In its report on what went wrong at Silicon Valley Bank, Federal Reserve regulators admitted to being slow to recognize and address problems. Photo by Alex Wong and Getty Images

Casey Quinlan
Indiana Capital Chronicle

WASHINGTON — New banking regulations proposed by federal watchdogs don’t go far enough in countering potential problems, but could help lower bank fees and calm financial markets and nerves, leading to a more stable financial system, according to some economists.

The Federal Reserve, FDIC and Government Accountability Office released reports last week blaming mismanagement of risk, including overreliance on uninsured deposits and rapid growth on problems at California-based Silicon Valley Bank and New York-based Signature Bank, which were shut down in March. The Federal Reserve report also criticized its own delay in recognizing and addressing problems at SVB, and changes in the supervision of banks resulting from the 2018 banking deregulation law.

In the Fed’s report, Michael Barr, vice chair for supervision at the Fed, said the regulator would “re-evaluate a range of rules for banks with $100 billion or more in assets.” In March, several Democratic senators called for the Fed to exercise its discretion to enforce stricter requirements for banks that have assets between $100 and $250 billion. Lawmakers are also considering options for holding bank executives accountable for their mismanagement.

Barr said that the Fed could require higher capital or liquidity requirements in some cases until there are better safeguards in place at a bank to protect against risk. He also mentioned the possibility of limits on incentive compensation in some cases. The report said that Silicon Valley Bank’s incentive compensation was “primarily based on SVBFG’s financial performance, with minimal to no linkage to risk management and control factors.”

Aaron Klein, senior fellow in economic studies at the Brookings Institution, said the Fed report doesn’t take enough responsibility for the magnitude of its mistakes or reasons for those mistakes even though it did admit its approach was “too deliberative.”

“It’s still too uncomfortable to admit publicly the magnitude and reason for its mistakes,” he said. “Nowhere in the report does the Fed acknowledge the impact of the SVB CEO serving on the board of the San Francisco Federal Reserve Bank that was in charge of its supervision, so absent more fundamental structural reforms, there will be further mistakes … Bank CEOs need to be taken off the boards of the Federal Reserve Banks who regulate them.”  Silicon Valley Bank CEO Greg Becker, left the board in March.

He added that stress tests are only as valuable as the scenarios they contemplate, and that they still failed to take into account one the Fed should have seen coming — higher interest rates.

“No stress test would have predicted COVID. Any stress test should have predicted interest rate hikes and they missed them both,” he said. “When you miss the one that no one could see coming and you miss the one that everyone should have seen coming, it ought to set off deeper alarm bells about the overreliance on the test to begin with.”

Congress Responds

Congress is also looking closely at how to prevent more bank failures and incentivize better risk management by banks. A bipartisan Senate bill, proposed by U.S. Sens. Elizabeth Warren (D-MA), Catherine Cortez-Masto (D-NV), Josh Hawley (R-MO), and Mike Braun (R-IN) would force bank executives to give up some or all of their compensation, which includes bonuses, performance pay, and salaries, for the five years that led up to the failure of their bank. According to CNBC’s reporting, Silicon Valley Bank employees were paid bonuses hours before federal regulators took over the bank.

On Thursday, the Senate Committee on Banking, Housing, and Urban Affairs held another hearing in a series of hearings on recent bank failures, where senators spoke to law professors and a U.S. Chamber of Commerce executive about how current law could hold bank executives accountable for their mismanagement.

Da Lin, assistant professor at law at the University of Richmond said there are limitations in federal regulators’ authority to remove bankers from office and prohibit them from continuing to work in the banking industry and that their enforcement tends to affect the rank and file workers more than executives. Executives are often shielded from knowledge of bank problems even though they have also not set up structures to prevent mismanagement of risk and other issues, law professors explained.

“Instead regulators have primarily excluded rank and file workers (from the industry) for low-level misconduct such as embezzlement that has little impact on banks’ safety or administration …,” Lin said. “… This disparity exists because the current law is not well-designed to be applied to senior bank leadership … The culpability requirement for removal and prohibition is overly demanding, requiring, as I have mentioned, personal dishonesty or a willful or continuing disregard for safety and soundness of the institution. Yet, failed management is seldom a deliberate act and is even less likely to be provable as one.”

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