Last month’s collapse of Silicon Valley Bank (SVB) saw the first real test of the new bankruptcy procedures put in place for financial institutions under Dodd Frank igniting a new debate on whether the system is working and potentially opening the door for renewed conversation on broader bankruptcy reform.

The Federal Reserve is currently conducting a holistic review of how this was allowed to happen, which they will release on May 1st, but here is what we know now:

November 2021: The San Francisco Federal Reserve issued six warnings to SVB, identifying several areas of concern that they needed to address. This is typically the first step before the Fed takes escalating enforcement action against a bank.

May 2022: The Fed issues another three warnings, identifying issues with the management of the bank as well as inadequacies in their internal stress testing processes.

Summer 2022: The Fed lowered the bank’s rating to ‘fair’, limiting its ability to grow through acquisitions.

November 2022: The Fed issued another warning, specifically citing SVB’s interest rate stress tests as inaccurate.

February 2023: Prior to the Fed raising interest rates to further combat inflation, the risks to institutions including SVB were explicitly reviewed and provided to Board members.

In hindsight, SVB’s rapid growth and reliance on riskier uninsured deposits should have and in fact did present red flags for regulators. Despite these indicators, the precipitous and unchecked failure of SVB forced the FDIC to take SVB into receivership under Title II of Dodd Frank to prevent further systemic risk to the nation’s banking system.

Within a week of SVB’s collapse, SVB Financial, the parent holding company under which SVB was an asset, filed for bankruptcy in New York in order to protect its remaining assets from FDIC claw-back. In a series of hearings in both the Senate and the House on March 28th and 29th, lawmakers on both sides of the aisle largely agreed that both bank management and bank regulators are at least partially to blame for the failure of SVB. Where they diverged was frequently on the question of whether new regulations were necessary or if regulators needed to make greater use of the tools already at their disposal.

After SVB Financial declared bankruptcy, President Biden issued a statement calling on Congress to increase regulations and stress testing for banks the size of SVB and provide new authority for the FDIC to claw-back bonuses, salaries, and stock buy-back funds from the executives of failed banks.

While somewhat unique to the banking industry, the concept of claw-backs is well known in bankruptcy. The question remains whether this issue will remain firmly in the financial services industry or if it will gain traction more broadly. Notably, SVB Financial filed for bankruptcy in New York, potentially limiting the ability for impacted Californians to be heard and increasing calls for bankruptcy venue reform.

The Federal Reserve is set to finalize its report on the collapse of SVB on May 1, 2023 and consensus has yet to be reached on what needs to be done to prevent similar situations in the future. Still, it has opened the proverbial can of worms and with Members of Congress jockeying for political space to legislation on the topic, we could see new proposals in the both Chapter 11 and Chapter 13 bankruptcy space based on SVB’s situation.

 

 

Ash Arnett, PACE Government Affairs, NACM’s Washington Representative