Crash Course on Current Issues (Federal Reserve Supervision and Regulation of Silicon Valley Bank Failure)

Introduction

• Topic: Crash Course on current issues
• Key Issue: Review of the Federal Reserve’s supervision and regulation of Silicon Valley Bank (SVB)

Background of Silicon Valley Bank (SVB)

• Founded: California Bank focused on Tech and Life Sciences startups
• Customer Base: Primarily venture capitalists and early-stage companies
• Deposit Growth:
  • 1983: 118 million
  • 2019: 58 billion
  • 2022: 94% of deposits were uninsured by FDIC

Events Leading to SVB Failure

• Major Focus: Early-stage Tech firms
• Deposit Inflows: Massive growth from 58 billion to 87 billion in three years
• Investment Strategy: Invested in long-term securities for higher returns
• Decrease in Venture Capital Activity:
  • Reversal in deposit growth
  • COVID-19 impacted deposit activity
• March 8, 2023: Announced significant loss from $21 billion of securities due to rising interest rates
• March 10, 2023: Closed by California Department of Financial Protection and Innovation, handed over to FDIC
• Withdrawals: $40 billion requested in one day
• Customer Base: Roughly 35,000 depositors, mostly high volume venture capitals

Supervisory Oversight Problems

• Supervisory Standards: Increase with firm size and complexity
• Category: Transitioned from Regional Banking Organization (RBO) to Large and Foreign Banking Organization (LFBO)
• Staffing Issues:
  • Lack of experience with governance and risk management practices
  • Slow to downgrade supervisory ratings
• Notable Oversights: Liquidity management and interest rate risks not addressed quickly

Specific Risk Exposures of SVB

• Held to Maturity Securities: Significant investment in long-term securities
• Deposit Concentration: High volume of uninsured deposits
• Inadequate Contingency Planning: Poor liquidity management
• Technology: Fast online withdrawals contributed to liquidity issues
• Ineffective Equity Raising: Insufficient response to liquidity challenges

Governance and Risk Management Issues

• Board Experience: Inexperienced board focusing on short-term gains
• Risk Management: Lack of proper risk appetite framework, weak internal controls
• Internal Audit: Weak challenge to management and delayed reporting
• Chief Risk Officer: Lacked skills, left in 2022; position vacant for 8 months
• Supervisory Oversight: Missed key vulnerabilities, slow to address issues

Liquidity Risk Management Issues

• Internal Stress Tests: Revealed deficiencies, operational shortfalls not identified as liquidity issues
• Management Responses: Slow and inadequate, focused on masking liquidity risk
• Supervisory Standards: Oversight was narrow, lagged against firm's complexity and growth

Interest Rate Risk Management Process

• Focus: Overemphasis on net interest income, ignored economic value of equity metric
• Policy Weakness: Lack of detailed scenario analysis and threshold breach reporting
• Removal of Hedges: Increased duration risk to maximize short-term gains
• Mismatch: Between asset and liability durations, emphasizing short-term gains

Enhancing Governance and Control

• Solutions: Enhanced reporting on net interest income and EV metrics
• Supervisory Role: Ensuring firms meet high governance and control standards

Conclusion

• Need for Improved Oversight: Supervisors need to take swift action in identifying and addressing vulnerabilities
• Importance of Robust Risk Management: Effective risk management frameworks required to avoid recurrence of such failures