Events Leading To Failure

The failure of Silicon Valley Bank (SVB) was the result of a confluence of strategic missteps, external economic pressures, and rapid changes in the banking environment, particularly impacting the technology and startup sectors it predominantly served. A detailed breakdown of the events leading up to its collapse is as follows:

• Rapid Growth and Strategic Focus
  SVB experienced significant growth from 2019 to 2021, with its assets expanding from $71 billion to over $211 billion. This growth was largely fueled by the tech and venture capital boom, which saw the bank’s deposits increase substantially during this period. SVB’s strategic focus on the technology and venture capital sectors, while initially beneficial due to high deposit inflows, also concentrated its risks. These deposits were predominantly uninsured, making the bank highly vulnerable to sector-specific downturns.
• Economic Environment and Interest Rate Changes
  The Federal Reserve’s response to inflation, which involved raising interest rates starting in 2022 after years of historically low rates, significantly impacted SVB. As interest rates rose, the value of SVB’s extensive portfolio of held-to-maturity (HTM) and available-for-sale (AFS) securities fell sharply. These securities, purchased during the period of low interest rates, suffered from unrealized losses as yields rose, thereby diminishing the bank’s liquidity due to the market’s devaluation of these assets.
• Asset-Liability Mismatch
  SVB’s asset-liability management strategy became a critical vulnerability. The bank had invested heavily in long-duration assets, like U.S. Treasury bonds and mortgage-backed securities, funded largely by short-term deposits. This mismatch was exacerbated by the rising interest rates, which led to a decline in asset values while the cost of maintaining short-term deposits increased. The bank’s decision to remove interest rate hedges in the preceding years further exposed it to these shocks.
• Mismanagement of Risks
  The bank’s risk management practices were inadequate for its scale and the complexity of its operations. Internal audits and risk management frameworks failed to adapt to the growing size and risk profile of the bank, particularly in terms of liquidity and interest rate risk management. The governance structure did not effectively challenge the bank’s strategic direction nor adequately oversee senior management’s handling of these risks.
• The Trigger: A Crisis of Confidence
  The immediate trigger for the bank run was a crisis of confidence following a significant announcement on March 8, 2023. SVB revealed a $1.8 billion loss from the sale of $21 billion in securities aimed at restructuring its balance sheet and announced plans to raise additional capital through stock offerings. This announcement raised alarms about the bank’s financial health, particularly among its tech-savvy and networked client base.
• The Bank Run
  The bank run commenced on March 9, 2023, as news of the capital raising and asset sales spread rapidly through social media and tech networks. Depositors, primarily from the technology and VC sectors, began withdrawing their funds in large numbers. Over $40 billion was withdrawn on that day alone, which was unprecedented in its speed and scale, fueled by the digital and interconnected nature of SVB’s client base. This rapid outflow of deposits overwhelmed the bank’s available liquidity, leading to its collapse.
• Regulatory and Supervisory Shortcomings
  There were significant supervisory and regulatory shortcomings in identifying and addressing the risks at SVB. The transition of SVB from the Regional Banking Organization (RBO) portfolio to the Large and Foreign Banking Organization (LFBO) portfolio did not bring about the necessary rigor or oversight that might have mitigated these risks. The Federal Reserve and other regulatory bodies failed to enforce stricter controls or require sufficient corrective actions despite noting vulnerabilities during supervisory reviews.
• So overall, the collapse of SVB was not just a result of external economic factors but also a profound failure of internal governance and risk management, coupled with inadequate regulatory oversight. These factors culminated in a rapid bank run that the bank was ill-prepared to handle, leading to its eventual failure. This case highlights the dangers of rapid growth without corresponding enhancements in risk management and the need for robust regulatory oversight to adapt in real-time to changing economic conditions and banking practices.

