Key Takeaways
This report examines the factors that contributed to the failure of Silicon Valley Bank. The report focuses on the role of the Federal Reserve, which was the primary federal supervisor for the bank and the bank holding company.
There are four key takeaways from the report:
1. Silicon Valley Bank's board of directors and management failed to manage their risks.
The report shows that Silicon Valley Bank was a highly vulnerable firm in ways that both its board of directors and senior management did not fully appreciate. These vulnerabilities—foundational and widespread managerial weaknesses, a highly concentrated business model, and a reliance on uninsured deposits—left Silicon Valley Bank acutely exposed to the specific combination of rising interest rates and slowing activity in the technology sector that materialized in 2022 and early 2023.
The full board of directors did not receive adequate information from management about risks at Silicon Valley Bank and did not hold management accountable for effectively managing the firm's risks. The bank failed its own internal liquidity stress tests and did not have workable plans to access liquidity in times of stress. Silicon Valley Bank managed interest rate risks with a focus on short-run profits and protection from potential rate decreases, and removed interest rate hedges, rather than managing long-run risks and the risk of rising rates. In both cases, the bank changed its own risk-management assumptions to reduce how these risks were measured rather than fully addressing the underlying risks.
On March 8, 2023, Silicon Valley Bank announced a balance sheet restructuring that included the sale of certain securities and an intention to raise capital. This occurred during a period of heightened uncertainty for the technology sector, and the bank faced a run by depositors on March 9. Deposit outflows were over $40 billion on March 9, and management expected $100 billion more the next day. This unprecedented outflow led the California Department of Financial Protection and Innovation (CDFPI) to close the bank on March 10.
2. Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.
While the firm was growing rapidly from $71 billion to over $211 billion in assets from 2019 to 2021, it was not subject to heightened supervisory or regulatory standards. The Federal Reserve did not appreciate the seriousness of critical deficiencies in the firm's governance, liquidity, and interest rate risk management. These judgments meant that Silicon Valley Bank remained well-rated, even as conditions deteriorated and significant risk to the firm's safety and soundness emerged.
For governance, Silicon Valley Bank was rated satisfactory in terms of management for both the holding company and the bank from 2017 through 2021, despite repeated observations of weakness in risk management. In terms of liquidity, Silicon Valley Bank was rated strong in that same period and subject to limited-scope liquidity reviews as part of guidelines for smaller firms, despite its significant asset growth and idiosyncratic business model.
3. When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.
As Silicon Valley Bank continued to grow and faced heightened standards in 2021, the regulations provided for a long transition period for Silicon Valley Bank to meet those higher standards and supervisors did not want to appear to pull forward large bank standards to smaller banks in light of policymaker directives. This transition meant that the new supervisory team needed considerable time to make its initial assessments.
After these initial assessments, liquidity ratings remained satisfactory despite fundamental weaknesses in risk management and mounting evidence of a deteriorating position. The combination of internal liquidity stress testing shortfalls, persistent and increasingly significant deposit outflows, and material balance sheet restructuring plans likely warranted a stronger supervisory message in 2022.
With regard to interest rate risk management, supervisors identified interest rate risk deficiencies in the 2020, 2021, and 2022 Capital, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to Market Risk (CAMELS) exams but did not issue supervisory findings. The supervisory team issued a supervisory finding in November 2022 and planned to downgrade the firm's rating related to interest rate risk, but the firm failed before that downgrade was finalized.
Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment. Further, the rating assigned to Silicon Valley Bank as a smaller firm set the default view of the bank as a well-managed firm when a new supervisory team was assigned in 2021 after the firm's rapid growth. This made downgrades more difficult in practice.
4. The Board's tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.
Over the same period that Silicon Valley Bank was growing rapidly in size and complexity, the Federal Reserve shifted its regulatory and supervisory policies due to a combination of external statutory changes and internal policy choices.
In 2019, following the passage of EGRRCPA, the Federal Reserve revised its framework for supervision and regulation, maintaining the enhanced prudential standards (EPS) applicable to the eight global systemically important banks, known as G-SIBs, but tailoring requirements for other large banks. For Silicon Valley Bank, this resulted in lower supervisory and regulatory requirements, including lower capital and liquidity requirements. While higher supervisory and regulatory requirements may not have prevented the firm's failure, they would likely have bolstered the resilience of Silicon Valley Bank.
Over the same period, supervisory policy placed a greater emphasis on reducing burden on firms, increasing the burden of proof on supervisors, and ensuring that supervisory actions provided firms with appropriate due process. Although the stated intention of these policy changes was to improve the effectiveness of supervision, in some cases, the changes also led to slower action by supervisory staff and a reluctance to escalate issues.