Last week, Federal Reserve Chairman Jerome Powell told reporters that in the days following the rapid collapse of Silicon Valley Bank, the main question regulators asked themselves was: “How did this happen?” The man responsible for answering that question is the central bank’s vice chair for supervision, Michael S. Barr, who is set to give testimony to the U.S. Senate Committee on Banking, Housing, and Urban Affairs Tuesday. And like many, Barr plans on pinning the blame on SVB’s execs.
“SVB’s failure is a textbook case of mismanagement,” he will tell senators, according to written testimony released by the Fed Monday. “The picture that has emerged thus far shows SVB had inadequate risk management and internal controls that struggled to keep pace with the growth of the bank.”
Politicians on both sides of the aisle have been quick to call out regulators after the collapse of SVB, as well as the failures of Signature Bank and Silvergate Bank, with Tennessee Sen. Bill Hagerty telling Bloomberg Monday that he is wondering “where was the SF Fed in terms of its regulatory oversight? Was the regulatory agency asleep at the wheel here?”
Barr plans to address those concerns Tuesday, saying he is “committed” to finding “any supervisory or regulatory failings” as he conducts an official review of the bank’s collapse that will be made public by May 1.
“The events of the last few weeks raise questions about evolving risks and what more can and should be done so that isolated banking problems do not undermine confidence in healthy banks and threaten the stability of the banking system as a whole,” he plans to say, adding that it’s critical “we fully address what went wrong.”
Textbook mismanagement and unheeded warnings
As Fortune previously reported, two key factors led to SVB’s downfall. First, rising interest rates cut the value of the mortgage-backed securities and U.S. treasuries that made up the majority of the bank’s portfolio over the past year, leaving it with billions in unrealized losses.
“The bank did not effectively manage the interest rate risk of those securities or develop effective interest rate risk measurement tools, models, and metrics,” Barr plans to tell Congress about this issue.
Second, SVB’s deposits were concentrated at venture capital firms and in the tech sector. These firms kept large amounts of money at the bank to make payroll and pay operating costs which meant that 93% of its deposits exceeded the Federal Deposit Insurance Corporation’s (FDIC) $250,000 insurance limit. And when stress at the bank began, the well-connected depositors “essentially acted together to generate a bank run,” Barr will explain Tuesday, noting it’s an example of how “the bank failed to manage the risks of its liabilities.” But Barr also plans to point out that management at SVB ignored supervisors “concern with the bank’s interest rate risk profile.”
Beginning in 2019, SVB was publicly warned on multiple occasions that there were “deficiencies” in its “liquidity risk management” amid rising rates—meaning if depositors rapidly asked for their money back, a bank run could ensue. Barr also noted that regulators lowered SVB’s management rating to “fair” and ranked its “enterprise-wide governance and controls” as “deficient-1″ last year, which meant the bank was considered to be “not well managed.”
”It is not the job of supervisors to fix the issues identified,” Barr will tell Congress Tuesday. “It is the job of the bank’s senior management and board of directors to fix its problems.”
The supervision of large U.S. banks is a shared responsibility of regional Fed regulators and Fed Board staff in Washington. And the blame game has been a common theme after SVB’s collapse. Alex Mehran, who served on the San Francisco Fed’s board of directors for six years, argued in an interview with Reuters last week that enforcing banking regulations is not the purview of the regional Fed Banks and their president, “it’s the purview of the regulators in Washington”—or the staff of the Fed Board and Congress.
A look in the mirror
Although SVB’s management ignored regulators’ warnings, some experts question whether more should have been done to address the brewing risks at the bank.
Konrad Alt, cofounder of the investment firm Klaros Group, who previously served as counsel to the Senate Banking Committee, told Fortune earlier this month that the main issue at SVB—not accounting for the risk of rising interest rates—has been well-known for years.
“‘The fact is, we’ve known that this was a gap for a long time….regulators should have caught it, and they didn’t catch it,” he said.
Barr will admit in his testimony Tuesday that most of the problems at SVB were “well-known” risks. And his report will determine whether the Fed’s supervision was “appropriate for the rapid growth and vulnerabilities of the bank” and if “more stringent standards” would have prevented its collapse.
The regulation of midsize U.S. banks, or those with assets between $100 billion and $250 billion, “merits additional attention” after SVB’s collapse caused systemic issues, Barr believes, arguing banks with assets of $100 billion or more could have larger-than-expected implications for financial stability.
“Part of the Federal Reserve’s core mission is to promote the safety and soundness of the banks we supervise,” he will tell Congress. “Deeply interrogating SVB’s failure and probing its broader implications is critical to our responsibility for upholding that mission.”