Policies enacted under former Federal Reserve Vice Chairman of Supervision Randal Quarles took center stage in the Fed’s recent report on failures in its supervisory practices. But he and experts say the problems go back much further.

Ana Moneymaker/Bloomberg

Federal Reserve last month Silicon Valley Bank bankruptcy report has put the policy goals of former vice president of supervision Randal Quarles back under the microscope.

Many factors contributed to what was then the second largest bank failure in the history of the United States, according to The report, but one find, in particular, puts the blame squarely at Quarles’ feet. Although he is not named in the report, he says his office led a change in supervisory practices that made supervisors reluctant to raise issues and take decisive action against banks.

“In interviews for this report, staff repeatedly mentioned changes in expectations and practices, including pressure to reduce the burden on companies, meet a higher burden of proof for a supervisory finding, and demonstrate due process when considering supervisory actions,” the report states. “There was no formal or specific policy requiring this, but staff felt a change in the culture and expectations of internal discussions and observed behavior that changed the way supervision was executed.”

But former Fed officials, supervisory policy experts and bank lawyers say the cultural flaws at play in Silicon Valley Bank’s supervision are nothing new for the central bank. They say the strong focus on gathering evidence and building a “consensus” before taking decisive action on persistent problems has been endemic at the institution for years.

There are different opinions as to why this is so. Some say it’s tied to supervision being a secondary consideration for the policy-focused institution. Others call it a focus on the wrong topics.

Quarles argues that the Fed’s longstanding modus operandi has been to cast a wide net in its oversight, a practice he said prioritizes the volume of subpoenas over the risk they pose to individual banks or overall financial stability.

Quarles said he tried to end this form of oversight, insisting that his directive was for supervisors to forego small infractions in favor of coming down hard on big issues. He said the report on Silicon Valley Bank, which says 31 supervisory findings were issued to the bank, is evidence that his advice was not heeded.

“I wasn’t able to do much in supervision and clearly I didn’t really do much in changing the culture, because the goal was to stop distracting both the institutions and ourselves with excessive attention to routine administrative matters and focus on what it’s really important, like interest rate and liquidity risk,” he said. “I often used the line, ‘And if they don’t do what’s really important, hit them in the hip and thigh.'”

The 31 Matters Requiring Attention and Matters Requiring Immediate Attention, commonly known as MRAs and MRIAs, raised with Silicon Valley Bank touched on a wide range of topics, according to monitoring documents released alongside the report last month. These included issues that apparently did not play a role in the bank’s collapse, including its management of external providers, the granularity of its loan risk scoring system, and its governance around loan procedures.

Some MRAs and MRIAs focused on general topics relevant to the bank’s eventual demise, including fund concentration, deposit segmentation, liquidity management, and interest rate modeling for internal stress tests. Still, the two central factors in Silicon Valley Bank’s collapse, its reliance on uninsured deposits and the lack of hedges on its long-term bond investments, were not highlighted in the published materials.

“Where is the specific MRA on SVB’s excessive exposure to uninsured deposits? Where is the specific MRA on SVB’s interest rate risk?” Randall Guynn, a Davis Polk bank regulation attorney, said. “They had 31 oversight findings, but couldn’t they have raised those issues in the 15 months after Quarles left or eight months after Barr took the job? Unless there’s more that hasn’t been disclosed, it just doesn’t nothing”. sense.”

Clifford Stanford, regulatory counsel at Alston & Bird and former counsel for the supervisory division of the Federal Reserve Bank of Atlanta, said the matter speaks to a long-standing complaint by many bankers that having to address a litany of minor issues it takes time. and the resources needed to remedy major concerns.

“There’s a sense that when a bank’s chief risk officer is looking to dedicate resources and is inundated with dozens of MRAs, the impact of the emphasis on any one MRA could be diluted,” he said.

However, Stanford said, oversight is largely a matter of judgment and it’s hard to know what potential threats will ultimately develop. If another problem had proved ruinous for Silicon Valley Bank, she said, the problems highlighted by the Fed might have been more prescient.

The Silicon Valley Report, commissioned by Quarles’ successor, Michael Barr, notes that it is difficult to identify a specific catalyst for cultural change. But it points to a 2018 “guidance on guidance” and a 2021 rule detailing appropriate activities for supervisors as key moments. Others have said that Quarles’s focus on transparency and consistency in the supervisory process meant that bank inspectors would hold their actions to a higher standard.

At first glance, all of these efforts were aimed at making bank supervision more effective, but the report states that they “also led to slower action by supervisory staff and a reluctance to escalate problems.”

Last month, a senior Fed official told reporters that Barr had undertaken efforts to change the supervisory culture at the Federal Reserve System, including meeting with supervisors and holding town halls and conferences to encourage them to be more aggressive in their supervision. But implementing changes throughout the Fed’s supervisory apparatus, which includes thousands of staff spread across the 12 regional reserve banks and the Board of Governors in Washington, is no easy task.

Quarles had a similar experience when he joined the Fed. In 2018 and 2019, he held town hall meetings at each reserve bank, hoping to explain his vision directly to each supervisor. Still, he said, there seems to be a disconnect between what he wanted and what those below him thought he wanted.

“There are changes in the supervisory culture that need to be made,” he said. “My message to supervisors was that they need to focus on the things that really matter, and that they need to draw institutions’ attention to the things that really matter. With the best of intentions, no doubt, they clearly did the exact opposite of that here.” .

The supervisory culture at the Fed has been a work in progress for more than a decade. After the 2008 subprime mortgage crisis and the passage of the Dodd-Frank Act in 2010, Fed leadership sought to strengthen supervisory standards on the board, particularly for large institutions. Previously, each reserve bank had more discretion over how they supervised the banks in their regions, leading to discrepancies from district to district in terms of supervisory priorities and results.

Brookings Institution scholar and former Treasury official Aaron Klein said cultural issues around oversight run deep at the institution. He has argued in favor of stripping the Fed of its regulatory mandate.

The emphasis on building consensus before acting comes from the Fed’s approach to monetary policy, he said, noting that the Fed has had unanimity on all of its rate-setting decisions for 18 years in a row. He added that while this aversion to dissent has promoted a lighter regulatory agenda in recent years, it is just the latest episode in a long-running saga.

“Did the Trump-appointed governors promote a culture of deregulation? Yes. Did they create a culture of consensus? No,” he said. “That culture stems from monetary policy, which is the telos of the Fed, its core objective.”

Karen Petrou, managing partner at Federal Financial Analytics, takes a less harsh view of the Fed’s future as a regulator, but agrees that the primacy of monetary policy within the organization has contributed to its supervisory weaknesses.

Petrou said supervisors are rarely surprised by failures; it is more the case that regulators identify critical problems that are not controlled. In the case of Fed-supervised banks, he blames this disconnect on supervisors receiving insufficient support from leaders.

“Supervisors need to be rewarded and given the tools, which they don’t have, to shorten problem actions,” he said. “What we constantly see in supervision is a negative feedback loop where banks don’t do what they’re told and sometimes even double down on trying to do as quickly as possible before they think they have to.” “. arrest.”

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