Assorted Thoughts on SVB
The Fed's supervisory review, revisiting a 2021 SVB acquisition, and the FRBSF board of directors
Brief thoughts on three points of discussion in the ongoing SVB fallout that I find intriguing or frustrating, or sometimes both in equal measure.
Federal Reserve Board Review of Supervision and Regulation of SVB
The Federal Reserve Board has announced that its Vice for Chair for Supervision, Michael Barr, will be leading a review of the supervision and regulation of Silicon Valley Bank.
The report will be released by May 1 and should cover a number of topics. I’ll focus here on two potentially worthwhile areas of review (as always, without claiming these are necessarily the most important things that should be reviewed).
Stress Testing and Interest Rate Risk Guidance and FAQs
Yesterday, a few hours before the Board announced its intention to conduct the review, Bloomberg reported that “[r]egulators in Washington are assessing whether SVB . . . had conducted the required planning and stress testing as the Fed raised interest rates starting last year.”
There are a few things this could be referencing, but returning to a subject touched on briefly in a post over the weekend, I wonder if some of it may relate to the Board’s guidance on the management of interest rate risk, which in 2013 a Board official had cited, in combination with supervisory vigilance, as being key when thinking about whether banks were appropriately positioned to deal with interest rate increases.
The main documents relevant here are a January 2010 interagency advisory on interest rate risk and a January 2012 follow up addressing frequently asked questions received by the agencies in response to the 2010 advisory.
Among other things, the 2010 interagency advisory “remind[ed] institutions that stress testing, which includes both scenario and sensitivity analysis, is an integral component of IRR management.” The agencies continued:
When conducting scenario analyses, institutions should assess a range of alternative future interest rate scenarios in evaluating IRR exposure. This range should be sufficiently meaningful to fully identify basis risk, yield curve risk and the risks of embedded options. In many cases, static interest rate shocks consisting of parallel shifts in the yield curve of plus and minus 200 basis points may not be sufficient to adequately assess an institution’s IRR exposure. As a result, institutions should regularly assess IRR exposures beyond typical industry conventions, including changes in rates of greater magnitude (e.g., up and down 300 and 400 basis points) across different tenors to reflect changing slopes and twists of the yield curve. Institutions should ensure their scenarios are severe but plausible in light of the existing level of rates and the interest rate cycle. For example, in low-rate environments, scenarios involving significant declines in market rates can be deemphasized in favor of increasing the number and size of alternative rising-rate scenarios.
Further:
At well-managed institutions, management compares stress test results against approved tolerances limits. Such reviews enable institutions to properly estimate and monitor key variables whose volatility will significantly affect IRR exposure. Moreover, in conducting stress tests, special consideration should be given to instruments or markets in which concentrations exist as such positions may be more difficult to unwind or hedge during periods of market stress.
The 2010 guidance concluded by saying:
Material weaknesses in risk management processes or high levels of IRR exposure relative to capital will require corrective action. Such actions could include recommendations or directives to:
Raise additional capital;
Reduce levels of IRR exposure;
Strengthen IRR management expertise;
Improve IRR management information and measurement systems; or
Take other measures or some combination of actions, depending on the facts and circumstances of the individual institution.
IRR management should be an integral component of an institution’s risk management infrastructure. Management should assess the need to strengthen existing IRR practices by incorporating the supervisory expectations and management techniques highlighted in this advisory.
The 2012 FAQs then addressed various requests for clarification. One FAQ asked whether performing rate shocks greater than plus or minus 300 bps was really necessary. The answer: sometimes, yes!
5. Should institutions perform rate shocks greater than ± 300 basis points?
Answer: Generally yes. Although the advisory suggests ± 300 and ± 400 basis points as examples of meaningful stress scenarios, the decision as to which stress testing scenarios are appropriate should be based on the institution’s risk profile and current economic conditions. Institutions should consider the current level of rates relative to the normal rate cycle. In a period of extremely low rates, a +400 basis point shock would provide a meaningful stress scenario while some negative-rate scenarios that result in negative market rates would provide less value to risk managers. Therefore, during low-rate environments, institutions may increase the number of positive-rate shocks, including very large positive-rate moves, while reducing the severity of negative shocks. In other rate environments, even more extreme ramped rate curve shifts or shocks may be appropriate.
Performing extreme shocks to measure IRR should provide useful information for risk management. More extreme stress scenarios can provide important risk management insights about on- and off-balance sheet positions and exposures. Institutions are encouraged to develop robust stress testing scenarios and to adjust scenarios as conditions change.
I want to be careful about making too much of the 2010/2012 guidance or overstating the degree to which if it were followed (assuming SVB did not in fact not follow it) everything would have been fine, but still it is probably something worth thinking about as the Board conducts its review.