Supervisory Shortfalls By Fed During SVB’s Transition From RBO To LFBO Portfolio

The transition of Silicon Valley Bank (SVB) from the Federal Reserve’s Regional Banking Organization (RBO) portfolio to its Large and Foreign Banking Organization (LFBO) portfolio highlighted several critical shortfalls and deficiencies in the Federal Reserve’s supervisory oversight.

• Inadequate Recognition of Risks During Transition
  As SVB grew rapidly in size and complexity, its supervision transitioned from the RBO to the LFBO portfolio. This shift was supposed to subject the bank to more stringent supervisory standards and closer scrutiny. However, the Federal Reserve’s supervisory team did not fully appreciate the extent of vulnerabilities introduced by SVB’s rapid growth, its concentrated exposure to the tech sector, and its significant reliance on uninsured deposits. The oversight didn’t adjust quickly enough to the bank’s evolving risks, showing a significant gap in understanding the effects of its business model changes.
• Lack of Phased Transition
  The Board of Governors raised the asset threshold for LFBO classification from $50 billion to $100 billion in July 2018, which delayed SVB’s transition to LFBO status until 2021. This administrative adjustment postponed the application of more stringent supervisory and regulatory standards. As a result, when SVB did transition, it faced abruptly stricter regulatory expectations without a gradual adjustment period, which was described internally as a “cliff event”. This lack of a phased transition failed to account for SVB’s rapid growth and its increasing exposure to sector-specific risks.
• Delays in Applying Stringent Supervisory Standards
  During SVB’s transition between supervisory portfolios, there was a significant delay in applying the more stringent supervisory and regulatory standards appropriate for its new size and complexity. This delay allowed SVB to continue operating under less rigorous standards longer than it should have, during which time it accumulated considerable exposure to interest rate and liquidity risks. The slow and delayed implementation of stricter rules meant that by the time tougher checks and rules were in place, serious risks had already become a part of the bank’s operations.
• Impact of COVID-19 and Examination Pauses
  The COVID-19 pandemic introduced additional complications during a crucial period of risk accumulation, particularly concerning SVB’s liquidity and interest rate exposure. Regulatory examinations were paused at a critical time when SVB was approaching the $100 billion asset threshold, leaving significant vulnerabilities unaddressed.
• Under-resourced and Overwhelmed Regulatory Framework
  From 2016 to 2022, while the banking sector assets grew by 37%, the headcount of regulatory supervisors declined by 3%. This discrepancy meant that as SVB’s needs grew more complex, fewer resources were available for adequate supervision. This resource strain became evident when SVB required more in-depth supervision upon transitioning to LFBO status, overwhelming the existing regulatory team.
• Supervisory Underestimation of Model Risks (related to the first point but more specific) The Federal Reserve supervisors did not adequately challenge the assumptions and effectiveness of SVB’s risk management models, particularly those related to liquidity and interest rate risks. This oversight was critical given the bank’s significant holdings of long-duration assets funded by short-term deposits. The supervisory team’s failure to fully recognize the risk of rising interest rates and the possibility of fast deposit withdrawals added to the already existing oversight problems.
• Lack of Proactive Supervisory Actions
  The supervisory team identified several vulnerabilities at SVB, including deficiencies in governance, risk management, and liquidity controls. However, there was a consistent pattern of insufficient supervisory action to compel timely remediation of these identified issues. When vulnerabilities were detected, the responses were often reactive rather than proactive, lacking the urgency required to address the systemic risks that were building.
• Cultural and Procedural Shifts in Supervision
  Under new leadership in 2021, the Division of Supervision and Regulation (DSR) began emphasizing a reduction in regulatory burdens, especially for RBO banks. This shift included a higher burden of proof for supervisory conclusions and a more elaborate due process for supervisory actions. These changes resulted in delays and a reluctance to escalate concerns about SVB’s risk management practices, slowing the response to emerging risks.
• Supervisory Ratings and MOU Process
  After transitioning to LFBO, SVB’s supervisory ratings for risk management and liquidity were downgraded significantly but came too late to be effective. Additionally, the process to issue a Memorandum of Understanding (MOU) was slow, involving multiple stakeholders such as the FRBSF, DSR, the Board of Governors’ legal department, and the California Department of Financial Protection and Innovation. This sluggish process contributed to the failure to implement corrective actions before the bank’s collapse.
• Communication and Coordination Failures
  There were notable failures in communication and coordination within the Federal Reserve and between the Fed and other regulatory bodies. As SVB transitioned portfolios, there should have been a more seamless transfer of knowledge and oversight responsibilities. Instead, there were gaps in transferring critical supervisory insights and in maintaining continuity in supervisory approaches, which hampered the effectiveness of the supervision during a critical period of the bank’s growth.
• Overall Supervisory Complacency
  A degree of complacency appeared to have set in among the Federal Reserve supervisors regarding SVB’s risk profile. The bank had been considered a well-managed institution, which may have led to a degree of supervisory bias or a lower perception of risk. This complacency was evident in the lagging supervisory response to emerging risks and in the delayed adjustments to supervisory intensity appropriate for a bank of SVB’s size and operational complexity.
• Hence, the oversight shortfalls during SVB’s transition from the RBO to the LFBO portfolio demonstrated significant lapses in risk assessment, supervisory rigor, and the timely application of regulatory standards, along with procedural delays, resource constraints, and inadequate risk assessment and response strategies. These deficiencies allowed underlying vulnerabilities to go unaddressed at a time when the bank was increasingly exposed to sector-specific downturns and broader financial market volatility. The case of SVB underscores the need for regulatory frameworks and supervisory practices that are dynamic and responsive to the rapid changes in bank profiles and risk landscapes.

Specific Risk Issues

Silicon Valley Bank (SVB) succumbed to a combination of internal vulnerabilities and external pressures, accelerating its collapse. Several specific risk issues were central to its failure, each compounding the impact. A detailed breakdown of each identified risk factor is as follows:

• Deposit Concentration: SVB had a highly concentrated deposit base largely stemming from the technology and venture capital sectors. This concentration created significant exposure to sector- specific downturns and increased the risk of rapid, large-scale deposit withdrawals. More than 55% of SVB’s deposits came from venture capital-backed companies, which significantly heightened its exposure to fluctuations within these industries, especially as they were particularly volatile during periods of economic stress.
• Type of Deposits: A large portion of SVB’s deposits were uninsured, which heightened the risk of bank runs as depositors lacked the protection of insurance coverage over the FDIC limit. These deposits tended to be more volatile, especially during market stress. In fact, around 94% of the deposits were uninsured, raising the stakes during the financial instability that the bank faced.
• Held-to-Maturity (HTM) Securities: SVBFG chose to invest a large portion of its client deposits in long-dated, held-to-maturity (HTM) securities, primarily government or agency-issued mortgage- backed securities (agency MBS). These securities are generally considered low risk from a credit perspective and offer a predictable return, fixed at the time of purchase. As of December 31, 2022, SVBFG’s HTM securities portfolio had a weighted average duration of 6.2 years, with the majority consisting of agency MBS that had maturities of 10 years or more. The HTM classification means these securities are carried at amortized historical cost, avoiding market value fluctuations. However, this also means that the bank was limited in its ability to adjust its portfolio in response to changing interest rate environments without reclassifying the securities as available-for-sale (AFS), which would require them to be marked to market. This inflexibility contributed to a rapid increase in unrealized losses on its investment portfolio as interest rates began to rise in 2022.
• Available-for-Sale (AFS) Securities: The AFS securities portfolio also suffered from similar valuation issues due to rising interest rates. These securities are marked to market, so the unrealized losses had a direct impact on the bank’s equity, further straining its financial health. The sharp decrease in the market value of these securities directly eroded the bank’s capital cushion, exacerbating its vulnerability during the crisis.
• Contingent Funding Plan and Capacity: The bank’s contingent funding plan proved inadequate during the crisis. It lacked sufficient capacity to handle the sudden and massive withdrawals that occurred. The plan’s assumptions about available liquidity under stress did not hold under the actual stress conditions experienced, leaving the bank vulnerable to a liquidity shortfall. The massive outflows, which exceeded tens of billions of dollars in just a few days, far surpassed the bank’s operational handling capacity and its liquidity buffers.
• Capital Raising Efforts: In the days leading up to the failure, SVB attempted to shore up its finances through a capital raising effort by selling shares and some of its securities holdings. However, these efforts were unsuccessful in restoring investor and depositor confidence and ultimately could not prevent the bank’s collapse. The bank announced a plan to raise approximately $2.25 billion, but this announcement backfired, accelerating the deposit withdrawals instead of halting them.

These risk factors combined to create a precarious financial situation for SVB. The concentration in specific sectors magnified the impact of economic shifts in those industries, while the bank’s asset-liability management issues left it exposed to interest rate risks that materialized as market conditions changed. The inadequate contingent funding plan and unsuccessful capital raising efforts were unable to stop the rapid depletion of liquidity, culminating in the bank’s rapid and dramatic failure.

Governance And Risk Management Failures

Silicon Valley Bank (SVB) faced a dramatic failure due to significant deficiencies in its governance and risk management frameworks, which were exacerbated by the bank’s rapid growth from $50 billion to over $200 billion in assets. A comprehensive breakdown is as follows:

• Management and Governance Failures:
  • Silicon Valley Bank (SVB) faced significant criticisms over its governance and risk management, particularly as it struggled to oversee a rapidly expanding financial institution. The bank’s board of directors and management were notably underprepared for the complexities associated with its rapid growth from $50 billion to over $200 billion in assets. This led to a governance structure that was unable to adapt to increased scale and complexity, leaving the institution vulnerable to mismanagement and oversight failures.
  • The focus on short-term profitability at SVB often overshadowed the need for robust risk management, resulting in inadequate oversight of key risk practices and a failure to anticipate the implications of the bank’s high concentration in volatile tech-sector deposits. These issues were compounded by the bank’s corporate governance systems, which were insufficient to navigate the economic and operational uncertainties effectively. Even when SVB was under the $100 billion asset mark and classified as an RBO, it maintained a CAMELS rating of “Satisfactory-2” during 2018, 2019, and 2020. This rating persisted despite several noted issues such as weaknesses in credit risk management, inadequate internal loan reviews, and technological shortcomings. The continuation of this satisfactory rating, largely influenced by the bank’s strong financial performance up to that point, highlights a significant disconnect between performance metrics and underlying risk factors.
• Failures Related to the Chief Risk Officer (CRO) Position:
  • The role of the Chief Risk Officer (CRO) at Silicon Valley Bank (SVB) was marred by significant deficiencies that critically undermined the bank’s risk management capabilities. The CRO position did not possess the requisite authority or resources necessary to effectively oversee the bank’s risk management framework, a crucial shortfall for an institution of SVB’s size and complexity. This lack of empowerment was exacerbated by periods of vacancy and instances where the role was filled by individuals who lacked sufficient experience to manage the associated risks effectively.
  • This instability within the CRO position contributed to a weakened risk management environment where strategic decisions were not adequately vetted for potential risks. The frequent turnover and inadequate qualification of those filling the CRO role culminated in April 2022, when the CRO at the time admitted to not having the necessary skills to navigate the complexities of a large, rapidly expanding bank and subsequently resigned. During the interim period before a new CRO was appointed in December 2022, SVB’s risk management was temporarily overseen by a team of senior risk managers who were also new to their roles. This situation further diluted the effectiveness of the risk management efforts, leaving the bank vulnerable to oversight failures during a critical period of growth and change.
• Shortfalls in the Internal Audit Function:
  • The internal audit function at Silicon Valley Bank (SVB) exhibited critical deficiencies that significantly impaired its ability to oversee and verify the bank’s adherence to risk management procedures. The audit function suffered from a lack of effective methodology to challenge the bank’s management adequately. It also consistently failed to deliver timely and sufficient reporting to the audit committee and did not provide prompt analysis of critical risk management functions. These shortcomings meant that significant risk exposures, particularly those related to interest rate risk and liquidity risk which were central to the bank’s collapse, went unidentified and unescalated.
  • Due to these severe deficiencies, a report issued on May 31, 2022, by supervisors pointed out the ineffectiveness of SVB’s internal audit as one of three major matters requiring immediate attention (MRIAs). The internal audit’s failure to provide adequate oversight and independent checks on the bank’s risk management and compliance frameworks underlined its inability to act as an effective counterbalance to management, leaving significant risk management issues unaddressed. This contributed substantially to the regulatory and operational oversights that precipitated the bank’s eventual failure.
• Supervisory and Regulatory Observations:
  • In their first comprehensive assessment in late 2021, LFBO supervisors identified profound gaps in
  • SVB’s governance and risk management capabilities. The supervisors deferred assigning a governance rating to allow more time for due diligence. This period highlighted ongoing challenges, as the bank’s board and management struggled to meet the heightened standards expected of larger institutions. They relied on external consultants in 2020, yet still failed to adequately transition from RBO to the more stringent EPS requirements of LFBOs.

