Board of Governors of the Federal Reserve System

Supervision of SVBFG by Critical Risk Areas

The three critical weaknesses of SVBFG were: governance and risk management; liquidity risk management; and interest rate risk and investment portfolio management. This section reviews these three aspects of SVBFG's operations and associated Federal Reserve supervision in greater detail.

A consistent theme across each area is that SVBFG's practices did not keep pace with its rapid growth in size and risk. The board of directors' and risk management's experience and capabilities were lacking for a firm that grew to over $200 billion in assets. With respect to both liquidity and interest rate risk, the management team was focused on short-term measures of risk and managing to profitability rather than understanding the longer-term risk exposure. Management was slow to address weaknesses in risk management and the riskiness of its balance sheet positions. Insufficiencies in the contingency funding plan, such as lacking sufficient capacity to monetize the liquidity buffer, were identified in November 2021 and remained only partially resolved when SVBFG failed.⁶⁹

Supervision also failed to keep pace in these areas. Although supervisors issued a number of supervisory findings in the four years leading up to SVBFG's failure, they missed some key issues that would eventually coalesce and lead to the rapid demise of SVBFG in March 2023. This section highlights the problems at SVBFG that were identified by the review team, including what supervisors found, what they missed, and what actions were taken in each key area. This section of the report also provides perspective from the review team on areas where further supervisory action may have been justified.

Governance and Risk Management

Overview

Corporate governance is the system of rules, practices, and processes that drive the direction and control of a firm. In order for a firm to be resilient under a broad range of economic, operational, and other stresses, the board of directors should provide for effective corporate governance with the support of senior management.⁷⁰ Supervisors assess governance structures, practices, and processes to determine if they are effective on a stand-alone and collective basis. Supervisors also assess: the board of directors' oversight of management; management's execution of the strategy and risk appetite; business lines' and finance's management and control of the risks they take; independent risk management's oversight of firmwide risks; and execution by internal audit of its assurance function.

SVBFG's growth far outpaced the abilities of its board of directors and senior management. They failed to establish a risk-management and control infrastructure suitable for the size and complexity of SVBFG when it was a $50 billion firm, let alone when it grew to be a $200 billion firm. The LFBO supervisory team recognized that governance and risk management were not sufficient for a firm of the size and risk of SVBFG in late 2021, conducted additional examination work in early 2022, and downgraded the Governance and Controls rating in August 2022.⁷¹

RBO Supervision of Governance and Risk Management

Supervisors assessed the board of directors and senior management as "effective" throughout SVBFG's time in the RBO portfolio despite clear signs that governance and risk management were not matching the growth of SVBFG. Even after supervisors began identifying and communicating issues with governance and risk management in 2018, the bank's CAMELS Management rating was "Satisfactory-2" for 2018, 2019, and 2020.

The CAMELS ratings letter dated March 6, 2019, states that "significant efforts are still needed to align risk-management practices with supervisory guidance (SR letter 16-11)."⁷² The letter also indicates the existence of additional weaknesses in liquidity and interest rate risk management, but these weaknesses were not reflected in the ratings. Similar feedback appears in the ratings letter dated April 13, 2020, but the Management rating remained a "Satisfactory-2."⁷³ This letter highlights an immature independent risk-management function that lacked authority, tools, and resources to appropriately monitor and test controls.

On May 3, 2021, supervisors issued the final RBO-based supervisory ratings letter that provided the ratings for the 2020 supervisory cycle.⁷⁴ Management and the board of directors' oversight were again rated "Satisfactory-2" indicating they were largely effective. SVBFG was approaching the $100 billion average total consolidated asset size threshold at which point it would become subject to the requirements of Regulation YY, the EPS requirements of the Dodd-Frank Act, as modified by EGRRCPA in 2018, the Board's tailoring rule, and related rulemakings in 2019.

The "Management" section of the letter highlights several significant concerns that could have led to a consideration of downgrading the Management rating to "Less-than-Satisfactory-3." First, the letter contains two MRAs regarding credit risk management and internal loan review. The nature of the findings is foundational with respect to credit risk management for a firm of SVB's size. Second, the letter highlights that management continued to struggle in addressing the firm's technology weaknesses. Finally, the Management rating commentary states "Management has been reactive as opposed to proactive in certain risk identification aspects but has demonstrated the ability and the willingness to address supervisory matters. An independent and effective LOD [line of defense] framework is fundamental to the Board and management's ability to plan for and respond to risks arising from changing business conditions, new activities, accelerated growth, and increasing complexity."⁷⁵

These issues indicate that risk management was lacking in important and fundamental ways and, therefore, are a cause for more than normal supervisory attention. Further, management was not identifying issues. They were reacting to supervisors identifying the issues. Under the applicable ratings definition, the ratings for Risk Management and Management could have been downgraded to a "Less-than-Satisfactory-3." Instead, supervisors maintained the "Satisfactory-2" rating given the strong financial performance of the firm at the time and the lack of realized risk outcomes from the risk-management weaknesses, a backward-looking perspective. A downgrade could have been justified in light of the potential for negative outcomes from identified risk-management deficiencies.

LFBO Supervision of Governance and Risk Management

The Liquidity Target examination in late 2021 provided some of the earliest insight to the new LFBO supervisory team that SVBFG's risk-management practices had not kept pace with its growth.⁷⁶ Meetings with SVBFG management at the time supported this supervisory concern, according to interviews with members of the supervisory team. These concerns surfaced coincident with the timing of the annual ratings cycle, so the supervisory team considered the possibility of a downgrade. As a result of discussions with the DST, LFBOMG, and Board staff in November 2021, Board staff provided a waiver for issuing the 2021 rating to ensure sufficient support was assembled for a downgrade in the Governance and Control rating.

