Senate Standing Committee on Banking and Financial Institutions

Good afternoon and welcome to our oversight hearing for the state supervision of Silicon Valley Bank, which failed in March. I do want to thank Senate Chair Limon and her staff, as well as the Assembly banking staff, for helping us organize today's hearing. Please note there is a background paper published on the committee's websites, and there are copies here in the room today. The purpose of today's hearing is to investigate whether the Department of Financial Protection and Innovation's supervision of Silicon Valley Bank, also called SVB, fell short and what can be done to help prevent a similar situation from occurring again. This hearing comes at an important time. Just recently, we saw the failure of First Republic Bank, another large California chartered bank. While First Republic will not be the focus of today's hearing, its failure adds urgency to today's discussions.

On April 11, the Assembly Banking and Finance Committee held an informational hearing on what led to SVB's failure. The overwhelming takeaway from our expert witnesses, was that SVB failure was a clear case of bank mismanagement, and SVB's leadership did not adequately manage the emerging risk to its business model. But SVB's failure also raises important questions about banking regulation and bank supervision. As a state-chartered bank, SVB was supervised by both the DFPI and the Federal Reserve. Did they have concerns about SVB? Did they take action? We have since learned the answers to those questions, and those answers are yes and yes -- kind of. Both federal and state bank supervisors identified a host of concerns about SVB's governance and risk management, and regulators communicated their concerns to SVB and took supervisorial actions, such as letters and even meetings.

But that seems to be as far as things went. And on April 28, the Federal Reserve issued a report, evaluating its own role in supervising SVB. In that report, the Federal Reserve acknowledged that supervisors did not fully appreciate the extent of SVB's vulnerabilities, and when they did identify those issues, they did not take sufficient steps to ensure that the bank fixed those problems. And earlier this week, DFPI issued its own report, which will be the focus of today's hearing. A link to that report can also be found on the committee's website. I want to share a few of my takeaways from DFPI's report. And first, I want to commend DFPI staff for their thoughtful and their thorough analysis of the department's supervision of SVB, including an acknowledgment of maybe some shortcomings.

And this report will be a useful reference point for many years to come, I believe. So, second, I still have questions about DFPI's role in supervising a bank as large and as complex as SVB. I believe that, in the value of California's Banking Charter -- I believe in the value of California's Banking Charter, and I also believe it is essential to a healthy banking system to have banks regulated by those who know the state best -- But in this case, the Federal Reserve was the lead supervisor, and I'm less certain about exactly what DFPI's contribution is for a bank such as this. Perhaps in today's hearing, we'll be able to learn more about that. Finally, DFPI's report serves as a reminder, a reminder that we have to get this right.

The bank run that led to SVB's collapse was unprecedented, but we have to assume it can happen again. Social media and the speed of modern finance: it means that we have to prepare for kinds of days that we saw in March, when SVB's customers pulled out $42 billion within 8 hours. In conclusion, I am very much looking forward to today's discussion. And my goal for this is to be constructive, and also to help us learn and to have a path forward. And with that, I would like to hand it over to my colleague, Chair Limon.

Thank you very much, Chair Grayson, thank you for getting us started today. I would also like to thank the Commissioner and her staff, for providing the report on Silicon Valley's Bank's failure, and for being here today to share their perspective and answer questions from committees -- committee members. Oftentimes, we take for granted the safety and soundness of our banks and the banking system as a whole. The safety of our banking system is a broad public benefit that helps us go about our lives, without second-guessing whether our payments are going to proceed or whether our savings will be available to pay our bills next month. But throughout modern history, we see periods when anxiety creeps up about the health of particular banks. And this is where we find ourselves today.

The two largest state-chartered banks in the state of California recently failed, despite relatively strong economic conditions, with record low unemployment and a positive GDP growth. So how did this happen? Today's hearing will focus on the failure of Silicon Valley Bank, which collapsed rapidly in March of this year. While we will hear from our state regulator today, I want to emphasize that the individuals primarily responsible for the failure of Silicon Valley Bank, the bank's board of directors and senior management, are not here. We must keep in mind that bank regulators are not bank operators. Government officials are not the ones making each decision that either increases or decreases the risk that affect a given bank. Ultimately, bank regulation and supervision can only go so far in protecting banks from failure.

That said, we know that bank failures can have negative consequences on the general public, which is why our laws are designed to reduce the frequency of, and mitigate fallout from bank failures. After a series of panics and crashes throughout the 19th and 20th centuries, the federal government led the way in designing important institutions to improve the stability of our banking system, namely the Federal Reserve and the Federal Deposit Insurance Corporation, or FDIC. Since their creation, the Fed and the FDIC have played a leading role in creating and implementing policies designed to protect individual banks and the broader financial system from taking on too much risk. In a secondary role, the states also have bank regulators who have oversight over financial institutions that choose to organize under a state charter, rather than a national one.

Similar to their federal partners, state bank regulators are charged with examining banks for compliance with a variety of safety and soundness requirements. These regulators serve as a second line of defense, in the event that the bank's board and management team fail to appropriately manage risk. But we see, from the example of Silicon Valley Bank, that this second line of defense was under-prepared and under-equipped to compel SVB's management to take remedial measures to address growing risk within the bank. As Chairman Grayson mentioned in his remarks, both the Federal Reserve report and the DFPI report acknowledge some of these failures.

I look forward to hearing testimony from the department today, and hope that we all walk away with a better understanding of the factors that led to the demise of Silicon Valley Bank, and a sharper focus on the policy options that can be pursued to prevent such failure from happening again. With that, I'd like to introduce Commissioner Clothilde Hewlett and invite her to share her opening remarks with the committee.

Chair Grayson and members of the committee, thank you for the opportunity to be here today. My name is Clothilde Hewlett and I have served as Commissioner of DFPI since December 2021, leading a team of dedicated public servants working every day to protect consumers and strengthen California's economy. I am joined today by DFPI's General Counsel, Avy Mallik, and Deputy Commissioner, Jeanette Quick, to assist with responding to technical questions. My remarks will center on the events leading to the failure of Silicon Valley Bank, current measures we have undertaken, and additional efforts we can pursue to strengthen our state's banking system in the future. Following an ... with investors, Silicon Valley Bank experienced a remarkably swift run that led to the bank's rapid deterioration.

Pursuant to my obligations, as Commissioner of DFPI, and due to SVB's insolvency, I moved swiftly, in coordination with federal regulators, the morning of March 10, 2023, to protect the remaining depositors and our state's financial system by taking possession of the bank and designating the Federal Deposit Insurance Corporation, known as the FDIC, as receiver. In the days and weeks that followed, DFPI conducted a thorough review of its own operations and formulated the recommendations you have before you, in our report. In assessing circumstances surrounding the demise of Silicon Valley Bank, and the important lessons learned, it is critical to have the context regarding how DFPI oversees California's financial system and protects the public. DFPI is the state-chartering authority for California's many banks and credit unions.

So let me take a moment to discuss the dual banking system in the United States and the importance of the state-chartered system. The United States has a dual banking system -- a parallel state and federal banking system, that coexists and operates in tandem. State banks and state bank regulators play an incredibly important role in the dual system. Nationally, state regulators supervise nearly 80% of all banks in the United States, which equates to more than 3800 state-chartered banks, with approximately $8.5 trillion in total assets. This includes overseeing two-thirds of agricultural lending and half of small business lending. State regulators are well-equipped to understand the unique demands faced by community and regional banks as they engage in local economic development-

because state regulators have a fuller understanding of the local community. The federal system involves national banks, chartered by the Office of the Controller of Currency, OCC, which also serves as their primary regulator. National banks are typically larger, in terms of geographic footprint and asset size, while state-chartered banks tend to be smaller, focusing on the needs of the community or geographic region. The state system involves a state bank charter, provided under state law, with oversight from both state and federal supervisors. In California, DFPI, chartered state banks and all banks are insured by the FDIC, should a bank fail. The FDIC is also responsible for the orderly resolution of the banks and acts as receiver. California state banks can choose whether to become a member of the Federal Reserve System, also known, and will refer to as the Fed.

As a membership is not a requirement under California law, Silicon Valley Bank elected to become a state member bank of the Fed, which meant the Fed was its federal regulator. On the federal side, the Fed designates domestic financial institutions with total consolidated assets of at least $100 billion, as large banks regulated under the Fed's large and foreign banking organizations, otherwise known as the LFBO. The Fed tailors its expectations for LFBOs, to account for their size, complexity, foreign exposure, risk profile and financial activities. Prudential requirements for LFBOs are set forth in the federal regulations and include enhanced capital, liquidity, risk management and stress testing requirements. As the bank grows, it generally receives increased federal regulatory scrutiny and requirements.

At this level, the Fed implements and enforces federal regulations, which include the Dodd-Frank stress testing and examinations pursuant to enhanced prudential standards, related to capital and liquidity. DFPI supervises 99 state-chartered banks that provide services to businesses and individuals across the state and beyond. Nearly half of DFPI state-chartered banks, 43, have under $1 billion in assets. Only nine DFPI-chartered banks have assets over $10 billion. The average assets of a state-chartered bank in California is approximately $4 billion. Silicon Valley Bank was one of our outliers, as one of DFPI's largest banks, with assets in excess of $200 billion. At the time, the department took possession of the bank. For nearly 40 years, Silicon Valley Bank offered services specifically designed to meet the needs of emerging industries in Silicon Valley and across California.

The bank was a critical partner for many other companies in California. From small businesses to nonprofit, startups, biotech and healthcare companies, it provided financial services to more than 50,000 business customers. Like many regional banks, Silicon Valley Bank provided services to its customers and community. Since 2002, the bank invested and loaned more than $2 billion in affordable housing projects. The DFPI examined the bank in coordination with its primary federal regulator, the San Francisco Federal Reserve Bank, also known as the SF Fed. Examination of Silicon Valley Bank's compliance with federal regulations, related to enhanced prudential standards and stress testing, were led by the Federal Reserve.

DFPI had two staff members dedicated to SVB supervision, and the SF Fed had 20 staff dedicated, with significant expertise in the supervision of large and foreign bank organizations. Beginning in 2020, SVB experienced unusually rapid and significant growth, primarily driven by increased deposit inflows from a rise in venture capital funding of companies in the technology industry, which were SVB's core customers. The institution grew rapidly in recent years, going from $50 billion in 2017, to over $100 billion in 2020, and over $200 billion in total assets in 2021. SVB reported: it provided banking services to roughly 44 percent of venture-backed tech and healthcare IPOs in 2022, and 55 percent in 2021. In addition to SVB's deposit base being highly concentrated in technology, SVB had a significant level of uninsured deposits.

As of the year, in 2022, SVB had $151.6 billion in uninsured deposits, representing 93.8 percent of the bank's total deposits. With SVB's rapid growth, SF Fed working with DFPI, identified deficiencies in SVB's bank management practices. Notably, the SF Fed and DFPI had initiated supervisory actions relating to SVB's risk management, liquidity and interest rate simulations. Although SVB had initiated some remediation efforts, the bank didn't act quickly nor aggressively enough to remediate its deficiencies. In November of 2021, the SF Fed informally raised concerns with SVB -- that they were not ready to operate under its large and foreign banking organization, LFBO, and requested the SVB explain how it intended to slow its growth. Regulators also issued a series of matters requiring immediate attention and matters requiring attention-

MRIAs and MRAs, regarding SVB's liquidity risk management. On May 31, 2022, the SF Fed and DFPI issued a supervisory letter, finding SVB's governance and risk management practices were below supervisory expectations. This included three new MRIAs related to board effectiveness, risk management program, and internal audit effectiveness. On August 17, 2022, the SF Fed and DFPI issued a supervisory letter that included supervisory ratings, noting unresolved MRIAs and MRAs from the November 2021 letter. SVB was subsequently notified that an MOU was being initiated. In October of 2022, the SF Fed examiners, with DFPI, identified concerns regarding the amount of unrealized losses for SVB's available-for-sale securities, AFS. On November 15, 2022, a supervisory letter was issued, notifying bank leadership that SVB's interest rate risk assumptions for its forecast model were unreliable.

SVB needed to address numerous issues, as highlighted in the supervisory letters, and regulators should have been more active in setting aggressive remediation timelines. However, as the Fed has acknowledged in its own report, it's also clear that the run on SVB was truly unprecedented. On March 8, the bank announced it had liquidated a bond portfolio at a $1.8 billion loss, and its holding company announced that it was seeking to raise $2.25 billion in capital. After the March 8 announcement, within the span of a few hours, the bank run began. On March 9, 2023, SVB received deposit withdrawal request of approximately $42 billion, representing nearly 25 percent of SVB's approximately $166 billion in total deposits.

As of the close of business that day, the bank had a negative cash balance of approximately $958,000,000. SVB was insolvent on March 9, 2023. At the close of business, DFPI coordinated with federal regulators, throughout Thursday evening and into the night, and into the early morning of the following day. On the morning of March 10, 2023, DFPI took possession of Silicon Valley Bank and appointed the FDIC as receiver. The bank failed in less than three days. Lastly, as I will detail in a minute, changes to our system and process must be taken seriously, due to a variety of factors. Other institutions faced downward pressure after SVB's failure, most notably First Republic, which I took possession of, liquidated and transferred to the FDIC as receiver in the early hours of May 1. J.P. Morgan has assumed all deposits, including all uninsured deposits, and substantially all assets of First Republic Bank.

DFPI has taken a hard look at our procedures, authorities and practices and recognizes the need to make changes, so that our state-chartered banks operate in a safe and sound manner. So let me turn to some key findings from DFPI's report. DFPI and the SF Fed identified deficiencies in SVB's risk management, liquidity and interest rate simulations, and had initiated supervisory actions in those areas, prior to the bank's collapse. SVB failed to remediate these issues to avert insolvency. Going forward, DFPI will coordinate, with federal regulators, to develop stronger and more effective systems to remediate deficiencies promptly. DFPI will add additional levels of supervisory review to elevate issues identified and expedite actions, as appropriate. DFPI will review its internal staffing processes to ensure that additional staff are assigned in a timely manner.

For banks with assets of more than $50 billion, DFPI will develop large bank supervisory plans, in coordination with federal regulators, for all banks with assets of more than $10 billion, with an increased focus on timelines for corrective action. DFPI will increase its focus on banks' uninsured deposit levels, in addition to continuing to monitor key indicators, such as a bank's concentration on a particular sector of an industry. Banks with over $50 billion in total assets will be subjected to heightened examination requirements regarding uninsured deposits, through the supervisory process. DFPI will require banks to consider how to quantify and best manage existing and emerging risks posed by technology-enabled activities, such as social media and real-time deposit withdrawals.

I look forward to working with our federal, and with you -- our state legislators and federal regulatory partners -- to strengthen and enhance our supervision of state-chartered banks. I welcome any questions you may have. And thank you again for the opportunity to speak to you today.

Thank you very much, Commissioner, for your presentation and your remarks. Colleagues, we will go ahead and begin with questions. We have Senator Caballero and Senator Min.

Thank you very much, Madam Chair, and thank you for your presentation today. We got the materials late. So cram job if I don't have all the terminology right. But you know I look at the fact that this Bank was regulated both by the federal government and by the state. And I'm disturbed by the fact that to me the oversight looks lackadaisical. So that's number one.

