Federal Reserve says it 'failed' in run up to Silicon Valley Bank collapse

The Federal Reserve failed in its role as banking industry watchdog in the run up to the collapse of Silicon Valley Bank, the central bank said on Friday.

The Fed sharply criticized leadership at Silicon Valley Bank for "a textbook case of mismanagement," but the report also faulted the Fed's lax oversight and an inability to anticipate the systemic threat posed by the bank's failure.

"Federal Reserve supervisors failed to take forceful enough action," said Michael Barr, the central bank's vice chair for supervision, who wrote the report. "SVB's failure demonstrates that there are weaknesses in regulation and supervision that must be addressed."

The collapse last month of Silicon Valley Bank, the nation's 16th largest bank, set off a financial panic that led to the failure two days later of another major lender, Signature Bank.

In response, the U.S. government took rapid and extraordinary steps to protect the financial system.

However, the financial stress continues to weigh on the banking system. Shares in regional lender First Republic Bank plummeted nearly 50% on Tuesday after it revealed that depositors fled en masse amid the crisis last month.

Barr called the report an "unflinching look" at the Fed's shortcomings in the lead up to the banking crisis, saying that the examination marks the first step in the central bank's effort to fix its supervision and regulation of banks vulnerable to extreme stress.

"Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity," Barr said.

"When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough," Barr added.

As the Fed aggressively raised interest rates over the past year, the spike dropped the value of Silicon Valley Bank's Treasury bonds and mortgage bonds, punching a hole in its balance sheet.

Because Silicon Valley Bank served a relatively concentrated group of Silicon Valley startups and venture firms, many of whom held uninsured deposits, a disclosure last month of the bank's financial losses caused a panic that quickly escalated into an old-fashioned bank run.

The Fed report described Silicon Valley Bank as "an outlier" for its degree of financial exposure, but it criticized the central bank for failing to recognize and address such risks before it was too late.

"Our first area of focus will be to improve the speed, force, and agility of supervision," Barr said.

The report also criticized the Fed for underestimating the systemic risk posed by the collapse of Silicon Valley Bank, suggesting that regulators overlooked the panic that could result from a bank concentrated in a slice of the tech industry.

"A firm's distress may have systemic consequences through contagion – where concerns about one firm spread to other firms – even if the firm is not extremely large, highly connected to other financial counterparties, or involved in critical financial services," Barr said

This is a developing story. Please check back for updates.