The examination of SVBFG's governance and risk management began in the first quarter of 2022 and culminated in three matters requiring immediate attention (MRIAs), which were communicated on May 31, 2022 (table 7).⁷⁷ The examination identified fundamental weaknesses in board effectiveness, risk management, and internal audit—three areas critical to the safety and soundness of financial institutions.

Table 7. Synopsis of SVBFG supervisory findings from the May 2022 letter on the governance and risk-management examination

The MRIAs reflected that SVBFG did not have the risk management and control infrastructure necessary for the safety and soundness of the institution and was falling short of the enhanced expectations of the EPS. SVBFG was required to respond to the MRIAs within 90 days, with the response to include gap assessments for risk management and internal audit to determine if there were further issues supervisors did not identify. Given the severity of issues, supervisors could have recommended an enforcement action that required compensating controls while the firm remediated the supervisory findings. Compensating controls could have included measures to constrain risk appetite, require additional reporting to the board of directors, or mandate the engagement of a third party to conduct an independent review.

The board, management, and chief risk officer (CRO) all failed to recognize that their year-long program for their risk-management framework to meet EPS was ineffective, until supervisors started identifying issues in late 2021. Consultants who did the initial 2020 EPS gap assessment with respect to SVBFG practices and helped execute the plan to close those gaps also failed to design an effective program. During the Governance and Risk Management examination, the Federal Reserve's CPC met with the incoming chair of the board of directors to communicate several observations from the examination. Observations included that the board had failed to establish appropriate risk management, internal governance structures were inadequate given SVBFG's growth, the board lacked large bank experience, and that internal audit coverage was inadequate.

The examination findings and the failure of management and the CRO to recognize the weaknesses in the consultant's gap assessment and plan led to supervisors' and SVBFG's conclusion that the CRO did not have the experience necessary for a large financial institution. The CEO indicated in February 2022 the intent to replace the CRO, who subsequently left SVBFG in April. While it is the responsibility of the businesses and functions like finance and treasury to manage risk in a safe and sound way in accordance with the board of directors' risk appetite, the vacancy in a post like CRO removes one layer of important internal oversight. Despite the CEO's active search for a new CRO, supervisors could have cited the violation of section 252.33(b) of Regulation YY using an MRIA.⁷⁸ In consultation with Board staff, supervisors decided not to issue the violation since the firm was actively searching for a CRO with the appropriate skills and experience.

The Governance and Risk Management examination highlighted a number of fundamental and critical weaknesses that provided the support for the downgrade of the LFI Governance and Control rating to "Deficient-1" and the CAMELS Management and Composite ratings to "Less-than-Satisfactory-3" on August 17, 2022.⁷⁹ These broad deficiencies contributed to the management failures highlighted in the liquidity and interest rate risk sections of this report. The difference between a Deficient-1 and Deficient-2 rating is whether the findings "put the firm's prospects for remaining safe and sound through a range of conditions at significant risk" (Deficient-1) or the findings instead "present a threat to the firm's safety and soundness, or have already put the firm in an unsafe and unsound condition" (Deficient-2).

The supervisory team, Reserve Bank leadership, Board staff, and the national LFBOMG agreed that SVBFG's safety and soundness did not appear threatened at the time of the rating. Financial performance was still considered satisfactory, so the risk-management deficiencies did not appear to threaten safety and soundness. They did not yet recognize the building liquidity and interest rate risk. By early 2023, when SVBFG's liquidity and interest rate risk profile had deteriorated, and risk management was not making sufficient impact, a Governance and Control rating of "Deficient-2" should have been considered.

SVBFG was responsive to concerns articulated in meetings and in the Governance and Risk Management examination report. In April 2022, the CRO left the organization. New risk officers with large bank experience were hired. While the search to fill the CRO position took until December 2022, independent risk management was run by a committee of the senior risk officers. Many of these officers were new and "still completing baseline assessments," according to the August 17, 2022, letter.⁸⁰

SVBFG board of directors materials from August 29, 2022, provided a summary of gaps in the firm's risk-management program, two full years after the initial efforts to meet EPS (figure 18).

The review of these materials provides indications that management was only addressing issues in response to supervisory findings rather than being proactively focused on safe and sound operation of the firm. SVBFG's materials seemed focused on compliance with EPS or responding to supervisory findings, rather than managing the actual risks of the firm. They had not yet demonstrated that strong risk management, internal audit, and board oversight are critical to the safe and sound operation of an institution.

Conclusions

The supervisory record shows that the Federal Reserve supervisors identified many, but not all, of the relevant issues with respect to Governance and Controls. The SVBFG supervisory team detected concerns related to governance and risk management starting in late 2021 through a series of meetings and the risk-management findings of the liquidity examination. Based on the supervisory record and interviews, certain factors impacted the pace at which supervisors acted on those concerns.

The increasing requirements and the supervisory portfolio transition were one set of key factors. Supervisors had rated SVBFG as "Satisfactory-2" in May 2021, only a few months before the larger, more experienced team took over. When the new team observed weaknesses in governance and risk management late in 2021, they were reluctant to issue a downgrade within seven months of the issuance of the prior rating without doing more examination work to support a change in view and related action.

A second factor was a focus on the apparent strong financial performance of SVBFG. Supervisors saw financial performance and the lack of realized risk outcomes during this period as offsets to underlying concerns related to governance and risk management.

