Silicon Valley Bank was chartered by the state of California. Its state regulatory agency was the California Department of Financial Protection and Innovation (DFPI). SVB was also a member of the Federal Reserve System so the Fed had some supervisory power. Finally, the bank was a member of FDIC, the third regulatory agency.
In the first article in this series, I had to correct an error. I mistakenly thought SVB was not a member of the Fed. Looking back, that was dumb. CEO Greg Becker was on the Board of Directors of the San Francisco Fed. It would be unusual for a non-member bank CEO to be on that board. My bad.
One question that has come up repeatedly is whether this was a failure of regulation. Prof. John Cochrane (Stanford and Hoover Institution) is a strong proponent of this idea on his blog “The Grumpy Economist.“ The article is well-argued with some empirical support. The comments are also generally informed and offer a variety of views. Give it a read if you have the time.
I believe Prof. Cochrane is mistaken. As I wrote March 17,
But it is frankly unbelievable that the Fed and/or FDIC didn’t know what was going on. They looked at the situation and realized that the bank needed to be put out of its misery before causing any more damage. The best solution was exactly what happened. Close the bank, call in FDIC and let the professionals sort everything out.
On March 19 the New York Times published an article about this very subject: “Before Collapse of Silicon Valley Bank, the Fed Spotted Big Problems.” (May be paywalled, but this link should work.) I’m going to summarize the story.
Time Travel to 2021
Supervisors at the San Francisco Fed noticed something was amiss at SVB. They issued six citations in the form of “matters requiring attention” and “matters requiring immediate attention.” Their concern was the bank’s liquid assets were inadequate to keep the bank afloat if trouble hit.
In response, did SVB move to liquidate some assets? Of course not. As far as I can tell from the Times article, the bank officers did exactly nothing.
By July, 2022, SVB was under full supervisory review. Let the Times tell the story:
But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was in a full supervisory review — getting more careful look — and was ultimately rated deficient for governance and controls. It was placed under a set of restrictions that prevented it from growing through acquisitions. Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose.
The Fed figured out that SVB’s models of risk were bad. The bank was assuming interest (coupon payments) on debt they held would rise with interest rates! This supports my guess that CEO Greg Becker knew nothing about banking (or finance).
Then Came 2023
Early in the year, SVB was put under a “full horizontal review.” The Fed was trying to assess the quality of risk management. Once again, deficiencies were found and the bank was notified.
SVB held 97% of its deposits that were above the FDIC $250,000 limit for insurance. This is an interesting form of risk. With that much in uninsured deposits, the account owners were likely to bail out at the first hint of trouble. In other words, a bank run would be swift and fatal for the bank. An additional source of risk is a customer base concentrated in a single industry, in this case technology firms.
January 2023 saw a retrenchment in Silicon Valley. Here’s the link to my earlier article about layoffs by tech companies. The Times adds that the decision to shift assets into long-term government securities increased interest rate risk exposure.
Many (including the Times) call SVB’s collapse a failure of regulation. I don’t believe that. What more could the regulators have done? They are regulators, not the bank’s managers. As such, they can advise management, but not make decisions for them. They issued a series of increasingly serious warnings. Greg Becker and his merry band of incompetents ignore the advice. This is a management failure.