Fed staff timidity blamed in Silicon Valley Bank failure; CLARITY Act stalls

The Washington Wrap is a weekly recap of financial regulation, news and chatter from around the capital.

At federal regulators

Federal Reserve supervisory staff failed to take decisive action to address Silicon Valley Bank's vulnerabilities before its failure in part because of a "longstanding culture of risk aversion" at the regulator, Vice Chair for Supervision Michelle Bowman said.

The bank failed in June 2023 as a result of factors that included unrealized accounting losses on its securities portfolio, a run-prone deposit base that was 94% uninsured and concentrated in companies backed by venture capital and a lack of operational readiness to borrow from the discount window, an independent review by the Starling Advisory Group found.

In remarks announcing the review's findings, Bowman said Federal Reserve staff "believed it was personally safer to take no action unless they were certain the action was exactly right."

In light of "persistent and systemwide divorcing of responsibility, authority and accountability," supervisory staff members were unsure who could provide clarity that a particular course of action was correct, she added.

In the future, examination teams will submit monthly reports directly to the heads of supervision and their respective reserve banks, identifying any supervisory issues or concerns in which an examiner was uncertain. The change "empowers our examiners to escalate concerns without fear, and it gives leadership real-time visibility into where our teams need clearer guidance," Bowman said.

_________________

The Federal Deposit Insurance Corp. proposed overhauling its Bank Merger Act framework to accelerate processing timelines and include credit unions and thrifts in competitive analyses.

Banks have been fighting for years to include credit unions and other competitors, including fintechs and non-local banks, in the Herfindahl-Hirschman Index screen. The proposal would update the regulator's approach to calculating whether market consolidation reduces competition too much, to include not just bank deposits but a representative share of deposits at thrifts, credit unions and banks' and thrifts' deposits in many cases. It would also codify maximum processing times for different categories of mergers, depending on deal size and complexity.

The new approach would also provide deemed approval within five business days for acquisitions of extremely small targets or certain operating subsidiaries.

_________________

The Office of the Comptroller of the Currency has begun issuing reduction-in-force notices as part of a new round of layoffs, with about 50 employees affected, many in policy roles, Bloomberg Law reported.

The notices follow the OCC's announcement in June that it planned to reduce head count through buyouts and other workforce measures.

_________________

The Fed confirmed that the public website for its National Information Center (NIC) experienced an outage Aug. 5, while saying that critical functions continued operating, The Wall Street Journal reported.

The cause of the outage was not identified. An internal message said failures in key NIC data pipelines caused significant downstream effects across several Fed business areas, including the discount window through which the Fed lends directly to banks during periods of financial stress.

Sen. Elizabeth Warren, the senior Democrat on the Senate Banking, Housing and Urban Affairs Committee, sought information from federal regulators about the alleged 48-hour outage and whether staffing reductions affected the system's operation, while separately questioning whether cuts to bank examiners have weakened regulators' oversight of technology vendors, including providers of AI services.

_________________

The Federal Reserve Board unanimously raised its benchmark interest rate by a quarter percentage point to 3.75% to 4% and signaled that another increase could come before year-end, citing inflation that Chairman Kevin Warsh said remains too high and persistent despite higher energy prices.

On Capitol Hill

Capital Alpha Partners analyst Ian Katz assigned a less than 10% chance that Congress will revive the CLARITY Act this year. Its failure would leave digital asset regulation to the SEC and the Commodity Futures Trading Commission (CFTC).

The bill received 49 votes in favor and 50 against in a procedural US Senate vote on Sept. 15, falling short of the 60 votes required to advance. The legislation was closely watched by banks because it would have established rules for stablecoin rewards, including whether digital-asset platforms could offer yield resembling interest on bank deposits.

"The banking lobby — in our sense largely community bankers — were effective in raising with Republican senators the specter of deposits leaving banks for stablecoins," Katz wrote in a Sept. 15 note. "That had been the big issue raised by banks in recent months, but they only started to make significant inroads with lawmakers in the weeks before the August recess."

Katz wrote that the bill is effectively stalled until at least 2027 and that the prospects of congressional action before year-end are very low. The legislation could face an even more difficult path if Democrats gain control of the House after the midterm elections, because the party would likely seek substantial changes before supporting a new version, he wrote.

Katz expects the SEC and CFTC to "shift into overdrive with aggressive, pro-industry proposals." The agencies could issue guidance and propose rules favorable to digital-asset firms, including measures involving crypto trading, custody and token offerings, he wrote.