Finally, in some instances, supervisors saw progress on remediation of supervisory findings or risk-management gaps as positive developments on a relative basis, rather than citing the gap that continued to exist relative to baseline expectations. An example of this is the CRO vacancy in 2022. Supervisors could have cited the absence of a CRO as a violation of the EPS but waited while SVBFG continued the ongoing search.

Liquidity Supervision

Overview

Liquidity is a financial institution's capacity to meet its cash and collateral delivery obligations at a reasonable cost.⁸¹ Liquidity risk is the risk that an institution's financial condition or overall safety and soundness is adversely affected by an inability (or perceived inability) to meet its obligations.

For SVB, an acute liquidity risk event on March 9–10, 2023, rapidly led to failure as depositors lost faith in the ability of SVB to meet its obligations.

Liquidity risk is inherent in banking as a primary purpose of financial institutions is to serve as a credit intermediary through gathering of short-term deposits and lending longer-term funds. In performing this function, maturity transformation occurs as customer deposits are generally shorter-term in nature (e.g., demand deposit accounts) than the loans financial institutions make (e.g., 30-year mortgages). Although maturity transformation provides a key economic function, it also gives rise to liquidity risk as depositors may request their funds back in a timeframe that is not aligned with the timeframe within which a financial institution has invested the funds. SVBFG relied on a concentrated and largely uninsured deposit base to fund the bank, and when depositor faith was lost, SVB was not able to meet depositor withdrawal requests in part because of the maturity transformation inherent in its business activities.

Due to the materiality of liquidity risk to financial institutions, regulatory authorities have extensive requirements and expectations for the sound management of liquidity risk. SVBFG was subject to SR letter 10-6 and the EPS of Regulation YY during the period reviewed. These expectations and standards specify a range of sound liquidity risk-management practices, including board and senior management oversight, establishment of liquidity risk tolerances, internal liquidity stress tests (ILSTs), and contingency funding plans (CFPs), among other areas. SVBFG's liquidity risk-management practices were fundamentally flawed across multiple standards and were a direct contributing factor to SVBFG's failure.

Consistent with SVBFG's governance and risk-management weaknesses, SVBFG's capabilities for managing liquidity risk were not suitable for a $200 billion firm. SVBFG's funding inherently relied on large, concentrated, and uninsured deposits. This construct, coupled with broadly deficient liquidity risk-management practices, created an environment where SVBFG was neither prepared for nor capable of responding to the acute liquidity event in March 2023. Throughout the period of SVBFG's rapid growth while in the RBO portfolio, supervisors also did not consistently identify and communicate changes in SVBFG's risk profile and the weakness in SVBFG's liquidity risk management. Supervisory assessments after SVBFG's transition to the LFBO portfolio were more reflective of SVBFG's practices; however, shortcomings in judgment and a slow pace to further act on concerns led to missed opportunities for early intervention or to require timely remediation.

Liquidity Supervision of SVBFG in the RBO Portfolio

Supervisors communicated a consistently positive assessment of SVBFG's liquidity position and liquidity risk-management practices while SVBFG was in the RBO portfolio. This review found a combination of factors that contributed to the underappreciation of liquidity risks and material risk-management weaknesses that were not being appropriately identified.

Supervision of Liquidity Risk Positions

While in the RBO portfolio, SVBFG's balance sheet was growing and overwhelmingly skewed toward large, uninsured deposits in non-maturity accounts from VC-backed and private equity clients. Further, a substantial portion of SVBFG's assets consisted of unencumbered investment securities, with an increasing proportion designated as held-to-maturity (HTM) by 2021.

Liquidity risk analysis for firms in the RBO portfolio commonly relies on simple regulatory reporting-based metrics and firms' internal risk reporting. On the surface, SVBFG's liquidity risk appeared to be substantially mitigated by its growing deposit base and a large proportion of assets invested in low-credit risk securities. In the case of SVBFG, these regulatory reporting metrics and the firm's risk reporting were not suitable for assessing the risk profile of the specific deposit base.

Supervision of Liquidity Risk Management

Due in part to SVB's "Strong-1" Liquidity rating and the perceived low level of inherent risk, the examination of liquidity risk-management practices during the annual CAMELS and BHC exams was not extensive. RBO "risk-focusing guidelines" led staff to conduct lighter reviews of areas where either inherent risk was considered low or risk-management practices were satisfactory. Typically, one person would cover multiple assignments (e.g., liquidity, interest rate risk, and the investment portfolio).

Liquidity risk management was not thoroughly examined, and material gaps in supervisory conclusions occurred. Supervisory correspondence on liquidity risk management was consistently favorable and included direct references to SVBFG's practices being aligned with interagency guidance. Later discussion of the 2021 Liquidity Target examination shows that a more thorough and well-staffed examination by Federal Reserve subject matter experts revealed foundational issues.⁸² The limited scope approach to liquidity risk-management reviews at SVBFG and a lack of horizontal perspectives may have contributed to the missed opportunities for more critical supervisory assessments.

The impact of these supervision weaknesses is that SVBFG's size and risk profile substantially outpaced liquidity risk-management practices, and SVBFG was materially unprepared for the EPS requirements that would come into effect.

Supervisory Work in the LFBO program

Foundational liquidity risk-management weaknesses were identified in the first key supervisory event after the transition to LFBO, the liquidity risk-management examination beginning in August 2021.⁸³ The review covered a baseline assessment of ILST, liquidity risk limits, and the CFP, relative to interagency guidance in SR letter 10-6 and Regulation YY EPS. The liquidity examination was led by the FRBSF and included a broader set of Federal Reserve System subject matter experts. Additionally, staff stated that use of work programs designed for LFBO firms, specifically documents used by the HLR program, aided their ability to assess practices and consider expectations for firms subject to Regulation YY.