It also may spark a renewed discussion over the role of supervisory guidance, which statements in 2018 and regulations adopted in 2021 had sought to clarify. For example, the Board’s version of the 2021 rule includes a statement saying that “examiners will not criticize (through the issuance of matters requiring attention), a supervised financial institution for, and the Board will not issue an enforcement action on the basis of, a ‘violation’ of or' ‘non-compliance’ with supervisory guidance.”
In light of the more recent way that the role of guidance has been characterized by the banking regulators, the 2010 guidance and the 2012 FAQs might read as a bit prescriptive, telling management that they “should” do certain things or “ensure” certain results, or saying that certain practices “will require corrective action.”
Did the way this guidance was applied change at all after the clarifications the agencies made concerning the role of guidance? In interviews recently, former Federal Reserve Board Governor Daniel Tarullo has implied it might have done. Specifically, Tarullo wonders whether supervisors may have felt constrained by “instructions they were operating under." He asks, “Did the supervisors feel inhibited?”1
I do not especially love this as an explanation because it feels frustratingly unfalsifiable. In particular, I am not sure it is possible to fairly evaluate whether supervisors did not do the right thing (1) because they simply erred or (2) because they wanted to do the right thing but felt constrained or inhibited by those above them.
On the other hand, I think Tarullo has a point that supervision is indeed in some sense about, for lack of a better word, vibes. So while I would be skeptical about this being the primary reason for the supervisory failures, it does seem like a legitimate topic for a portion of the Board’s inquiry.
Transition to LFI Supervision
Until 2021, the four quarter total average assets of SVB Financial Group were below $100 billion. As a result, the Federal Reserve Board oversaw SVB’s activities in the context of the Board’s supervisory program for community and regional banking organizations.
It is probably unfair to call the supervisory approach for firms in this category light touch, but as a general matter firms in this group are regarded as presenting fewer supervisory issues. For example, in the Board’s latest supervision and regulation report, the Board disclosed that “nearly 97 percent of top-tier CBOs and RBOs are rated satisfactory or stronger. More than 97 percent of CBO and RBO state member banks are rated satisfactory.”
Once SVB Financial crossed the $100 billion average assets threshold, the company transitioned to what the Board calls Large Financial Institution supervision. Specifically, SVB Financial became part of Large and Foreign Banking Organization (LFBO) group, which includes non-GSIB “U.S. firms with total assets of $100 billion or more and all foreign banking organizations operating in the U.S. regardless of size.”
As compared to community or regional banking organization supervision, LFBO supervision “includes some cross-firm supervisory activities” and the Board staff in DC are more involved in setting broad supervisory priorities. At the same time, “firm-specific teams at the local Reserve Bank conduct most of the supervisory work, subject to oversight by the Board.”
Either because institutions in the LFI supervisory group are more difficult to manage, because supervision of these firms is more rigorous, or some combination of the two, the proportion of LFIs with unsatisfactory ratings is much higher than as compared to the CBOs or RBOs.2
In light of the above, a non-exhaustive list of things I’d be interested in seeing addressed in the Board’s review:
Was the oversight of SVB Financial and SVB when they were supervised as part of the RBO group appropriately calibrated to the activities of the company and the bank, which may have been different from other firms of similar size in the RBO group?
Were examiners and supervisors in the RBO group prepared to deal with the rapid growth the company and the bank experienced, even before crossing the $100 billion threshold? How did they do so?
How did the transition to the LFBO group go? Given how quickly SVB Financial and SVB grew, were the company and the bank prepared to become subject to the increased supervisory expectations that may come with being an LFI? If not, what actions did supervisors and examiners take?
What were the comparative roles of the Board staff in DC and the staff of the Reserve Bank in San Francisco in supervising the company and the bank?
The Board’s Order Approving the 2021 SVB Financial Acquisition of Boston Private
In 2021, the Federal Reserve Board unanimously approved SVB Financial’s application to acquire Boston Private Financial Holdings.3 At the time, SVB Financial had around $116 billion in total assets and Boston Private had around $10 billion in total assets.
As part of the order, the Board included a standard financial stability analysis. This analysis concluded that financial stability considerations were consistent with approval.
Both SVB Group and Boston Private predominately engage in commercial banking and wealth management activities, with funding largely derived from core deposits. The proposed acquisition would increase SVB Group’s size by less than 9 percent as measured by total assets, deposits, or leverage exposure, and the consolidated institution would still hold well below 1 percent of total U.S. financial system assets.
[…]
In light of all the facts and circumstances, this transaction would not appear to result in meaningfully greater or more concentrated risks to the stability of the U.S. banking or financial system.
