The Upcoming Fed IG Report About SVB
Assuming he still is on track to meet the September 2023 deadline he has set for himself, this week the inspector general for the Federal Reserve Board1 will release a report examining the Board’s supervision of Silicon Valley Bank.2 The OIG report will represent another effort to understand what went wrong in the supervision of SVB and its holding company, and will complement reports released earlier this year by Federal Reserve Board Vice Chair for Supervision Michael Barr and, separately, the Government Accountability Office.
This post looks at a key open question I hope the OIG report will at least try to address. Not, to be clear, because I believe the OIG report is necessarily going to have the “correct” take on the question (if such a thing is possible) or because I believe the VCS Barr report is wrong on it, but simply because the answer to the question is important in evaluating the supervisory changes that are to come.
What Explains the Lack of Supervisory Assertiveness?
VCS Barr Report
The VCS Barr report earlier this year concluded that SVB’s supervisors had appropriately identified vulnerabilities, but failed to “take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.”
Based on interviews with unidentified staff members, VCS Barr attributed these failures, at least in part, to changes in supervision made under his predecessor.
In the interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce burden on firms, meet a higher burden of proof for a supervisory conclusion, and demonstrate due process when considering supervisory actions.
In these interviews staff identified a “shift in culture and expectations from internal discussions and observed behavior that changed how supervision was executed.” The VCS Barr report concludes that, in some cases, this “led staff not to take action.”
Chair Powell Comments
In a Congressional appearance in June, Chair Powell had an exchange with Representative Velázquez on this point.3 Chair Powell made clear that he had no reason to doubt that the individuals interviewed for the report genuinely felt the way they did, but stopped short of offering his own definitive view on the question.
Rep. Velázquez: Were you aware of the cultural shift [described in the VCS Barr report]?
Chair Powell: I can’t really characterize it that way. Certainly I was aware that we were trying to avoid excessive regulatory burden. That is always an appropriate --
Rep. Velázquez: So you disagree with Chair Barr’s report in that respect?
Chair Powell: I’m sure that the people who wrote the report were accurately reporting what they heard from back --
Rep. Velázquez: How often were you meeting with Vice Chair Quarles?
Chair Powell: Reasonably frequently. We sat quite near each other.
Rep. Velázquez: And never discussed the cultural shift?
Chair Powell: I didn’t say that. But I don’t remember it --. The way you are describing it is not what I recall. I recall Vice Chair Quarles talking about things like focusing on the really important issues and not getting diverted into other --
Rep. Velázquez: So the way it was described by Vice Chair Barr is not what you recall?
Chair Powell: Well, as I said, I had no part in preparing the report. I am confident that the people -- that the staff -- who worked on the report reported accurately what they heard. I am sure that that’s right.
The OIG Report
It is not a bold prediction to say that the OIG report is likely to at least partially concur with the VCS Barr report by saying that, yes, the supervision of SVB could have been more assertive.
We can make this prediction not only based on the evidence in the public record so far but also because OIG reports into the failures of state member banks have a multi-decade track record of reaching this conclusion. For instance:
Legacy Bank – “Our analysis of FRB Chicago’s supervision of Legacy revealed that FRB Chicago identified the bank’s fundamental weaknesses, including ineffective Board oversight, poor internal controls, and a high concentration in CRE loans, but did not take early and forceful supervisory action to address those weaknesses”
Bank of Whitman – “Our analysis of FRB San Francisco’s supervision of Whitman from 2005 through 2011 revealed that FRB San Francisco identified corporate governance weaknesses and other significant deficiencies during its first examination in 2005 but did not take sufficient supervisory action to address these weaknesses until September 2009.”
Community Banks of Colorado – “our analysis of FRB Kansas City’s supervision of CBC revealed that FRB Kansas City identified the bank’s heightened credit risk and its potential threat to capital but should have taken earlier supervisory action to address those issues”
Bank of the Commonwealth - “Our analysis of FRB Richmond’s supervision of Commonwealth revealed that FRB Richmond identified the bank’s fundamental weaknesses during the 2000 examination but did not take early and decisive action to resolve those weaknesses.”
Further to these individual examples, note also that in a summary of its analysis of state member bank failures from 2009-20114 the OIG included as its lead supervisory observation the following:
Stronger Supervisory Action Sooner – We noted in our 20 reports that examiners often identified many of the SMBs’ key safety and soundness risks, but did not take sufficient supervisory action in a timely manner to compel the Board of Directors and management to mitigate those risks. In many instances, supervisors eventually concluded that a supervisory action was necessary, but that conclusion came too late to reverse the bank’s deteriorating condition.
An Open Question
When looking at the remains of a failed bank it is obviously easy to say that supervisory actions could have been more assertive. This is almost always going to be just sort of definitionally true. Moreover, as many of the prior OIG reports note, it is often difficult to say exactly how much a difference would have been made in a given case by more assertive supervision.
But setting those caveats aside for the moment, and assuming that a lack of supervisory assertiveness as to fundamental safety and soundness issues was a material contributor to the disorderly failure of SVB,5 that still leaves the question of why the supervisory approach was insufficiently assertive in this specific case.
As the previous OIG reports make clear, both long before and also immediately after the 2008 financial crisis Federal Reserve Board supervisory staff failed to be appropriately assertive in their oversight of state member banks. So if, more than a decade later, supervisors again failed in a similar fashion with respect to SVB, what best explains this?
Is it that this lack of supervisory assertiveness was a problem previously, that the problem was fixed sometime in the 2010s, but then supervision became broken again under Vice Chair for Supervision Quarles?
Or is it that this has always been a problem, that the Board’s efforts to fix it have never really taken hold despite the best of intentions and despite multiple people who tried, and that the cultural shift identified in the VCS Barr report, although maybe important for other reasons, is sort of a distraction here?
***
One might reasonably respond to this by saying that the question set out above is actually not, at this time, all that interesting or important. After all, regardless of why supervision of SVB was not as assertive as it could have been, reports suggest that the current state of supervision is trying very hard to correct for that (perhaps too hard, some claim), and maybe from a going forward perspective that is the more relevant thing to focus on.
This is fair enough, but nevertheless I do think further analysis of the cultural shift apparently identified by staff in their interviews for the VCS Barr report remains worthwhile for at least two reasons.
First, as just an academic matter, and as discussed on this blog before, I thought the treatment of this question in the VCS Barr report was a little disappointing. Again, not because I believe VCS Barr is necessarily wrong on this, but rather because the VCS Barr report could have, but frustratingly did not, offer concrete evidence of this cultural shift and its consequences. Instead, the report stuck to attributions to interviews with unidentified individuals, without citing specific examples of how, specifically, this cultural shift led to supervisors being less assertive than they in hindsight should have been.
Second, and more importantly, attempting to answer this question is necessary because if the Board under VCS Barr is going to attempt to “enhance our supervisory culture, our practices, our behaviors,” it is critical to have an accurate understanding of the root cause of its prior failings.6
Thanks for reading! Thoughts on this post and other posts are welcome at bankregblog@gmail.com
This is a little loose in its description of the IG. The office in question is responsible for both the Board and the CFPB, and its full title is Office of the Inspector General for the Board of Governors of the Federal Reserve System and the Consumer Financial Protection Bureau.
A separate OIG report on the Board’s supervision of Silvergate Bank is also expected this week, again assuming the OIG remains on track to meet the September 2023 deadline it has set for itself.
The exchange quoted below starts at around the 38:50 mark in the CSPAN video linked in the text.
This report is also cited in the VCS Barr report itself. See pp. 94-95.
This should go without saying but just in case I will say it anyways: obviously SVB’s management is primarily to blame for the bank’s failure, and nothing in this post is intended to absolve them of that responsibility.
Again, see footnote 5.