Bank Regulation after SVB

Below are our nine initial impressions of the Fed’s report.1  All emboldening is ours. Our citations are not exhaustive nor are they necessarily exclusive to one impression, only, but we only show a citation once. Overall, anticipate more supervision—more exams, more horizontal reviews, and more attempts to reverse the loosening of scrutiny in 2017 – 2020.

1. They won’t let history repeat.

If your bank has any of SVB’s deficiencies, anticipate findings, rather than warnings or suggestions, especially if such items have been mentioned in the past. A review of those findings is really the bulk of the report in pages 27– 66. See pages 2729, 40, 48, (especially) 50, 54, and 65 for tables and summaries of SVB’s deficiencies related to governance, interest rate risk, and liquidity risk.

2. Don’t (or no longer) anticipate the benefit of the doubt or patience.

  • “The supervisory record on SVBFG shows a focus on consensus-building and a perceived need to form ironclad assessments about what had already gone wrong and less on judgments with a more open mind about what could go wrong.”  pg 97
  • “This experience also suggests an opportunity to shift the culture of supervision toward a greater focus on inherent risk, and more willingness to form judgments that challenge bankers with a precautionary perspective.” pg 97
  • Rehashing supervisory lapses prior to The Financial Crisis, “…supervisors who identified deficiencies but did not always demand swift corrective action or hold managers accountable when deficiencies were identified and communicated;” pg 93
  • “… in some instances, supervisors saw progress on remediation of supervisory findings or risk-management gaps as positive developments on a relative basis, rather than citing the gap that continued to exist relative to baseline expectations.”  pg 51
  • Key Takeaway 3 on page ii: “When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.” pg ii
  • “Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment.” pg ii
  • “With regard to interest rate risk-management, supervisors identified interest rate risk deficiencies in the 2020, 2021, and 2022 CAMELS exams but did not issue supervisory findings (MRA/MRIA). The deficiencies were only communicated as written advisories or verbal observations.”  pg 9

3. Be proactive, not simply reactive to findings

Don’t wait. Self-identify weaknesses (or risk being identified as manager who can’t identify risks and weaknesses).

  • The word “proactive” appears eight times.
  • ’Management has been reactive as opposed to proactive in certain risk identification aspects but has demonstrated the ability and the willingness to address supervisory matters. An independent and effective LOD [line of defense] framework is fundamental to the Board and management’s ability to plan for and respond to risks arising from changing business conditions, new activities, accelerated growth, and increasing complexity.’ These issues indicate that risk management was lacking in important and fundamental ways and, therefore, are a cause for more than normal supervisory attention. Further, management was not identifying issues. They were reacting to supervisors identifying the issues.” pg 47
  • “The review of these materials provides indications that management was only addressing issues in response to supervisory findings rather than being proactively focused on safe and sound operation of the firm. SVBFG’s materials seemed focused on compliance with EPS or responding to supervisory findings, rather than managing the actual risks of the firm. They had not yet demonstrated that strong risk management, internal audit, and board oversight are critical to the safe and sound operation of an institution.” pg 51
  • “Enhance Risk Identification” “… weak risk identification can have severe consequences…” and “Supervisors can reconsider what types of foundational exams are most relevant for firms of all sizes to ensure appropriate identification of risks.”  pg 95, 96
  • Key Takeaway #2 on page i: “Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.” pg i

4. Growing firms that are near asset thresholds will need to be better prepared
…and will be given less time to meet supervisory expectations.

  • “… the firm was not prepared for EPS.” (EPS is short for “Enhanced Prudential Standards.”) pg 35
  • “The impact of these supervision weaknesses is that SVBFG’s size and risk profile substantially outpaced liquidity risk-management practices, and SVBFG was materially unprepared for the EPS requirements that would come into 53
  • “Further, the long transition periods provided by the rules that did apply further delayed the implementation of requirements such as stress testing that may have contributed to the resiliency of the firm.” pg 91
  • “While supervisors did issue supervisory findings, the delay in a rating downgrade meant that SVBFG effectively continued to operate below supervisory expectations for more than a year despite its growing size and complexity.” pg 9

5. Anticipate lower asset-size thresholds for increased scrutiny.

This means increased expectations for all bank holding companies, except possibly for Category I firms. We make no predictions for statutory changes for Category II, III, IV or “other” (over $50B) firms, but:

  • The entire section, “Federal Reserve Regulation” in pages 8191, especially page 87 and the conclusion on page 91: “A comprehensive assessment of changes from EGRRCPA, the 2019 tailoring rule, and related rulemakings show that they combined to create a weaker regulatory framework for a firm like SVBFG….”
  • “These reviews focused on the largest, most systemically important firms, which are now supervised as part of the LISCC program. The fact that smaller institutions such as SVBFG can drive systemic disruptions suggests that one might consider lessons from these reviews and development of the LISCC portfolio for a broader range of firms where distress could have systemic implications.”  pg 94
  • Key Takeaway 4 on page iii: “The Board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.” pg iii
  • “Over the same period, supervisory policy placed a greater emphasis on reducing burden on firms, increasing the burden of proof on supervisors, and ensuring that supervisory actions provided firms with appropriate due process. Although the stated intention of these policy changes was to improve the effectiveness of supervision, in some cases, the changes also led to slower action by supervisory staff and a reluctance to escalate issues.” pg iii
  • “Specifically, the threshold for EPS was raised from $50 billion in assets to $100 billion in assets, and SVBFG was subject to a less stringent set of EPS when it reached the $100 billion threshold than would have applied before 2019 (see the “Federal Reserve Regulation” section). Critically for supervision, the Board raised the threshold for heightened supervision by the LFBO portfolio from $50 billion in assets to $100 billion in assets in July 2018 to track the new EGRRCPA thresholds…”   pg 10, 11

6. However, thresholds don’t need to be lowered to increase regulatory scrutiny and findings.

This is just a sampling of the regulations and expectations mentioned:

  • SR 10 – 1, interest rate risk, which applies to all banks. Anticipate renewed emphasis on EVE, not just NII.
  • SR 10 – 6, liquidity risk. “The examination cited foundational liquidity risk-management weaknesses across all areas reviewed. Importantly, the weaknesses were assessed to be gaps relative to both interagency guidance—applicable to banks of all sizes—and Regulation YY EPS that reflect heightened standards for firms like SVBFG.” pg 54
  • SR 12 – 7: stress testing, which to date has never been fully expected of non-GSIBs, applies to all banks over $10B.
  • SR 11 – 7, model risk, which lets examiners investigate nearly every aspect of a bank. “Changing model assumptions, rather than improving the actual liquidity position, is not an appropriate way to restore compliance with limits.” pg 58
  • The above isn’t all the guidance mentioned, and please don’t forget credit risk: “The nature of the findings is foundational with respect to credit risk management for a firm of SVB’s size.” pg 47

7. Wouldn’t want to be them.

“Consultants who did the initial 2020 EPS gap assessment with respect to SVBFG practices and helped execute the plan to close those gaps also failed to design an effective program.” pg 48

8. Wrong kind of gap analysis.

There’s no citation for this one, but if your initial response to enhanced supervision is “wonder what our peers are doing?” There’s a good chance that the answer will be: “getting MRAs.” Your firm needs to identify and manage its own risks, which is the best conclusion to draw from the 118-page report.

9. Do not succumb to the tyranny of metrics!

This is more advice and less impression: keep it simple! Don’t increase the size of management and board risk reports. Focus on what matters: how can you lose money and what are you going to do about it? If you can do that, you’ll make every regulator happy (unless you took their parking spot).

1. Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank