The Federal Reserve is facing criticism over Silicon Valley Bank’s collapse, with

lawmakers and financial regulation experts asking why the regulator failed to catch and
stop seemingly obvious risks. That concern is galvanizing a review of how the central
bank oversees financial institutions — one that could end in stricter rules for a range of
banks.

In particular, the episode could result in meaningful regulatory and supervisory changes
for institutions — like Silicon Valley Bank — that are large but not large enough to be
considered globally systemic and thus subject to tougher oversight and rules. Smaller
banks face lighter regulations than the largest ones, which go through regular and
extensive tests of their financial health and have to more closely police how much easy-
to-tap cash they have to serve as a buffer in times of crisis.

Regulators and lawmakers are focused both on whether a deregulatory push in 2018,
during the Trump administration, went too far, and on whether existing rules are
sufficient in a changing world.

While it is too early to predict the outcome, the shock waves that Silicon Valley Bank’s
demise sent through the financial system, and the sweeping response the government
staged to prevent it from inciting a nationwide bank run, are clearly intensifying the
pressure for stronger oversight.

“There are a lot of signs of a supervisory failure,” said Kathryn Judge, a financial
regulation expert at Columbia Law School, who also noted that it was too early to draw
firm conclusions. “We do need more rigorous regulations for large regional banks that
more accurately reflect the risks these banks can pose to the financial system,” she said.

The call for tougher bank rules echoes the aftermath of 2008, when risky bets by big
financial firms helped to plunge the United States into a deep recession and exposed
blind spots in bank oversight. The crisis ultimately led to the Dodd-Frank law in 2010, a
reform that ushered in a series of more stringent requirements, including wide-ranging
“stress tests” that probe a bank’s ability to weather severe economic situations.

But some of those rules were lightened — or “tailored” — under Republicans. Randal K.
Quarles, who was the Fed’s vice chair for supervision from 2017 to 2021, put
a bipartisan law into effect that relaxed some regulations for small and medium-size
banks and pushed to make day-to-day Fed supervision simpler and more predictable.

Critics have said such changes could have helped pave the way for the problems now
plaguing the banking system.
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“Clearly, there’s a problem with supervision,” said Daniel Tarullo, a former Fed
governor who helped shape and enact many post-2008 bank regulations and who is now
a professor at Harvard. “The lighter touch on supervision is something that has been a
concern for several years now.”
Image
Jerome H. Powell, right, the chair of the Federal Reserve, and Randal K. Quarles, then
the vice chair for supervision, at the Fed, in 2018. “The events surrounding Silicon
Valley Bank demand a thorough, transparent and swift review,” Mr. Powell said in a
statement this week.Credit...Aaron P. Bernstein/Reuters
The Federal Reserve Bank of San Francisco was in charge of overseeing Silicon Valley
Bank, and experts across the ideological spectrum are questioning why growing risks at
the bank were not halted. The firm grew rapidly and took on a large number of
depositors from one vulnerable industry: technology. A large share of the bank’s
deposits were uninsured, making customers more likely to run for the exit in a moment
of trouble, and the bank had not taken care to protect itself against the financial risks
posed by rising interest rates.

Worsening the optics of the situation, Greg Becker, the chief executive of Silicon Valley
Bank, was until Friday on the board of directors at the Federal Reserve Bank of San
Francisco. The Fed has said reserve bank directors are not involved in matters related to
banking supervision.

Questions about bank oversight ultimately come back to roost at the Fed’s board in
Washington — which, since the 2008 crisis, has played a heavier role in guiding how
banks are overseen day to day.

The board has indicated that it will take the concerns seriously, putting its new vice
chair of supervision, Michael Barr, in charge of the inquiry into what happened at
Silicon Valley Bank, the Fed announced this week.

“The events surrounding Silicon Valley Bank demand a thorough, transparent and swift
review by the Federal Reserve,” Jerome H. Powell, the Fed chair, said in a statement.
It is unclear how much any one of the 2018 rollbacks would have mattered in the case of
Silicon Valley Bank. Under the original postcrisis rules, the bank, which had less than
$250 billion in assets, most likely would have faced a full Fed stress test earlier,
probably by this year. But the rules for stress tests are complex enough that even that is
difficult to pinpoint with certainty.

“Nobody can say that without the 2018 rollbacks none of this would have happened,”
Ms. Judge said. But “those rules suggested that banks in this size range did not pose a
threat to financial stability.”

But the government’s dramatic response to Silicon Valley Bank’s collapse, which
included saving uninsured depositors and rolling out a Fed rescue program, underlined
that even the 16th-largest bank in the country could require major public action.

Given that, the Fed will be paying renewed attention to how those banks are treated
when it comes to both capital (their financial cushion against losses) and liquidity (their
ability to quickly convert assets into cash to pay back depositors).

There could be a push, for instance, to lower the threshold at which the more onerous
regulations begin to apply. As a result of the 2018 law, some of the stricter rules now
kick in when banks have $250 billion in assets.