The examination cited foundational liquidity risk-management weaknesses across all areas reviewed. Importantly, the weaknesses were assessed to be gaps relative to both interagency guidance—applicable to banks of all sizes—and Regulation YY EPS that reflect heightened standards for firms like SVBFG. In total, six supervisory findings were delivered in a November 2021 feedback letter: two MRIAs and four MRAs (table 8). These findings became the support for a liquidity rating of "Conditionally Meets Expectations" and a downgrade of the CAMELS Liquidity rating to "Satisfactory-2" in August 2022.

Table 8. Synopsis of SVBFG supervisory findings from the November 2021 letter on the liquidity examination

Supervisors, however, did not associate the foundational nature of the findings with concerns about the adequacy of SVBFG's liquidity position. Supervisors continued to assess SVBFG's inherent liquidity risk profile favorably in the August 2022 CAMELS and LFI ratings letter, stating "…actual and post-stress liquidity positions reflect a sufficient buffer…".⁸⁴ Supervisors primarily relied on the comparatively large percentage of the balance sheet held in cash reserves and investment securities, and SVBFG's estimated coverage relative to the U.S. LCR reduced requirements as drivers of the favorable liquidity position assessment.

Based on the severity of the six findings from the 2021 liquidity examination, however, a more negative assessment (e.g., "Deficient-1" for Liquidity) would have been supportable. For example, the severity of the concerns on ILST alone may have been sufficient to warrant a negative view on the adequacy of SVBFG's liquidity position. Since the Global Financial Crisis, ILST has become the industry and supervisory standard for measuring an individual firm's liquidity risk profile and determining required levels of liquidity. Without an acceptable ILST, it is difficult to determine whether a firm's liquidity position is adequate or deficient.

Evolution of Liquidity in 2022

In addition to monitoring SVBFG's remediation progress from the 2021 liquidity examination, supervisors were tracking developments impacting SVBFG's risk profile. The deterioration of SVBFG's liquidity profile was evident in reporting by SVBFG, such as the results of its ILST. Supervisors were moving toward including these adverse developments in supervisory communications (e.g., likely rating downgrades upon the completion of the 2023 HLR and the in-process MOU). However, these communications did not materialize in a timely manner, and at times assessments relied on supervisory judgment that did not show elevated concerns for the actual liquidity position, only risk-management practices.

Consistent with the weaknesses in liquidity supervision during the RBO period, multiple factors contributed to an underappreciation of liquidity risk and lack of timely communication of concerns.

• Declines in client deposits in 2022:Q2. Market conditions contributed to reductions in client deposits at SVB in the second quarter of 2022 as technology and venture clients were drawing down their balances. At a May 24, 2022, monthly liquidity continuous monitoring meeting, SVB management highlighted targeted actions, such as pricing promotions, to attract and retain deposits, but at this time there were no material signs of stress. The June and July information provided by SVB on the newly implemented ILST highlighted weakness in the liquidity risk profile.

• Shortfalls in internal liquidity stress tests in 2022:Q3. In response to the 2021 Liquidity examination MRAs, SVBFG developed and implemented an updated ILST. SVBFG became subject to the Regulation YY EPS on July 1, 2022, including a 30-day liquidity buffer based on ILST results (figure 19).⁸⁵ SVBFG reports show there was not a sufficient balance of highly liquid assets that could be readily sold or "monetized." SVBFG management and supervisors characterized the 30-day deficit as an "operational shortfall" because of deficiencies in SVBFG's contingent funding options and current capabilities for executing these options. Conversely, the 90-day deficit was viewed as a "real shortfall" (i.e., SVBFG did not have sufficient liquidity to meet projected outflows in the timeframe). SVBFG management planned to undertake⁸⁶ actions by year-end 2022 to expand capacity for repurchase agreement funding and managing aspects of the funding structure and investment portfolio to remediate the modeled shortfalls. The 2022 LFI and CAMELS ratings letter assessed the liquidity position as adequate, and concerns were focused on the 2021 Liquidity examination issues. SVBFG, however, was apparently out of compliance with the Regulation YY 30-day liquidity buffer requirement and the modeled shortfalls represented a material safety-and-soundness concern. Given the apparent violation of Regulation YY, an MRIA providing a directive to the board and senior management to immediately take action to remedy the ILST deficit through raising additional liquidity would have been appropriate. The liquidity ratings should have been downgraded.

  Figure 19. Summary of SVBFG internal liquidity stress test

  

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  Source: SVBFG internal material, June 21, 2022.

• Deposit pressures continue to erode SVBFG's liquidity position in 2022:Q3. As deposit outflows increased, the ILST shortfalls increased. Despite modeled shortfalls of roughly $18 billion for the 30-day point at August 31, 2022, and roughly $23 billion for the 90-day point at September 30, 2022, the supervisory record displays that the assessment of inherent liquidity risk did not materially change and the assessment of liquidity risk-management practices was improving.

• Management recognizes liquidity risk in 2022:Q4. Year-to-date deposit trends and potential risks heading into 2023 were first substantively reported by bank management to the SVBFG board of directors in 2022 in board materials.⁸⁷ They highlight the deposit trends and financial risks facing SVBFG and the actions being considered to restructure the balance sheet. The plan presented by bank management at the November 2022 board of directors strategy meeting indicates more significant measures were deemed necessary to improve SVBFG's liquidity and protect against the risk of continued deposit pressures and to meet modeled liquidity needs over the 30- and 90-day points (figure 20). Importantly, these materials and supporting discussions from the continuous monitoring meetings continued to characterize the ILST 30-day shortfalls as "operational" rather than substantive breaches of Regulation YY.

  Figure 20. Presentation to the SVBFG board on potential balance sheet management actions

  

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  Source: SVBFG internal material, November 8–9, 2022.

• Management responses in 2022:Q4. Most significantly, management began actions to address liquidity pressures by increasing Federal Home Loan Bank (FHLB) advances, initiating efforts to increase repurchase agreement capacity and incorporating new stress assumptions that lowered liquidity requirements, among other actions. Most substantively, management targeted changes to ILST assumptions in October 2022 that had the effect of reducing the size of the modeled liquidity shortfall. They updated methodologies for unfunded lending commitments and intraday liquidity that reduced requirements in the combined scenario at the 30-day horizon by approximately $8 billion and $5 billion, respectively. Supervisors were aware of these changes and planned to evaluate their reasonableness during the upcoming 2023 HLR assessment of ILST. Management's intent behind the changes is not clear from SVBFG governance materials or interviews with supervisors. However, based on the materially less-conservative nature of the changes and the timing coinciding with periods of severe ILST shortfalls, it would have been reasonable for supervisors to express concern with SVBFG's liquidity position and risk-management practices. Changing model assumptions, rather than improving the actual liquidity position, is not an appropriate way to restore compliance with limits.

2023 Horizontal Liquidity Review

HLR is the Federal Reserve System's horizontal program for evaluating liquidity risk at LFBO firms. HLR is an annual exercise to assess select liquidity risk-management practices, and SVBFG participated for the first time in 2023. Supervisors viewed this assessment as critical for the SVBFG liquidity rating. SVBFG was in-scope for the ILST and buffer monetization workstreams,⁸⁸ as well as a review of SVBFG's progress against outstanding supervisory issues from the 2021 Liquidity examination. The HLR team had not yet conducted internal vetting sessions to calibrate and finalize recommended supervisory feedback prior to SVBFG's failure, so these are not final conclusions.

The preliminary HLR assessment was that SVBFG's ILST did not meet supervisory expectations and an MRIA would be recommended. Specific areas of concern focused on SVBFG's insufficiently supported deposit outflow speed assumptions and, to a lesser degree, the recent changes to make lending commitments and intraday assumptions less conservative. Regarding the deposit outflow concerns, supervisors determined that SVBFG had insufficiently supported a key assumption that a material portion of deposit outflows in stress would not occur until days 31–90. To remediate this concern, additional deposit outflows would likely have been incorporated inside 30 days, leading to further deterioration in the ILST 30-day metric.⁸⁹

Regarding the buffer monetization workstream, the preliminary HLR assessment was that material weaknesses remained in SVBFG's CFP, particularly the quantification, evaluation, and operational testing of contingent funding sources. The most significant concerns related to SVB's insufficient monetization capacity and options for repurchase agreement funding as well as the lack of operational testing of all contingent funding sources, particularly the discount window. SVBFG's ILST shortfall remediation plan from July 2022 cited the need to expand capacity and options for repo funding, including increased bilateral relationships, FICC direct membership, tri-party, and the Federal Reserve's Standing Repurchase Agreement facility, among other sources.⁹⁰ These efforts were not complete by March 2023.

Liquidity in 2023

Supervisory engagement with SVBFG in January and February 2023 occurred through continuous monitoring meetings, and the supervisory record shows supervisors had limited concerns on the liquidity position. Only concerns with liquidity risk management practices were communicated to SVBFG, not the substantive liquidity positions. SVBFG's internal materials included incrementally more detailed updates on the heightened liquidity risk profile. SVBFG management highlighted to its board that the CFP remained activated on the lowest level, efforts continued to pursue the funding restructuring initiatives (i.e., FHLB advances, brokered CDs, and unsecured term debt) discussed in November 2022, and breaches persisted on some risk metrics. However, neither the January nor February 2023 board meeting materials indicate any increasing consideration of the restructuring options that would be enacted in March 2023.

Supervisors had limited interaction with SVBFG management about the proposed restructuring prior to the events of March 8 and after. After the public announcement on March 8, the DST increased the frequency of communication as SVBFG provided updates on its rapidly evolving liquidity situation. Supervisors focused on the potential for the firm to pledge additional collateral to the FHLB or the discount window, but SVBFG's inadequate preparedness to access contingent funding sources likely contributed to the failure of the bank on the morning of Friday, March 10.

The acute liquidity stress on March 9 was far beyond historical precedents for how quickly a large financial institution can fail. Still, weaknesses in SVBFG's preparedness for a contingent liquidity event may have contributed to SVBFG's inability to access contingent funding sources in a time of need. SVBFG was not able to monetize (immediately raise funds against) its investment securities. SVBFG had not arranged for enough access to repo funding and had not signed up for the Federal Reserve's Standing Repurchase Agreement facility. SVBFG had limited collateral pledged to the Federal Reserve's discount window, had not conducted test transactions, and was not able to move securities collateral quickly from its custody bank or the FHLB to the discount window. While contingent funding may not have been able to prevent the failure of the bank after the historic run on the bank, the lack of preparedness may have contributed to how quickly it failed.

Conclusions

This review of the supervisory record shows that the Federal Reserve supervisors identified some, but not all, of the liquidity risk-management issues that proved pivotal in the failure of SVBFG. Moreover, supervisory responses, in hindsight, were not rapid enough given the widespread deficiencies at SVBFG, deteriorating financial conditions, and the specific combination of shocks that SVBFG faced.

From the perspective of RBO supervision, supervisors relied heavily on asset liquidity to evaluate liquidity risk, which led to an underappreciation of the inherent risks in SVBFG's distinctive deposit base and growing investment in HTM securities. Moreover, standard liquidity risk metrics and the risk-focusing guidelines routinely used in the RBO portfolio proved inadequate for SVBFG. Because of the perception of a strong liquidity position, supervisors did not pursue extensive risk-management reviews and supervisory staffing remained relatively light, despite the rapid growth of SVBFG.

From the LFBO perspective, supervisors did not appropriately assess the liquidity impacts of emerging signs of liquidity stress and SVBFG's increasingly material balance sheet restructuring efforts. Supervisors did not accurately reflect the implications of ILST liquidity shortfalls in the assessment of liquidity. As a result, liquidity ratings for SVB and SVBFG were not appropriately updated in 2022 and 2023 to reflect the multiple data points that displayed fundamental weaknesses in the liquidity position and risk-management practices. This combination left SVBFG acutely vulnerable to the shocks that materialized.

Interest Rate Risk and Investment Portfolio Supervision

Background

Sensitivity to market risk reflects the degree to which changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect a financial institution's earnings or capital.⁹¹ For SVB and SVBFG, market risk primarily reflects exposure to changing interest rates.

Supervisors and regulators recognize that some degree of interest rate risk (IRR) is inherent in the business of banking.⁹² At the same time, however, institutions are expected to have sound risk-management practices in place to measure, monitor, and control IRR exposures. SR letter 10-1 emphasizes the importance of effective corporate governance, policies and procedures, risk-measuring and monitoring systems, stress testing, and internal controls related to the IRR exposures of institutions. The framework begins with sound corporate governance and covers strategies, policies, risk controls, measurements, reporting responsibilities, independent review functions, and risk-mitigation processes. Importantly, effective IRR management not only involves the identification and measurement of IRR, but also provides for appropriate actions to control this risk.

The key metrics used to measure IRR include

• Earnings at risk (EaR) or net interest income (NII) at risk: This is an IRR metric that captures short-term exposure to interest rate movements. It measures NII volatility generally over a one-year horizon based on yield curve shocks. For example, firms will shock interest rates by 100, 200, or more basis points (bps) in either direction then estimate the impact to NII. A variety of different yield curve shocks and twists can be used for this exercise. Deposit assumptions are important for this analysis as firms must assume the amount of the market rate movement they will pass through to deposit accounts (also known as "deposit betas").
• Economic value of equity (EVE): This is an IRR metric that estimates the structural mismatches of a bank balance sheet relative to yield curve movements. It is often viewed as a longer-term measure as it is a discounted cash flow approach that estimates the present value (PV) of balance sheet cashflows to estimate economic equity (PV of assets – PV of liabilities = economic value of equity). The IRR portion of this exercise comes from shocking interest rates by various amounts (e.g., +/− 100, 200, or more bps) to estimate exposures as cashflow paths change. Deposit assumptions are important in this exercise, so cashflows must be estimated based on customer characteristics.

Interest Rate Risk Management at SVBFG

SVBFG had fundamental weaknesses in risk management. SVBFG management was focused on a short-term view of IRR through the NII metric and ignored potential longer-term negative impacts to earnings highlighted by the EVE metric. Management believed that SVBFG was asset sensitive, meaning NII would increase in rising rate environments, but did not consider idiosyncratic risks to SVBFG or the uniqueness of its customer base and the manner in which it could be impacted by rate increases. SVBFG had risk-measurement weaknesses as highlighted by SVBFG's internal audit weaknesses and lack of governance and controls. SVBFG did not conduct back-testing, had limited sensitivity testing, and did not have an adequate second line function to provide review and challenge to decisions and model assumptions.

SVBFG's interest rate risk policy, which is a firm's governing document for the management and measurement of IRR, exhibited many weaknesses.⁹³ The policy did not specify scenarios to be run, how assumptions should be analyzed, how to conduct sensitivity analysis, or articulate model back-testing requirements. Further, there was no description of how limits were set and calibrated. It was also not apparent that limits had been reviewed for potential recalibration or that the current level of the limits had been supported since at least 2018. Management should ensure limits are appropriate for a firm's business model, earnings base, and capital position. Lastly, the policy did not specify the ongoing reporting requirements for threshold breaches over prolonged periods.

Interest Rate Risk Modeling, Limits, and Reporting

SVBFG's risk appetite statement (RAS) set by the board, which sets limits within which the bank controls the risk, only included the NII metric and not the EVE metric. Further, the NII metric was included only as a down 100 bps 12-month ramp instead of a range of plausible shocks. Ramp scenarios gradually adjust rates and are less stressful than an immediate rate shock. The NII metric is a short-term view of risk. In the 2017 RAS, it states that managing interest rate risk within defined policy limits allows the firm to achieve a level of profitability that enhances shareholder value.⁹⁴ It is clear that NII and profitability were the focus for SVBFG.

As EVE was not part of the risk appetite, there is no evidence that the full board was aware of the status of the EVE metric or that it was breaching limits for years. Communication of the EVE limit breaches did, however, go to the Risk Committee of the board. The board of directors is responsible for overseeing the establishment, approval, implementation, and annual review of IRR management strategies, policies, procedures, and risk limits. The full board should understand and regularly review reports that detail the level and trend of the institution's IRR exposure.

SVBFG only used the most basic IRR measurement. Only parallel rate curve changes were modeled. Non-parallel shifts were not being reported to the Asset/Liability Committee (ALCO). Non-parallel shifts allow management to understand the sensitivity of the portfolio to different movements in the shape of the yield curve and are an important piece in understanding IRR sensitivity. The ALCO was provided with sensitivity analysis that showed the impact of shifts in key model assumptions only on an infrequent basis.

SVBFG's IRR results showed that there was a mismatch between the repricing of assets and liabilities on the bank's balance sheet. The results showed that SVBFG had historically been asset sensitive, which means that NII increased as rates increased. This was due to the nature of SVBFG's balance sheet that had consisted of predominantly non-interest-bearing deposits on the liability side and a mix of floating rate loans and fixed rate securities on the asset side. SVBFG expected to benefit in a rising rate environment, as it generally assumed that deposit betas would be low.

In response to EVE breaches, SVBFG made model changes that reduced the level of risk depicted by the model. In similar fashion to the response to liquidity shortfalls, management changed assumptions rather than the balance sheet to alter reported risks. In April 2022, SVBFG made a poorly supported change in assumption to increase the duration of its deposits based on a deposit study conducted by a consultant and in-house analysis.⁹⁵ Under the internal models in use, the change reduced the mismatch of durations between assets and liabilities and gave the appearance of reduced IRR; however, no risk had been taken off the balance sheet.⁹⁶ The assumptions were unsubstantiated given recent deposit growth, lack of historical data, rapid increases in rates that shorten deposit duration, and the uniqueness of SVBFG's client base.

Balance Sheet Mismanagement

In early 2022, at a time when rates were rising rapidly, SVBFG became increasingly concerned with decreasing NII if rates were to decrease, rather than with the impact of rates continuing to increase. This was based on observed yield curve inversion that could be an indication of an impending recession and a subsequent decrease in rates. The bank began positioning its balance sheet to protect NII against falling interest rates but not rising ones. SVBFG was very focused on NII and profits and the NII sensitivity metrics were showing that NII was exposed to falling rates. Rising rates were seen as an opportunity to take profits on hedges, and the bank began a strategy to remove hedges in March 2022, which were designed to protect NII in rising rate scenarios but also would have served to constrain NII if rates were to decrease. Protecting profitability was the focus.

This strategy of removing hedges extended the duration of the securities portfolio and caused the EVE metric to worsen throughout 2022 (figure 21). SVBFG was expecting the deposit duration lengthening would be an offset to the increasing investment portfolio duration, but this only provided temporary relief from the EVE metric breaching limits. Instead, rates rose, investment portfolio duration lengthened, deposits shifted from non-interest bearing to interest bearing, and liability duration fell.⁹⁷ This mismatch of durations on the asset and liability sides of the balance sheet caused the EVE metric to worsen and breach SVBFG's EVE limits once again. Importantly, there was no evidence that management made the full board aware that the EVE metric was breaching limits for years.

SVBFG's margins were getting squeezed and the models were not able to keep pace. As SVBFG experienced non-interest-bearing deposit outflows in 2022, it shifted to more costly interest-bearing deposits and wholesale borrowings. In July 2022, firm management stated that this shift in funding mix was actually a good thing because it gave interest expense some room to fall in a down-rate scenario. In July 2022, SVBFG removed the rest of the hedges protecting NII from rising rates, and management started to think about adding hedges to gain NII if rates were to decrease. SVB remained steadfast in its commitment to protecting NII in down-rate scenarios but did not protect against rising rate environments.

Compounding the poor balance sheet management was a lack of oversight by independent risk management and internal audit. SVBFG had a Financial Risk Management group, but it acted more in collaboration than as an effective challenge to the business. Internal audit had findings related to incorrect data inputs, inadequate governance of IRR models, and inaccurate NII position dating back to December 2020 but did not have the internal stature to drive remediation.

Federal Reserve Supervision

SVB's CAMELS rating for Sensitivity to Market Risk was "Satisfactory-2" from 2018 until the 2022 CAMELS vetting on November 1, 2022, when it was planned to be downgraded to "Less-than-Satisfactory-3." The downgrade was not finalized or issued because SVB failed before the letter was sent to the firm. During the initial vetting of the 2022 CAMELS exam on October 11, 2022, the Sensitivity rating remained "Satisfactory-2".

Subsequent to that vetting, SVBFG's models were no longer showing an increase in NII from rising rates as was previously reported. SVBFG management indicated that NII and NIM would decline in the fourth quarter of 2022, and net income would decline substantially by year-end 2022. Based on this new information, there was a follow-up vetting for the Sensitivity rating on November 1, 2022. Supervisors issued an MRA on IRR simulation and modeling (table 9).⁹⁸

Table 9. Synopsis of SVBFG supervisory finding from the November 2022 letter on interest rate risk

Conclusions

A review of the supervisory record shows that Federal Reserve supervisors identified some but not all of the interest rate risk-management issues that contributed to the failure of SVBFG. Supervisory responses for IRR were not rapid or severe enough given the fundamental issues in this area that actually drove poor decisions at SVBFG.

Beginning in the RBO portfolio, Federal Reserve supervisors did not conduct an in-depth review of IRR and investment portfolio management. Instead, IRR and the investment portfolio were assessed through CAMELS exams that focused on key assumption changes and new models, versus reviewing IRR models and risk-management practices. Only one examiner was responsible for reviewing IRR and the investment portfolio, and, in some cases, would also review liquidity and model risk management (MRM) during a two-to-three-week timeframe. That level of resources proved insufficient.

