Fed Seeks Sweeping Changes to Bank Rules in Aftermath of SVB Failure

The Federal Reserve’s bank-supervision chief called for an extensive reevaluation of how the institution oversees US financial firms following the failure of Silicon Valley Bank.

Source: Bloomberg | Published on April 28, 2023

Fed banking regulations

The Federal Reserve’s bank-supervision chief called for an extensive reevaluation of how the institution oversees US financial firms following the failure of Silicon Valley Bank, which he blamed on the company’s weak risk management and supervisory foot-dragging by the Fed.

The central bank will revisit the range of rules that apply to firms with more than $100 billion in assets, including stress testing and liquidity requirements, Michael Barr, the Fed’s vice chair for supervision, said in a letter accompanying a lengthy report released in Washington on Friday. SVB’s failure demonstrated the need for stronger standards applied to a broader set of firms, Barr said.

He also suggested the regulator could require additional capital or liquidity, or limit share buybacks, dividend payments or executive compensation, at firms with inadequate capital planning and risk management.

“Following SVB’s failure, we must strengthen the Federal Reserve’s supervision and regulation based on what we have learned,” Barr said. “This report represents the first step in that process.”

The 102-page report provides the clearest picture yet of how rapidly the situation at SVB deteriorated and the various factors behind its quick collapse. It also shows regulators were aware of most of the bank’s lurking issues, but by the time they took steps toward decisive action, it was too late.

At the same time, the report blames the approach under Barr’s predecessor Randal Quarles, who served as Fed vice chair for supervision from 2017 to 2021 and led the Fed’s effort to “tailor” regulations for mid-size and regional lenders, following 2018 legislation that eased rules for those firms.

Secret Process

The document represents one of the most detailed looks to date at how the Fed supervised an individual bank, a process that is often shrouded in secrecy and confidentiality. The Fed’s Board “has determined that releasing this information is in the best interest of the public,” the report said.

Barr said the Fed would reevaluate how it supervises and regulates a bank’s management of interest-rate liquidity risks, and said it should consider applying standardized liquidity rules to a broader set of firms. He also said the Fed should require a broader set of firms to take into account unrealized gains or losses on available-for-sale securities, “so that a firm’s capital requirements are better aligned with its financial positions and risk.”

The Fed will seek comment on such proposals soon, Barr said, though he noted that any such rules would not take effect for several years. Other possible steps will follow later.

Barr also called for changes to improve “the speed, force and agility of supervision,” including more continuity in how the Fed oversees banks of different sizes, so firms will be ready to quickly comply with heightened supervisory standards as they grow, and stronger penalties for banks that fall short of supervisory standards.

For example, he suggested that the Fed could more quickly require banks to raise capital if deficiencies are found.

“Higher capital or liquidity requirements can serve as an important safeguard until risk controls improve, and they can focus management’s attention on the most critical issues,” he said. “As a further example, limits on capital distributions or incentive compensation could be appropriate and effective in some cases.”

In a briefing with reporters, a senior Fed official said many of the changes would not require legislative approval.

Republican Pushback

Still, the recommendations are likely to face fierce resistance from Republicans in Congress, as well as the banking industry. Representative Patrick McHenry, the GOP chairman of the House Financial Services Committee, called the report “self-serving” in a statement Friday.

“While there are areas identified by Vice Chair Barr on which we agree — including enhancing attention to liquidity issues, especially when a firm is rapidly growing — the bulk of the report appears to be a justification of Democrats’ long-held priorities,” including calls for more regulation, he said.

The Government Accountability Office also released a report Friday that was more critical of foot-dragging on SVB, saying the San Francisco Fed’s actions “lacked urgency.”