Even with the benefit of hindsight, other than perhaps overstating the level of comfort that should have been drawn from SVB’s core deposits, this still seems right to me. If the narrow question is whether SVB Financial by acquiring Boston Private meaningfully increased risks to financial stability, I think the answer still quite reasonably may be no.
But let’s talk about the paragraph I omitted from the above quote. Here, the Board said:
Other measures of stability risks point to de minimis increases as a result of the acquisition. The organization would not be a critical services provider or so interconnected with other firms or markets that it would pose significant risk to the financial system in the event of financial distress. In addition, the pro forma organization would have minimal cross-border activities and would not exhibit an organizational structure, complex interrelationships, or unique characteristics that would complicate resolution of the firm.
Again, to be fair to the Board, if the question is whether adding Boston Private did anything meaningfully harmful from a resolvability perspective, I think the answer is reasonably no, and the paragraph holds up fine (ish).
But if you read these statements as claims not about relative increases but about the overall resolvability of SVB Financial more broadly, they become much tougher to defend in light of recent events, in particular the conclusion over the weekend that the systemic risk exception needed to be invoked.
As with the 2012/13 statements about interest rate risk highlighted in the post over the weekend, the point here is not to criticize anyone with the benefit of hindsight, but is instead just to flag things that I would expect to come in for further scrutiny in the weeks ahead. At the least, I would guess going forward that this boilerplate language about resolvability may be used a little less frequently in Board orders concerning banks of SVB’s size.
The FRBSF Board Issue - Embarrassing But Nothing More Than That, I Think
The Federal Reserve Bank of San Francisco currently has a vacancy among the ranks of its Class A directors.4
The vacancy is recent. Until Friday, the seat was occupied by SVB Financial CEO Greg Becker. This is of course pretty embarrassing for all involved, and as someone already skeptical of the weird public/private Reserve Bank structure, I would not mind at all if this led to another try for reform.
I do want to push back, though, on the idea that Becker’s presence on this “powerful board” had much of anything to do with the supervision of SVB Financial or SVB. As the Board explains in its Roles and Responsibilities of Reserve Bank Directors publication:
Reserve Bank directors have no involvement in matters related to banking supervision, including specific supervisory decisions.
Also:
Reserve Bank directors have no involvement in regulatory, applications, or enforcement matters.
In its guide to conduct for directors, the Board tells Reserve Banks that they must “clearly document, in their bylaws, the roles and responsibilities of directors, including restrictions on their involvement in supervision and regulation activities.”
The bylaws of the FRBSF have duly done so. For example:
The Board [of the Reserve Bank] shall not be involved in the supervision and regulation of financial institutions and shall not receive confidential supervisory information.
Or:
The Board [of the Reserve Bank] shall, in accordance with law, appoint the General Auditor, the Secretary, and officers at the level of Senior Vice President and above, except those whose primary duties involve supervision and regulation matters.
Class A Directors and covered Class B Directors shall not be involved in the selection, appointment, or compensation of officers whose primary duties involve supervision and regulation matters.
As part of the investigation Vice Chair for Supervision Barr is conducting it is perfectly reasonable to seek to confirm that these restrictions were appropriately observed, but I would be surprised if any issues were found.
Even so, I guess we again have to talk about vibes. Culture is obviously not driven by directors alone, but it does in my experience vary from Reserve Bank to Reserve Bank. This is not necessarily a bad thing, but it could become problematic if, for example, the FRBSF’s general outlook about banking and tech affected its supervisory approach.
It is not clear if this was the case here, and even if it plausibly was I am not sure if it is feasible for this sort of thing to be analyzed in VCS Barr’s report that is due in around 45 days. As a longer-term matter, though, I think the discussion could benefit from a debate as to whether any improvements or changes should be made here.
Thanks for reading! Thoughts, challenges, criticisms are always welcome at bankregblog@gmail.com
Tarullo did not mention specifically the debate over guidance in this most recent interview, but this is an issue he has written about at length before. Also I had written 99% this post before coming across it, but I see that Jeremy Kress had a thread on Twitter today on similar themes.
This data is broader than is ideal for purposes of this post, as it lumps together everyone over $100 billion, including U.S. G-SIBs, the U.S. operations of large foreign banks, and fairly boring regional banks. So we do not have a breakdown of how banks of SVB’s size in particular are rated.
The Board at the time included Chair Powell, Vice Chair Clarida, Vice Chair for Supervision Quarles, and Governors Bowman, Brainard and Waller.
Class A directors represent the member banks of a particular district and are elected by those member banks. See Federal Reserve System Boards of Directors.