GAO Faults Management and Regulators for Bank Failures
Commentary by Sebastian Souchet
In a Report to the House Financial Services Committee, GAO found that poor liquidity and risk management practices were factors contributing to the failure of Silicon Valley Bank ("SVB") and Signature Bank ("Signature"). GAO said that regulators identified these risks, but failed to sufficiently address them.
- Liquidity and Risk Management
Because of SVB’s increasing reliance on uninsured deposits from the technology and venture capital sectors, GAO described SVB’s client base as "concentrated and interconnected". As a result, SVB faced a "significant and sudden" requests for withdrawals of deposits from clients which amounted in over $40 billion, upon speculation of SVB’s distress before closing.
GAO found that SVB was impacted by rising interest rates because of its investments in longer-term securities. GAO reported that SVB did not effectively address interest rate risks of its securities and as a result, had over $15 billion in unrealized losses in its held-to-maturity securities portfolio.
GAO found that Signature had exposure to the digital assets industry and declining liquidity before its failure but because of its "weak liquidity" practices, management had difficulty fully understanding its liquidity position. GAO said that Signature reduced its exposure to the digital asset industry and replaced its deposits with cash and borrowings collateralized with loans and securities. GAO said that Signature’s balance sheet cash holdings were reduced from $30 billion in 2021 to $6 billion in 2022. When Signature began to experience deposit withdrawals as a result of SVB’s closure, GAO reported that Signature did not have sufficient cash to satisfy the large deposit withdrawal requests.
- Regulators’ Supervisory Actions
GAO said that the Federal Reserve Bank of San Francisco ("FRBSF") gave SVB generally positive ratings from 2018 until 2022, finding SVB’s overall condition to be "satisfactory" and assigning the highest possible rating to SVB’s liquidity management practices as well as the second highest possible rating to its management practices. After SVB moved into the Large Financial Institution rating system, GAO said that examiners found liquidity and management problems that had not been previously recognized. GAO reported that despite FRBSF staff recognizing SVB' deficiencies, the supervisory steps taken by FRBSF were inadequate. Further, GAO found that FRBSF’s actions "lacked urgency" in addressing these deficiencies.
In an assessment of the FDIC’s supervisory practices, GAO said that the FDIC’s ratings of Signature were overall "satisfactory", assigning Signature the second-highest available rating for its management practices. GAO acknowledged that the FDIC took multiple supervisory actions as a result of Signature’s liquidity contingency planning and internal controls, however, GAO said that these actions were "inadequate" and that the FDIC "lacked urgency" despite Signature’s repeated failures and long-standing liquidity and management deficiencies.
Commentary
The findings of GAO’s preliminary review of the U.S. banking regulators’ actions with respect to the failures of SVB and Signature Bank appear largely consistent with the recent reports on such banks’ failures published by the Federal Reserve and the FDIC.
In addition to its findings, GAO also notes that it intends to further examine issues related to such banks’ failures in upcoming GAO reviews, including:
- how SVB’s Category IV designation affected SVB supervision prior to its failure, given that the Federal Reserve examiners “found liquidity and management deficiencies not previously identified under the Regional Banking Organization supervision program” once the Federal Reserve classified SVB as a Category IV bank (p. 19);
- the Federal Reserve’s, Federal Reserve Bank of San Francisco’s, and the FDIC’s decision-making process for escalating supervisory actions (pp. 23 and 26); and
- the U.S. banking regulators’ use of the systemic risk exception and how it may “weaken market participants’ incentives to properly manage risk if they come to expect similar emergency actions in the future” (p. 31).
Interestingly, GAO notes that it recommended in 2011 that federal banking regulators “consider additional triggers that would require early and forceful regulatory actions tied to specific unsafe banking practices” (p. 27). While the U.S. banking regulators established a working group to review enforcement practices and tools, and adopted capital-related triggers in 2013, GAO said that the banking regulators “did not take further steps to implement noncapital triggers to initiate more timely action.” GAO said it continues “to believe that incorporating noncapital triggers would enhance the framework by encouraging earlier action and giving the regulators and banks more time to address deteriorating conditions before capital is depleted” (p. 27).
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