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TL;DR: The Feds on SVB and Deposit Insurance Reform



The Federal Reserve recently published a whopping 118-page review of the failure of Silicon Valley Bank (SVB), and three days later the FDIC published a 75-page report outlining several ideas to reform our deposit insurance system. We know you are busy, so we read those 192 pages for you. Here is a TL;DR version of those publications, along with a few takeaways:

First, the Federal Reserve’s Review of Silicon Valley Bank.

The Fed’s review highlighted a handful of errors in management, governance, and regulatory oversight. These errors, combined with SVB's unique business model, rapid growth (it grew from $71 billion to over $211 billion from 2019 through 2021), and changes in technology, created the perfect storm for a fatal run on the bank’s deposits. On March 9, the bank had deposit outflows of $40 billion, and it expected another $100 billion the next day—the bank was closed by state regulators before that could happen. Although Silicon Valley Bank was unique, there are some lessons to be learned from this failure:

  • Senior Management and the Board Must Learn and Grow. SVB’s failure to adapt to its growth became a serious problem as it saw its business model become more complex and subject to increased regulatory requirements. The Fed noted that the bank’s senior management and members of the Board did not have the experience needed to effectively assess and manage the risks of a +$200 billion financial institution, and that inexperience played a major part in the bank’s failure. Put simply, senior management failed to provide adequate information to the Board, and the Board failed to hold senior management accountable. For example, senior management finally provided appropriate information to the Board outlining the bank’s liquidity problems in November 2022, only five months before the bank’s failure.
  • Compensation Should Incentivize Long-term Success. The Fed alleged that compensation at SVB was largely based on short-term financial performance, without regard to risk management metrics, and it became a problem over time. On top of that, liquidity and interest rate risk assessments at the bank lacked long-term considerations—short-term profits took precedence over managing long-term risks. This heavy focus on short-term performance encouraged excessive risk taking and prevented the Bank from appropriately assessing and managing those long-term risks. Much to the chagrin of outsiders, several SVB executives even received cash bonuses on March 10, 2023, which was (coincidentally enough) the same day the Bank failed.
  • Technology Has Changed the Speed of a Bank Run. The Fed’s review highlighted the “highly networked” customer base at SVB, and their ability to quickly transfer their funds, as reasons for the speed and severity of the run on the bank’s deposits. Social media fueled hysteria, and technology allowed for near-immediate withdrawals. As noted above, the bank lost $40 billion in deposits in one day. To help put that into perspective, during the 2008 financial crisis Wachovia lost $10 billion over the course of eight days, and WaMu lost $19 billion over the course of sixteen days.
  • Supervisory Issues Are More than a Compliance Exercise. The Fed’s review discussed several instances where Senior Management and the Board at SVB focused on simply resolving supervisory issues, rather than focusing on the risks that those requirements were designed to address. Further, the bank’s risk management systems failed to keep pace with its growth, which led to serious weaknesses in its ability to properly manage liquidity and interest rate risks in a rising rate environment.
  • Expect Increased Regulation. Importantly, the Fed also acknowledged that SVB’s failure was due (at least in part) to inadequate regulatory oversight, including unsupported regulatory ratings and a recent culture that tended to make continuing operating practices easier for banks. For example, SVB received satisfactory and strong ratings during its examinations from 2017 through 2021, even as the bank’s condition deteriorated. Michael Barr, the Vice Chair for Supervision of the Fed, has already signaled upcoming changes to capital requirements, stress testing, interest rate and liquidity supervision, oversight of “novel activities” (such those involving fintech or cryptocurrencies), and the overall nature and speed of regulatory supervision and corrective actions.

Second, the FDIC’s Report on Deposit Insurance Reform.

In the wake of the run on Silicon Valley Bank (and others that followed), the FDIC issued a report outlining a few ideas to reform our deposit insurance system in order to promote financial stability and further reduce the risk of similar runs. The FDIC’s report discussed three options, including limited, unlimited, and targeted coverage. Spoiler alert: the FDIC likes “targeted” coverage.

  • Limited Coverage. Limited coverage would maintain the current structure, while considering an increase to the $250,000 limit. Although this approach might benefit small- to mid-sized businesses, the FDIC admits that this approach would not be sufficient to cover many of the largest uninsured deposits. For example, unless this approach involved a massive increase to the insurance limit, this approach probably would not have prevented the run on Silicon Valley Bank, since the average amount on deposit with the bank was reportedly in excess of $4 million. This limited coverage approach, even with an increase to the $250,000 limit, would not likely reduce the risk of a run at a financial institution with a high concentration of uninsured deposits.
  • Unlimited Coverage. Unlimited coverage would provide limitless insurance coverage. Although this approach would essentially eliminate the risk of a deposit run, the FDIC acknowledges that this approach has several drawbacks. For example, this approach would encourage risk taking by banks, creating a so called “moral hazard,” and it could have a significant impact on other asset markets (e.g., where deposits serve as a substitute to those asset markets). As you might expect, this approach would also require a significant increase to the Deposit Insurance Fund, which would lead to much higher assessments on banks. In fact, the FDIC suggested that unlimited coverage would likely require up to an 80% increase to the Deposit Insurance Fund.
  • Targeted Coverage. The FDIC likes its identified third option, the idea of targeted coverage—coverage that would significantly increase insurance for certain categories of business payment accounts (e.g., transaction accounts used by businesses to pay their expenses, employees, etc.). In fact, the FDIC already has some experience with this type of targeted coverage approach. For example, you may remember the Transaction Account Guarantee (TAG) Program during the 2008 financial crisis, which provided unlimited coverage to certain types of transaction accounts for institutions that chose to participate, but the TAG Program ended in 2012. Even with a targeted coverage approach, the FDIC admits that it would be difficult to define the specific types of business payment accounts that merit increased coverage, and that banks and depositors may try to play the system to circumvent coverage. On top of that, this increased coverage for business payment accounts would also involve higher assessments on banks to match the increase to the Deposit Insurance Fund, as well. Overall, the FDIC feels that targeted coverage would be the best way to increase financial stability without expanding the safety net more broadly, but there is work to do on just how this option would be implemented.

There you have it—you are all caught up (for now)! Stay tuned for more as we will likely see some increased regulatory oversight and costs for financial institutions of all sizes.

This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.

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