Fed's Independent SVB Review Challenges Parts of Its 2023 Postmortem

Federal Reserve supervisors knew, or should have known, about Silicon Valley Bank's vulnerabilities as early as March 2022 -- a full year before the bank collapsed -- yet failed to take prompt, decisive action to force the bank to reduce them, according to the initial findings of an independent review released Friday by Vice Chair for Supervision Michelle Bowman.

The seven findings

Federal Reserve Vice Chair for Supervision Michelle Bowman released Friday the initial findings of the independent review of Silicon Valley Bank's March 2023 failure -- a review she called for in June 2023 and commissioned from the Starling Advisory Group after her confirmation as Vice Chair for Supervision. The report is the first in a series, structured to be independent of Federal Reserve System staff and principals, Bowman said.

The initial report set out to answer three questions: whether supervisory staff identified SVB's vulnerabilities well in advance, why they did not take prompt and decisive action if so, and whether supervisory actions or inactions contributed to the failure.

It offers seven preliminary findings. First, SVB failed from a confluence of vulnerabilities: real but unrealized accounting losses on its securities portfolio that exceeded its capital, a run-prone deposit base that was 94 percent uninsured and concentrated in venture capital-backed technology companies, and a lack of operational readiness to borrow from the discount window when it was needed.

Second, supervisory staff knew -- or should have known -- about those vulnerabilities as early as March 2022. Third, despite that, staff did not take prompt and decisive action to encourage or require SVB to reduce its interest rate risk or the concentration of its vulnerabilities.

Fourth, the delays were not caused by the regulatory tailoring mandate in the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 -- or by any directive or suggestion from the former Vice Chair for Supervision to reduce supervision intensity. In fact, the former vice chair had stepped down in October 2021, well before 2022, when SVB's vulnerabilities became most apparent.

Fifth, a significant factor in the inaction was a long-standing culture of risk aversion: staff believed it was personally safer to take no action unless certain the action was exactly right. Sixth, a lack of clarity about decision rights compounded that culture -- amid what the report calls a persistent, Systemwide divorcing of responsibility, authority, and accountability, staff were unsure who could certify a particular action was correct.

Seventh, the report takes aim at one of the most repeated postmortem claims: that social media fueled SVB's run. None of the accounts making that claim tried to substantiate it, the report says; Charles River Associates, analyzing the question at Starling's request, concluded that social media did not trigger the run and that there was no evidence it accelerated it. Among other things, 96 percent of the social media chatter about the run appeared after SVB's failure was already inevitable.

Where the new review differs from the Fed's 2023 account

The findings diverge from parts of the Fed's 2023 internal postmortem, but the two reviews are not mirror opposites. The earlier report said the Board's tailoring approach in response to the 2018 law, together with a shift in supervisory policy, impeded effective supervision. The new review says the delays were not caused by the law's regulatory tailoring mandate or by any directive or suggestion from the former Vice Chair for Supervision.

Bowman framed the stakes in the speech: SVB's collapse "sparked contagion that quickly spread to Signature Bank and First Republic Bank and threatened to spread throughout the banking system, requiring extraordinary government intervention," and "fundamentally shook public confidence in the effectiveness of bank supervision."

The reforms announced

Bowman said the Fed has not waited for the review's completion to act. The Board issued a Statement of Supervisory Operating Principles that refocuses supervision on identifying significant threats to safety and soundness and financial stability as early as possible, then taking prompt, decisive action. It redirects examiners to prioritize threats that could significantly harm a bank's financial condition or financial stability -- "instead of focusing excessively on procedural or documentation footfaults" -- and expands the supervisory toolkit to include observations alongside MRAs and enforcement actions, giving examiners more room to calibrate responses by severity.

To address the culture problem, examination teams will now submit monthly reports directly to the heads of supervision and their respective Reserve Banks, flagging any supervisory issue where an examiner was uncertain -- about whether the standard for action was met, or whether action might conflict with Board or Reserve Bank leadership expectations. The goal, Bowman said, is to let examiners escalate concerns without fear while giving leadership real-time visibility into where teams need clearer guidance.

What comes next

This is the first of a series -- Starling's review continues, and further reports will follow. The question for the next installments is whether they name the decision points: which supervisors saw SVB's vulnerabilities in 2022, and what, specifically, will change in how the Fed holds banks to account before the next failure. Until then, Bowman's release stands as the Fed's own acknowledgment that its supervisory staff knew, or should have known, about SVB's vulnerabilities a full year before the bank failed -- and did not act decisively.