Commentary
March 28 hearings on bank regulation exposed the shortfall of federal regulation. The hearings came in the wake of the Silicon Valley Bank (SVB) failure and the stresses on other banks, like Signature and Republic.  To put it frankly, the hearings exposed our regulators appear to be virtually useless.
Among things we learned last week: We’ve long known the Federal Reserve (the Fed) assesses risk to certain large banks as part of its regulatory duties.  But it emerged last week that the Fed’s risk assessments took no account of the breakneck speed at which interest rates were rising. It turned out this was the SVB’s biggest risk. SVB had invested its deposits in long-term bonds, but as rates rose, bond values declined and SVB suffered unrealized losses on its bond portfolio. Ordinarily, since the bonds were intended to be held to maturity, that would not be a problem; the bonds would pay off 100 percent of their face value at maturity. The losses were unrealized; that is, “on paper.” But depositor demands for withdrawals forced SVB to sell off those bonds, causing the “unrealized” bond losses to be “realized.” SVB’s liabilities—the amounts it owed its depositors—exceeded its assets (i.e., the bonds that had declined in value), causing the bank to become insolvent.
According to Michael S. Barr, the Fed’s Vice-Chair for Supervision, the Fed knew SVB was at risk for rising interest rates as early as November, 2021. Barr disclosed that SVB rated a “3” on the CAMELS scale, an acronyn for regulators assessments’ of a given bank’s Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to the market. The CAMEL scale runs from “1”, the best, to “5,” the worst. So, clearly, there were early warnings. But regulators only asked SVB management (which was, presumably, only medicore, based on SVBs CAMEL rating) to take steps to improve; they did nothing more proactive to avoid the SVB disaster. The Fed’s failure to act avert the SVB failure—perhaps to seize it as interest rate rises first started putting its balance sheet out of balance—points to a significant regulatory failure, both by the Fed and the FDIC, which shares bank oversight responsibility….