The dirty secret about bank holding company regulation

What is Mitsubishi? Most Americans say a car company, and while that’s true, Mitsubishi is also the sixth largest bank in the world, a business that dwarfs its auto arm. Mixing a car company and a bank is illegal in America, where the Bank Holding Company Act separates banking and commerce. Bank holding companies are regulated by the Federal Reserve, a job that requires the Fed to monitor the relationship between the bank and affiliated companies under the parent holding company. The failure of Silicon Valley Bank (SVB) exposes a dirty little secret about what holding company regulation often entails: not that much.

SVB was not your typical bank. America’s 16^th largest bank before its failure, SVB had $200 billion in assets but only 16 branches; most banks that size have around 1,000. SVB didn’t bank people; it banked tech firms, ranging from small start-ups to those who hit it big, like Roku and Roblox. Its ten largest customers had $13 billion in total deposits, such as the crypto/stablecoin company Circle which had over $3 billion in deposits at the bank when it failed.

SVB Financial Group was SVB’s bank holding company. Sitting under the Financial Group umbrella was SVB Capital. SVB Capital had $9.5 billion in assets under management, investing in over 760 “unicorns” and other venture capital (VC) firms, which themselves banked at SVB. As SVB Capital’s website touted: “Through our relationships with more than 50% of all venture-backed companies in the U.S., and with funds and corporations across the globe, SVB Capital’s family of investment solutions give you unmatched access to this unique asset class.” This same reliance on venture capital to gain customers returned to bite SVB when the VC community turned on it. The day before SVB went under, while its stock was still trading at over $100 per share, multiple VCs told their companies to run, exacerbating the bank’s problems.

The Federal Reserve had two regulatory and supervisory roles for SVB Financial Group: one for just SVB, the other for the entire holding company, including SVB Capital and its relationship with the bank. What requirements did SVB Capital place, legally or informally, on firms it invested in to bank with SVB? This includes other VC firms in which SVB Capital invested, who then pressured the companies they invested in to bank at SVB. What did the Fed uncover in its regular supervision and regulation of SVB Capital that could have offered insights into what was going on at SVB?

While the Federal Reserve has started reporting what it did as a bank regulator, including filing reports, flagging problems, and giving management passing grades, it has said nothing about what it was doing to regulate the holding company. The Federal Reserve’s official testimony to Congress mentions SVB’s bank holding company in a footnote and never mentions SVB Capital. It was as if that company played no role in the bank’s failure.

Ironically, newly-elected Senator J.D. Vance (R-OH), formerly a venture capitalist, raised the question of VCs’ role in SVB’s collapse, tying SVB’s provision of services to VCs having their portfolio companies to bank at SVB.

Problems in holding company regulation go beyond SVB. Take the case of Dickenson Financial, a bank holding company based in Kansas City. Dickenson owns two small banks: Armed Forces Bank and Academy Bank. These two banks serve very different customers: Armed Forces branches are on military bases, and Academy branches are at Walmarts. But they operate the same business model: hitting low-income consumers with high overdraft fees. Both banks are routinely among the highest in the nation in their reliance on overdraft fees for profit. Armed Forces Bank routinely makes over half its profit on overdrafts, while Academy Bank made over 100% of its profit from overdrafts for four straight years.

This is not a coincidence but rather the outcome of a clear business strategy articulated by their parent holding company. Each of these banks has been operating under this strategy for many years. Yet, there is no evidence that the Kansas City Fed has done anything other than bless this strategy. After all, both banks have continued to operate with regulatory blessing.

There is a real question of how much actual regulation and supervision occurs at bank holding companies like SVB and Dickenson. In both cases, holding companies operate business models that cry out for stricter supervision and stronger regulatory action. One wonders how many more bank holding companies have similar problems and where are the Federal Reserve Regional Banks in doing their job.

One area where holding company regulation is quite active is with the so-called “globally systemically important banks” (GSIBs). These are the largest, most interconnected banks, like JPMorgan Chase or Goldman Sachs. These holding companies generally include investment banks and other smaller entities providing services. The Federal Reserve has been focused on these companies, particularly the merged commercial and investment banks, since the Fed advocated for allowing those giant bank mergers, culminating in Congress repealing parts of the Glass-Steagall Act at the end of the Clinton presidency.

SVB failing is a painful lesson that more than just the handful of largest banks are what the Fed deems “systemically important.” The Fed has committed to an internal review of its regulatory and supervisory failures. Many are skeptical that the Fed will honestly assess its own failures, myself included. One litmus test is whether the Fed includes in its report what, if anything, it did as SVB’s holding company regulator. Either way, the Fed needs to act far more aggressively when it sees bank-holding companies employing unsafe business practices before we have more multi-billion-dollar bank failures.

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