Due of a Flawed Banking System Pending Risk was Undetected

by Wall Street Rebel - Michael London | 03/20/2023 8:14 AM
Due of a Flawed Banking System Pending Risk was Undetected

Silicon Valley Bank miscalculated its risks in the face of increasing interest rates since it relied on an inaccurate model. As a result, it was subject to a regulatory investigation for the better part of 2022.


The Federal Reserve had been aware of Silicon Valley Bank's dangerous practices for over a year, but this was not enough to prevent the bank's failure.

A source close to the situation said the Fed sent many warnings to the bank about its difficulties.

An assessment of the expanding bank by the Federal Reserve in 2021 revealed major flaws in how it managed important risks. Regulators handed out six citations at the Federal Reserve Bank of San Francisco, which monitored Silicon Valley Bank. These alerts, which were designated as "matters needing attention" and "matters requiring quick action," signaled that the company was not doing a good job of ensuring that it would have sufficient cash on hand that was easy to get if there was a problem.

Yet, the bank did not address the vulnerabilities it had. Silicon Valley Bank was in the midst of a thorough supervisory evaluation by July 2022. It was subjected to a more in-depth examination and eventually received a rating of inadequate for its governance and controls. It was subjected to a series of constraints that barred it from expanding by purchasing other businesses. In the fall of 2016, members of the San Francisco Fed staff convened a meeting with top management at the company to discuss the former's capacity to acquire access to sufficient cash in the event of a crisis and the latter's potential exposure to losses if interest rates increased.

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Incorrectly anticipating that rising interest revenue would greatly enhance the company's financial condition as rates went up, business managers misjudged the impact of a rate hike. When the company's predictions diverged from reality, the Fed became aware of the problem.

Around the beginning of 2023, Silicon Valley Bank was undergoing what is known as a "horizontal review" by the Federal Reserve. This was an evaluation that was designed to determine how effective the bank's risk management was. During the examination, more flaws were discovered; however, at that time, it was clear that the bank's future was doomed. Early in the month of March, it was confronted with a run on the bank, and it collapsed.

UBS acquired Credit Suisse on Sunday after the latter was caught up in the widespread panic that followed the failure of Silicon Valley Bank. This sent shockwaves throughout the larger American financial system, which eventually led to a comprehensive intervention on the part of the government designed to stop the panic from spreading further.

The failure of regulators to identify concerns and take appropriate action in a timely manner led to the collapse of Silicon Valley Bank on March 10. This failure has given rise to a number of important questions. In retrospect, many of the factors that led to its downfall seem to be self-evident, including the following: Customers were more inclined to flee at the first indication of crisis since the federal government did not guarantee almost 97 percent of the bank's deposits, which were measured in terms of their value. Most of the bank's depositors were people working in the IT industry, which has been going through a difficult period as a direct result of recent increases in interest rates, which have had a negative impact on the company.

The long-term debt that Silicon Valley Bank owned had lost value as the Federal Reserve hiked interest rates to combat inflation. So, it was forced to sell such assets at a large loss to acquire cash to cover a flood of consumer withdrawals.

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Leading an inquiry into the supervisory failures at the bank I Michael S. Barr, the Fed's vice chair for supervision. We anticipate that by May 1st, the investigation findings will be made available to the general public. Members of Congress are also conducting their own investigations to determine what went wrong. On March 29, the House Financial Services Committee will hold a hearing to discuss the recent failure of many large banks.

The bank's management seems to have ignored warnings about impending financial and operational issues from Federal Reserve regulators and failed to make any preparations for the future. For example, a source says that company management was alerted to cybersecurity issues by internal workers and the Fed, but they chose to disregard such warnings.

The company's new owner, the Federal Deposit Insurance Corporation (FDIC), remained silent.

Notwithstanding this, the scope of the known problems at the bank raises concerns as to whether or not the Federal Reserve Bank inspectors or the Board of Governors in Washington might have done more to coerce the institution into addressing its flaws. The reason why is still unknown. It doesn't matter what kind of intervention was attempted to preserve the bank; whatever it was, it wasn't enough.

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The emphasis of Mr. Barr's assessment of the Silicon Valley Bank's failure will be on a few key topics, including why the problems highlighted by the Fed persisted after the central bank released its first list of items needing care. Bloomberg has already revealed the existence of these first warnings. In addition, the investigation will determine if supervisors felt they had the power to escalate the matter and whether they brought the concerns to the attention of the Federal Reserve Board.

It is anticipated that the Fed's report will provide information concerning Silicon Valley Bank that is normally kept hidden as part of the confidential bank supervision procedure. In addition, proposals for regulatory and supervisory improvements will be included.

Mr. Barr was already undertaking a "holistic examination" of Fed regulation. One of the factors that might influence the study's outcome is the possibility that a very modest but sizable bank could cause significant disruptions to the economy's monetary system. The bank's demise and the domino effect it caused are likely to spark a larger-scale push for more stringent financial oversight.

Generally, financial institutions with fewer than $250 billion in assets are exempt from the most burdensome aspects of bank supervision. This has become even more the case ever since a "tailoring" law was passed in 2018 during the administration of Donald Trump and was implemented by the Fed in 2019. Because of these developments, the regulations for smaller banks became less rigorous.

Even while Silicon Valley Bank was still below that threshold, its failure highlighted that even financial institutions that are not big enough to be considered internationally systemic might nonetheless create widespread issues in the US banking system.

As a direct consequence, Fed officials may contemplate imposing stricter regulations on those large but not enormous institutions. Authorities may consider, for example, posing the question of whether financial institutions with between $100 billion and $250 billion in assets should be required to keep a greater amount of capital on hand when the market price of their bond holdings falls, which is known as an "unrealized loss."

While the Federal Reserve works to complete its investigation into what went wrong at Silicon Valley Bank and determine the next steps, it faces serious political consequences for failing to prevent the problems from happening.

One of the primary sources of worry is that Greg Becker, the bank's chief executive officer, was on the board of directors of the Federal Reserve Bank of San Francisco until March 10 of this year. The appearance of the situation is not good, even though board members do not participate in the oversight of banks

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Concerns also surround the possibility that Federal Reserve Chair Jerome H. Powell may have permitted excessive deregulatory activity during the tenure of the Trump administration. From 2017 to 2021, Randal K. Quarles was the Fed's vice chair for supervision. During his tenure, he oversaw the implementation of a regulatory rollback bill approved in 2018 that, as many predicted at the time, has made the banking sector more vulnerable.

Regarding regulation questions, Mr. Powell almost often defers to the Fed's supervisory vice chair, and he did not vote against the proposed reforms. Lael Brainard, a Fed governor at the time but now a prominent economic advisor for the White House, voted against several of the adjustments and pointed out in dissenting remarks that some of them may be potentially harmful.

She cautioned that "the crisis demonstrated clearly that the distress of even noncomplex large banking organizations generally manifests first in liquidity stress and quickly transmits contagion through the financial system." "The crisis demonstrated clearly that the distress of even noncomplex large banking organizations generally manifests first in liquidity stress."

Senator Elizabeth Warren, a Democrat from Massachusetts, has requested an impartial investigation into what took place at Silicon Valley Bank and has strongly recommended that Mr. Powell not be engaged in any part of this process. According to what she said in a letter sent out on Sunday, he "bears direct responsibility for — and has a lengthy record of failure with" bank regulation.


                       US Banking Crisis: The Truth Behind The Disaster


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