SVB’s Demise: The Fed Can Stop the Next Failure Without New Rules

It’s clear that regulators missed something at Silicon Valley Bank before its collapse — along with its investors, depositors and others. To prevent similar bank failures, President Joseph Biden has already pledged to push Congress and the Federal Reserve to strengthen banking rules. But in fact, the rules already in place could have been used better and more actively. 

The obvious thing Congress could do is reverse the 2018 legislation that raised the balance-sheet size threshold where tougher rules kick in for banks that pose a systemic threat. Had this limit not been increased, both SVB and Signature Bank, closed by New York regulators over the weekend, would have been subject to mandatory stress testing and rules designed to help banks survive sudden deposit outflows.

The US essentially created a two-tier system where medium-sized banks operated under less onerous restrictions than their larger peers. In Europe, lenders must meet the same standards regardless of size, so the region just doesn’t have the same Achilles heel of weaker oversight for a big chunk of its financial system. SVB was the 16th-biggest bank in the US — hardly a minnow.

Both of the failed US firms could have been forced by regulators to better manage their liquidity and asset risks. The legislative change gave the Fed discretion over whether banks the size of Signature and SVB should be held to the tougher standards of systemically important banks. The fact that systemic risks were invoked to justify the weekend support package proves that SVB at least should have been more tightly governed.

That trigger point for systemically important banks was lifted to $250 billion from $50 billion in the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act, which was Republican sponsored but got wide bipartisan support. The legislation also said the Fed was free to decide for itself whether banks with assets of $100 billion or more should be treated in the same way as the larger institutions.

SVB passed that lower threshold during 2019, while Signature Bank cleared it during 2020. The Fed could have demanded that both banks perform liquidity stress tests and meet liquidity coverage ratio rules. This would have made the risks of deposit flight and losses from selling assets much more apparent to both managements and supervisors. That might have changed how they operated — and prevented their failures.

US regulators take a very light touch approach to smaller institutions and the impetus is on those banks to pay attention to the risks they run, Michael Barr, vice-chair for supervision at the Fed, told the Peterson Institute for International Economics last week. He called this an appropriate framework.

Barr is now going to lead a review of the Fed’s oversight of SVB. Dennis Kelleher, chief executive officer of Better Markets, a lobby group, said regardless of the threshold debate, the failures of supervision by the Fed were so glaring that there should be an independent review of its actions. The primary blame lies with the executives of the banks, Kelleher said. “But a major contributor to what happened here is a failure of the supervisors, who are on the ground to make sure that a bank is operated in a safe and sound manner and doesn’t threaten the financial system,” he added.

Barr is already set to toughen banking rules when the Fed releases its final implementation of the global Basel banking standards, expected some time after May. He is likely to beef up capital requirements related to big investment banks’ trading risks and operational risks, while potentially helping them out with an easing of leverage ratio rules and the extra capital charges laid on the largest global firms.

What he should also do is look again at how and when the Fed uses its discretion to get more involved for lenders with $100 billion to $250 billion in assets. Some might be very dull and sensibly run institutions that have safely operated within that range for years. Others will be rapidly growing institutions already approaching the systemically important level – SVB had $211 billion in assets at the end of 2022, triple its size at the end of 2019.

Democrats including Elizabeth Warren and Bernie Sanders have already called for the threshold to be reduced back to $50 billion, but that would require legislation by a fractious Congress, which seems a big ask right now.

The reality is that Barr can formally tighten up supervision and regulation of smaller banks as he finalizes US implementation of the Basel rules. The Fed has questions to answer about why it wasn’t more involved with SVB — but it doesn’t need to rely on Congress to get a grip on similar risks elsewhere in US banking.

More From Bloomberg Opinion:

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• SVB Collapse Shows Fickleness of Crypto Money: Andy Mukherjee
• SVB and Silvergate Have Echoes in Texas Bank Crisis: Paul J. Davies

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To contact the author of this story:

Paul J. Davies[email protected]

To contact the editor responsible for this story:

Mark Gilbert [email protected]