LIQUIDITY RISK MANAGEMENT DEFICIENCIES

• Silicon Valley Bank’s (SVB) liquidity risk management was fundamentally flawed, exacerbated by rapid growth and inadequate oversight, which significantly contributed to its failure.
• Regulatory Requirements vs. SVB’s Liquidity Management Practices:
  Liquidity is crucial for a bank’s ability to meet its cash and collateral obligations at a reasonable cost. SVB’s liquidity risk management was inadequate for its size, particularly as it expanded from $50 billion to over $200 billion in assets between 2019 and 2021. Regulation mandates strong liquidity management practices including board oversight, establishing liquidity risk tolerance, internal liquidity stress testing, and contingency funding plans. However, SVB’s practices didn’t meet these standards, and regulators didn’t notice how its risk profile changed as it rapidly accumulated large amounts of uninsured deposits from venture capital-backed and private equity clients.
• Modeling and Stress Testing Shortfalls:
  SVB’s 30-day liquidity buffer modeling and stress testing were criticized for not reflecting realistic stress scenarios. These models underestimated the potential for large-scale, rapid withdrawals, which eventually occurred and outstripped the bank’s liquid asset reserves. For instance, in August 2022, SVB identified a modeled 30-day liquidity shortfall of $18 billion and a 90-day shortfall of $23 billion, both of which were incorrectly treated as “operational shortfalls” rather than serious safety and soundness concerns.
• Actions Considered by Management and Regulators:
• In response to the liquidity crisis, SVB management and regulators considered several measures
  • Developing a plan to address shortcomings in liquidity stress testing and contingency funding.
  • Redesigning the internal audit function to enhance risk management oversight.
  • Revising liquidity stress testing to incorporate more realistic assumptions and immediate stress scenarios rather than expected evolution over time.
• Despite these efforts, by the fourth quarter of 2022, management started to realize the seriousness of the liquidity problems. Efforts included increasing Federal Home Loan Bank advances and expanding repurchase agreement capacity. However, the adjustments to the assumptions used in modeling the 30- day liquidity shortfall, which artificially reduced the shortfall by $5 billion, were inadvisable as they did not reflect the underlying risk accurately.
• Regulatory Oversight and the Final Breakdown:
  Throughout 2022 and into early 2023, SVB’s management failed to adequately address these liquidity issues, leading to a continued deterioration in the bank’s liquidity position. The regulatory oversight was insufficient; supervisors focused on SVB’s liquidity risk management practices rather than on the actual liquidity positions. This oversight culminated in a crisis on March 8 and 9, 2023, when SVB faced a rapid withdrawal of deposits, leading to its collapse. Supervisors had limited interaction with SVB during this critical period, and the bank was ill-prepared for the massive outflows that ensued.
• The above points highlight the critical failures in SVB’s liquidity risk management, including inadequate internal controls, unrealistic modeling assumptions, and insufficient regulatory oversight, all of which contributed significantly to the bank’s rapid downfall.