Examiners' conclusions with respect to SVBFG's IRR practices highlighted several areas of concern that were either not raised as findings or were communicated as written advisories or verbal observations. Limit breaches with respect to the EVE metric were evident in the 2020, 2021, and 2022 CAMELS exams. In the 2020 CAMELS exam, the examiner proposed an advisory on the lack of escalation, monitoring, and taking actions to remediate breaches. Additionally, in several CAMELS exams (2020, 2021), examiners identified issues related to lack of sensitivity testing, back-testing, gaps with policies, ineffective control functions, and lack of oversight from senior management and the board of directors. During the 2021 CAMELS exam, the examiner proposed an observation related to lack of sensitivity testing of key assumptions. Still, the lack of controls and oversight demonstrate fundamental weaknesses in risk management that should have been communicated to SVBFG through an MRIA.

SVBFG's transition from RBO into the LFBO portfolio did not materially increase the level of supervisory scrutiny of interest rate risk for some time. The LFBO supervisors conducted quarterly monitoring meetings with corporate treasury and the CFO, some of which should have raised supervisory concern. In January 2022, SVBFG discussed increasing the duration of its deposit assumptions. The proposed change was not aligned with SVBFG's actual experience. In April 2022, SVBFG presented a gap assessment against SR letter 10-1, highlighting fundamental weaknesses, such as limited scenarios, limited behavioral models, lack of timely reporting, data quality issues and limited data quality controls, and limited formal governance and review of results. At that time, supervisors did not document any supervisory concerns, changes to ratings, or changes to the 2022 supervisory plan.

After the firm transitioned to the LFBO portfolio, the supervisory team discussed conducting an IRR exam during 2022 but decided to defer this to the third quarter of 2023 in order to prioritize governance and liquidity exams. During 2022, coverage of SVBFG's management of IRR was mainly through continuous monitoring and the 2022 CAMELS exam with limited scope on IRR where one examiner was responsible for multiple risks. In the fall of 2022, management identified that internal IRR models were unreliable, and supervisors issued an MRA. Supervisors should have conducted comprehensive IRR and investment portfolio reviews, with adequate resources, and communicated findings through MRIAs. Exams staffed with limited resources, high-level scope, lack of IRR regulations, and the high-level nature of existing guidance (SR letter 10-1) all impeded supervisors from conducting a thorough assessment.

Overall, Sensitivity to market risk had been rated Satisfactory for many years, which reduced the urgency to conduct a deep-dive IRR review because supervisory planning is risk-focused, and areas with findings or that are poorly rated garner more supervisory focus.

 

References

 

 69. SVBFG Liquidity Planning Target Supervisory letter, November 2, 2021. Return to text

 70. SR letter 12-17. Return to text

 71. SVBFG and SVB 2021 Supervisory Ratings letter, August 17, 2022. Return to text

 72. SVB 2018 CAMELS Examination Report, March 6, 2019; See Board of Governors of the Federal Reserve System, "Supervisory Guidance for Assessing Risk Management at Supervised Institutions with Total Consolidated Assets Less than $100 Billion," SR letter 16-11 (June 8, 2016, revised February 17, 2021), https://www.federalreserve.gov/supervisionreg/srletters/sr1611.htm. Return to text

 73. SVB 2019 CAMELS Examination Report, April 13, 2020. Return to text

 74. SVB 2020 CAMELS Examination Report, May 3, 2021. Return to text

 75. SVB 2020 CAMELS Examination Report, May 3, 2021. Return to text

 76. SVBFG Liquidity Planning Target Supervisory letter, November 2, 2021. Return to text

 77. SVBFG and SVB Governance and Risk Management Target Supervisory letter, May 31, 2022. Return to text

 78. 12 C.F.R. § 252.33(b) requires a bank holding company to appoint a chief risk officer with appropriate experience to manage the risks of a large, complex firm. Return to text

 79. SVBFG and SVB 2021 Supervisory Ratings letter, August 17, 2022. Return to text

 80. SVBFG and SVB 2021 Supervisory Ratings letter, August 17, 2022. Return to text

 81. SR letter 10-6. Return to text

 82. SVBFG Liquidity Planning Target Supervisory letter, November 2, 2021. Return to text

 83. SVBFG Liquidity Planning Target Supervisory letter, November 2, 2021. Return to text

 84. SVBFG and SVB 2021 Supervisory Ratings letter, August 17, 2022. Return to text

 85. 12 C.F.R. § 252.35(b). Return to text

 86. Source: SVBFG internal materials. Return to text

 87. Source: SVBFG internal materials. Return to text

 88. SVBFG 2023 LFBO Horizontal Liquidity Review Entry Letter, November 17, 2022. Buffer monetization refers to a firm's ability to sell high-quality liquid assets/highly liquid assets against regulatory requirements set forth in Regulation YY, Regulation WW (if applicable), and safety-and-soundness expectations established in SR letter 10-6. Return to text

 89. Supervisors noted that sensitivity analysis was conducted to assess the potential impact on ILST if additional deposit outflows from days 31–90 were included inside 30 days; results indicated a worst-case scenario of an additional $27 billion of deposit outflows within 30 days. Return to text

 90. Source: SVBFG internal materials. Return to text

 91. Board of Governors of the Federal Reserve System, Commercial Bank Examination Manual. Return to text

 92. Board of Governors of the Federal Reserve System, "Interagency Advisory on Interest Rate Risk," SR letter 10-1 (January 11, 2010), https://www.federalreserve.gov/boarddocs/srletters/2010/sr1001.htm. Return to text

 93. Source: SVBFG internal materials. Return to text

 94. Source: SVBFG internal materials. Return to text

 95. Source: SVBFG internal materials. Return to text

 96. Source: SVBFG internal materials. Return to text

 97. Source: SVBFG internal materials. Return to text

 98. SVB 2022 CAMELS Examination Supervisory letter, November 15, 2022. Return to text