Another major focal point will be the content of stress tests. While banks used to be run
through an “adverse” scenario that included creative and unexpected shocks to the
system — including, occasionally, a jump in interest rates like the one that bedeviled
Silicon Valley Bank — that scenario ended with the deregulatory push.

An interest rate shock will be included in this year’s stress test scenarios, but the larger
question of what risks are reflected in those exercises and whether they are sufficient is
likely to get another look. Many economists had assumed that inflation and interest
rates would stay low for a long time — but the pandemic upended that. It now seems
clear that bank oversight made the same flawed assumption.
Image
The collapse of Silicon Valley Bank could precipitate changes for financial institutions
that are not large enough to be considered globally systemic and thus subject to tougher
oversight and rules.Credit...Jason Henry for The New York Times
Many people were wrong about the staying power of low rates, and “that includes
regulators and supervisors, who are supposed to think about: What are the possibilities,
and what are the scenarios?” said Jonathan Parker, the head of the finance department
at the Massachusetts Institute of Technology’s Sloan School of Management.

And there is a bigger challenge laid bare by the current episode: Several financial
experts said the run on Silicon Valley Bank was so severe that more capital would not
have saved the institution. Its problem, in part, was its huge share of uninsured
deposits. Those depositors ran rapidly amid signs of weakness.

That could spur greater attention in Congress and among regulators regarding whether
deposit insurance needs to be extended more broadly, or whether banks need to be
limited in how many uninsured deposits they can hold. And it could prompt a closer
look at how uninsured deposits are treated in bank oversight — those deposits have long
been looked at as unlikely to run quickly.

In an interview, Mr. Quarles pushed back on the idea that the changes made under his
watch helped to precipitate Silicon Valley Bank’s collapse. But he acknowledged that
they had created new regulatory questions — including how to deal with a world in
which technology enables very rapid bank runs.

“Certainly, none of this resulted from anything that we changed,” Mr. Quarles said. “You
had this perfect flow of imperfect information that really increased the speed and
intensity of this run.”

In the days after the collapse, some Republicans focused on supervisory failures at the
Fed, while many Democrats focused on the aftershocks of deregulation and possible
wrongdoing by the bank’s executives.

“All the regulators had to do was read the reports that Silicon Valley Bank was
submitting, and they would have seen the problem,” Senator John Kennedy, Republican
of Louisiana and a member of the Banking Committee, said on the Senate floor.

By contrast, two Senate Democrats — Elizabeth Warren of Massachusetts and Richard

Blumenthal of Connecticut — sent a letter to the Department of Justice and the
Securities and Exchange Commission on Wednesday urging the agencies to investigate
whether senior executives involved in the collapse of Silicon Valley Bank had fallen short
of their regulatory responsibilities or violated laws.

Ms. Warren also unveiled legislation this week, co-sponsored by roughly 50 Democrats
in the House and Senate, that would reimpose some of the Dodd-Frank requirements
that were rolled back in 2018, including regular stress testing.

Senator Sherrod Brown, Democrat of Ohio and chairman of the Banking Committee,
told reporters that he intended to hold a hearing examining what happened “as soon as
we can.”
Mr. Barr, who started at the Fed last summer, was already reviewing a number of the
Fed’s regulations to try to determine whether they were appropriately stern — a reality
that had spurred intense lobbying as financial institutions resisted tougher oversight.

But the episode could make those counterefforts more challenging.

Late on Monday, the Bank Policy Institute, which represents 40 large banks and
financial services companies, emailed journalists a list of its positions, including claims
that the failures of Silicon Valley Bank and Signature Bank were caused by “primarily a
failure of management and supervision rather than regulation” and that the panic
surrounding the collapses proved how resilient big banks were to stress, since they were
largely unaffected by it.

The trade group also emailed those talking points to congressional Democrats, but other
trade groups, including the American Bankers Association, have stayed silent, according
to a person familiar with the matter.

“We share President Biden’s confidence in the nation’s banking system,” a spokesman
with the American Bankers Association said. “Every American should know that their
accounts are safe and their deposits are protected. Our industry will work with the
administration, regulators and Congress to further bolster that trust.”

The fallout could also kill big banks’ attempts to roll back regulations that they say are
inefficient. The largest banks had wanted the Fed to stop forcing them to hold cash
equivalents to what they say are safe securities like U.S. government debt. But Silicon
Valley Bank’s failure was caused in part by its decision to keep a large portion of
depositors’ cash in longer-dated U.S. Treasury bonds, which lost value as interest rates
rose.

“This definitely underscores why it is important that there be some capital requirement
against government-backed securities,” said Sheila Bair, a former chair of the Federal
Deposit Insurance Corporation.

Catie Edmondson contributed reporting.

Jeanna Smialek writes about the Federal Reserve and the economy for The Times. She
previously covered economics at Bloomberg News. More about Jeanna Smialek

Emily Flitter covers finance. She is the author of “The White Wall: How Big Finance Bankrupts
Black America.” More about Emily Flitter