved in matters related to banking supervision.

Questions about bank oversight ultimately come back to roost at the Fed’s board in Washington — which, since the 2008 crisis, has played a heavier role in guiding how banks are overseen day to day.

The board has indicated that it will take the concerns seriously, putting its new vice chair of supervision, Michael Barr, in charge of the inquiry into what happened at Silicon Valley Bank, the Fed announced this week.

“The events surrounding Silicon Valley Bank demand a thorough, transparent and swift review by the Federal Reserve,” Jerome H. Powell, the Fed chair, said in a statement.

It is unclear how much any one of the 2018 rollbacks would have mattered in the case of Silicon Valley Bank. Under the original postcrisis rules, the bank, which had less than $250 billion in assets, most likely would have faced a full Fed stress test earlier, probably by this year. But the rules for stress tests are complex enough that even that is difficult to pinpoint with certainty.

“Nobody can say that without the 2018 rollbacks none of this would have happened,” Ms. Judge said. But “those rules suggested that banks in this size range did not pose a threat to financial stability.”

But the government’s dramatic response to Silicon Valley Bank’s collapse, which included saving uninsured depositors and rolling out a Fed rescue program, underlined that even the 16th-largest bank in the country could require major public action.

Given that, the Fed will be paying renewed attention to how those banks are treated when it comes to both capital (their financial cushion against losses) and liquidity (their ability to quickly convert assets into cash to pay back depositors).

There could be a push, for instance, to lower the threshold at which the more onerous regulations begin to apply. As a result of the 2018 law, some of the stricter rules now kick in when banks have $250 billion in assets.

Another major focal point will be the content of stress tests. While banks used to be run through an “adverse” scenario that included creative and unexpected shocks to the system — including, occasionally, a jump in interest rates like the one that bedeviled Silicon Valley Bank — that scenario ended with the deregulatory push.

An interest rate shock will be included in this year’s stress test scenarios, but the larger question of what risks are reflected in those exercises and whether they are sufficient is likely to get another look. Many economists had assumed that inflation and interest rates would stay low for a long time — but the pandemic upended that. It now seems clear that bank oversight made the same flawed assumption.

Many people were wrong about the staying power of low rates, and “that includes regulators and supervisors, who are supposed to think about: What are the possibilities, and what are the scenarios?” said Jonathan Parker, the head of the finance department at the Massachusetts Institute of Technology’s Sloan School of Management.

And there is a bigger challenge laid bare by the current episode: Several financial experts said the run on Silicon Valley Bank was so severe that more capital would not have saved the institution. Its problem, in part, was its huge share of uninsured deposits. Those depositors ran rapidly amid signs of weakness.

That could spur greater attention in Congress and among regulators regarding whether deposit insurance needs to be extended more broadly, or whether banks need to be limited in how many uninsured deposits they can hold. And it could prompt a closer look at how uninsured deposits are treated in bank oversight — those deposits have long been looked at as unlikely to run quickly.

In an interview, Mr. Quarles pushed back on the idea that the changes made under his watch helped to precipitate Silicon Valley Bank’s collapse. But he acknowledged that they had created new regulatory questions — including how to deal with a world in which technology enables very rapid bank runs.

“Certainly, none of this resulted from anything that we changed,” Mr. Quarles said. “You had this perfect flow of imperfect information that really increased the speed and intensity of this run.”

In the days after the collapse, some Republicans focused on supervisory failures at the Fed, while many Democrats focused on the aftershocks of deregulation and possible wrongdoing by the bank’s executives.

“All the regulators had to do was read the reports that Silicon Valley Bank was submitting, and they would have seen the problem,” Senator John Kennedy, Republican of Louisiana and a member of the Banking Committee, said on the Senate floor.

By contrast, two Senate Democrats — Elizabeth Warren of Massachusetts and Richard Blumenthal of Connecticut — sent a letter to the Department of Justice and the Securities and Exchange Commission on Wednesday urging the agencies to investigate whether senior executives involved in the collapse of Silicon Valley Bank had fallen short of their regulatory responsibilities or violated laws.

Ms. Warren also unveiled legislation this week, co-sponsored by roughly 50 Democrats in the House and Senate, that would reimpose some of the Dodd-Frank requirements that were rolled back in 2018, including regular stress testing.

Senator Sherrod Brown, Democrat of Ohio and chairman of the Banking Committee, told reporters that he intended to hold a hearing examining what happened “as soon as we can.”

Mr. Barr, who started at the Fed last summer, was already reviewing a number of the Fed’s regulations to try to determine whether they were appropriately stern — a reality that had spurred intense lobbying as financial institutions resisted tougher oversight.

But the episode could make those counterefforts more challenging.

Late on Monday, the Bank Policy Institute, which represents 40 large banks and financial services companies, emailed journalists a list of its positions, including claims that the failures of Silicon Valley Bank and Signature Bank were caused by “primarily a failure of management and supervision rather than regulation” and that the panic surrounding the collapses proved how resilient big banks were to stress, since they were largely unaffected by it.

The trade group also emailed those talking points to congressional Democrats, but other trade groups, including the American Bankers Association, have stayed silent, according to a person familiar with the matter.

“We share President Biden’s confidence in the nation’s banking system,” a spokesman with the American Bankers Association said. “Every American should know that their accounts are safe and their deposits are protected. Our industry will work with the administration, regulators and Congress to further bolster that trust.”

The fallout could also kill big banks’ attempts to roll back regulations that they say are inefficient. The largest banks had wanted the Fed to stop forcing them to hold cash equivalents to what they say are safe securities like U.S. government debt. But Silicon Valley Bank’s failure was caused in part by its decision to keep a large portion of depositors’ cash in longer-dated U.S. Treasury bonds, which lost value as interest rates rose.

“This definitely underscores why it is important that there be some capital requirement against government-backed securities,” said Sheila Bair, a former chair of the Federal Deposit Insurance Corporation.

Catie Edmondson contributed reporting.