Monday morning saw the second-largest failure of a U.S. bank in history and the third major one this year, with First Republic Bank ($229 billion total assets) seized by regulators and subsequently sold to JP Morgan Chase.
The post-mortem on First Republic will be written in the coming weeks.
Late last week, though, the Federal Reserve and the Federal Deposit Insurance Corp. released their analyses of what occurred at Silicon Valley Bank (SVB) and Signature Bank of New York (SBNY), respectively, in the runup to their being shut down and sold.
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While both reports point to many failures of federal regulation, the two banks’ management and boards of directors also made key mistakes. As in most corporate failures, bankruptcies, frauds, and other financial blow-ups, the mistakes made by the management of SVB and Signature were not esoteric or inscrutable. And in some cases maybe were not mistakes at all.
Key decisions were often made by individuals or small informal groups of executive officers, without always following prescribed processes. — FDIC’s Supervision of Signature Bank report
Here are six all-too-common risk management missteps made in the management suites of one or both banks, according to the FDIC and the Fed. If they sound familiar, it’s because they’re not specific to banking.
Both banks pursued rapid, unrestrained growth but didn’t develop commensurate risk management practices and controls. In particular, at SBNY, some sloppy governance set the stage.
“[Signature] bank’s organizational structure lacked clear decision-making processes, transparency as to who made decisions, and documentation as to approval and escalation protocols,” according to the FDIC. “Key decisions were often made by individuals or small informal groups of executive officers, without always following prescribed processes.” There were also instances of “concentrated authority without adequate safeguards.”
At SVB, the Fed said in its report, the bank failed its own liquidity stress tests. So what did the bank do? It switched to less-conservative stress-testing assumptions, according to the Fed, which masked some of the liquidity risks. SVB also changed some of its risk management assumptions around interest rates to reduce how those risks were measured.
The Fed said that Signature’s management had a low appetite for risk related to liquidity. However, bank examiners found several breaches in risk metrics. For example, in 2021, according to the Fed, SBNY breached a 10% risk indicator for digital assets related to deposit growth. So what did it do? It increased the limit to 35%.
At SBNY, executives appeared to go through the motions when dealing with regulators.
“Executives were sometimes disengaged from the examination process and dismissive of [bank examiners’] findings,” according to the FDIC. Any actions taken by SBNY “were more ‘check-the-box’ or done to assuage the examiners.”
Both teams of bank executives made some faulty assumptions about their client bases. Signature in particular “expressed its belief that the deposit base was largely stable based on its client-centric business model,” according to the FDIC. “Large depositors typically also maintained their operating account or lending relationship with the bank, and it was assumed their deposits were ‘sticky’ — that is, unlikely to move.”
In the case of both SVB and SBNY, that assumption was catastrophic — in one day, SBNY lost 20% of its deposits. SVB saw $40 billion of deposits go out the door in 24 hours.
Even though banking is all about risk, executives had little incentive to manage risks. At SVB, according to the Fed, the bank’s board “did not hold management accountable for effectively managing the firm’s risks.” In addition, according to the Fed, “SVB’s senior management responded to the incentives approved by the board of directors; they were not compensated for managing the bank’s risk, and they did not do so effectively. We should consider setting tougher minimum standards for incentive compensation programs.”
Michael Barr, Fed vice chair of supervision
Finally, when the crisis kicked into high gear, the banks’ management teams did not handle it well. While some contingency plans existed, lack of attention to detail and general sloppiness prevented their enactment.
At SBNY, when customers made large deposit withdrawal requests, “SBNY management had a difficult time initially ascertaining how much borrowing it needed to fund pending wires; had approached the Federal Home Loan Bank of New York (FHLB) too late in the day to draw against its line; and did not have sufficient collateral pledged at the Federal Reserve’s discount window to cover pending wire requests.”
While SVB had a contingency funding plan, it identified flaws in it in November 2021; the issues were only partially resolved when the bank failed, said the Fed.
Said Michael Barr, the Fed’s vice president of supervision: “[SVB] waited too long to address its problems, and ironically, the overdue actions it finally took to strengthen its balance sheet sparked the uninsured depositor run that led to the bank’s failure.”