Interest Risk Management Deficiencies

Silicon Valley Bank’s (SVB) deficiencies in its interest rate risk management process were notably evident in its modeling processes, which failed to accurately predict the impacts of rising interest rates on its financial stability. These deficiencies, along with the inadequate use of key financial metrics, contributed significantly to the bank’s eventual failure.

• Deficiencies in Models:
  SVB’s interest rate risk management process was criticized for its reliance on outdated or overly simplistic models that did not adequately account for volatile market conditions or the potential for rapid increases in interest rates. The bank’s models failed to incorporate complex scenarios involving sudden shifts in the economic landscape, which became a reality as the Federal Reserve raised rates to combat inflation.
• Inadequate Use of Financial Metrics:
  Proper use of metrics such as Net Interest Income (NII) at risk and the Economic Value of Equity (EVE) could have significantly improved SVB’s management of interest rate risks. NII at risk measures the potential loss in net interest income due to changes in interest rates, providing insights into the impact of rate changes over a specific time horizon. EVE, on the other hand, measures the long-term value of the bank’s assets and liabilities under different interest rate scenarios.
  • NII at Risk: SVB’s risk appetite statement (RAS) focused almost exclusively on NII and ignored EVE. Management anticipated that NII would increase in a rising rate environment due to an incorrect assumption of low deposit betas and only tested a limited number of interest rate changes. They did not conduct backtesting and had only limited sensitivity testing. This narrow focus led management to position the bank’s balance sheet for a falling rate cycle in anticipation of a recession, removing hedges against rising rates from March to July 2022, which ultimately never materialized and adversely affected the bank’s profitability when rates continued to rise. Proper application of this metric would have allowed SVB to better understand and plan for the potential impacts of interest rate changes on its earnings, particularly from its interest-earning assets and interest-paying liabilities. This could have led to more informed strategic decisions, such as adjusting asset durations or hedging interest rate exposures.
  • Economic Value of Equity (EVE): The removal of rate hedges and the shift in the bank’s deposit base from noninterest-bearing to interest-bearing deposits increased the duration of the bank’s liabilities and negatively impacted the EVE metric. Despite its importance, EVE was excluded from the RAS and was not adequately monitored by the full board, though it was reviewed by the Risk Committee. Management also adjusted the assumed withdrawal rates for deposits and other unsubstantiated assumptions, making the EVE outcomes appear more favorable than they were, distorting the economic reality. Using EVE effectively would have helped SVB assess the potential decrease in the economic value of its equity under various interest rate scenarios. This would involve more robust stress testing and scenario analysis, allowing the bank to implement strategies to mitigate potential decreases in equity value due to rising rates.
• Regulatory Oversight and Risk Management Failures:
  • The Asset/Liability Committee (ALCO) at SVB considered only parallel shifts in the yield curve, ignoring nonparallel shifts that would have indicated potential problems. From 2018 to 2022, SVB’s market risk was rated as “Satisfactory-2” by supervisors. However, by the 2022 review cycle, this rating was downgraded to “Less than Satisfactory-3”, a review that was not finalized until after SVB had failed.

Overall, SVB’s approach to managing interest rate risk was fraught with critical oversights and a lack of comprehensive strategy. The bank’s failure to properly incorporate and evaluate key metrics such as NII at risk and EVE, along with a lack of robust modeling and stress testing, left it highly vulnerable to the destabilizing effects of rising interest rates. These shortcomings in the bank’s risk management framework were exacerbated by regulatory oversights and insufficient internal controls, contributing significantly to the bank’s rapid downfall. Enhanced modeling processes and better utilization of these metrics could have provided earlier warnings and more effective mitigation strategies, potentially averting the severe consequences that SVB ultimately faced.