And I'm wondering if the state has to be a little bit more aggressive in assuming primary oversight when it's min our state and it's part of a state charter, number one.

But the other thing is that it bothers me that we have individuals that aye fiscally responsible for the money that people if there's one thing you could say about our banking system is that it's very sound and that people really depend on banks and we want them to put their money in a bank instead of in their mattress. Right.

And so, I'm wondering if there were any repercussions to the bank supervisors. They're listed as supervisors, but they're really the managers of the bank and the board of directors that should have been dogging some of this. And having been involved in a Bank startup and then sitting as an advisory board Member, there were all kinds of things we had to study and to learn about bank operations in order to be good stewards of people's money.

And I'm wondering if anybody lost their job, if anybody has personal liability, if anybody will lose a license because they were negligent, or if there's any repercussion for the fact that the federal government had to come and blow up ,the FDIC had to say, hey, you know what? We're going to cover everybody because if not then, a lot of businesses are going to suffer.

I'm glad they did. I'm really glad they did. But to lose $21 billion or whatever the number is for some reason I remember that is. It's unbelievable to me that we kind of go, 'Ah let's see if we can do a better job next time'. And so I'm a little bit concerned about it and I'm wondering if you can tell me were there any repercussions to anybody and is there a need for the state to take much stronger oversight because whatever we did, did not work?

Well, first and foremost, I would say yes, there is a need for the state to take greater oversight. That's why we aye enhancing our examination team as it relates to our large bank portfolio. And that oversight has to start at the very beginning. We had two bank examiners against 20 bank examiners. So in order to have a voice, we have to start at the very beginning of an exam when the roles in the duties of the exam are being scoped out.

We have to be more aggressive as a state when we observe deficiencies and we acknowledge that and that will occur going forward, saying that we don't necessarily have to duplicate the duties and process and procedures of our federal regulators. So for instance, in this exam we had the role of examining the management and the governance and IT and what we would refer to as the Bank Secrecy Act and antimoney laundering.

And we should still continue to do that, but in a more enhanced way, where we have more frequent monitoring and a real clear definition of roles right up front, where we're outlining, where we're going to exercise our independent duties so I would say that first and foremost, and that is one lesson we are going to implement going forward. Now, the beauty about DFPI is the Legislature in creating this Department, created it with many different programs.

You have financial institutions, you have the California Consumer Financial Protection Law, and you also put securities under our Department and that gives us several different enforcement tools. Just like the federal government has the Department of justice, they have the SEC in addition to enforcement under Federal Reserve. Once we turned the possession of that bank over to the FDIC, we no longer have control over the licensee in our role as a financial institution regulator.

But that does not mean that we don't haney control in other areas. So, when you ask can we as a financial institutions regulator do anything in terms of board management is no longer within our jurisdiction, but there may be other things that are within our jurisdiction. Just like I'm quite sure that before this is over there will be numerous investigations and litigations in other areas.

So I can't say that there is nothing that's going to occur as a result of the mismanagement in the areas of governance and in particular risk management.

So I guess if I could follow up with that, what would be very helpful, at least for some of us, is to know in the end whether you need more authority to be able to start some action based on the information that you uncovered as part of the investigation. Because when I read the findings from both your organization and the federal government, it's pretty sterile and maybe it's intended to be that way because it's part of a regulatory framework. But it would be helpful for us to know if there are some changes we can make as a Legislature that put some accountability.

I would hate to think that these bank directors or bank managers would go on to another bank and get a job and I would like to know how much they were making in this position because I know bank presidents, et cetera, make a whole heck of a lot of money. How much were they getting paid to do such a poor job? If there's some suggested legislation that you feel would give, would put for lack of a better word, the fear of God in people whose business it is to protect people's assets.

That would be really helpful because I'm frustrated by a process that said, oh, we'll take over. We'll liquidate your assets, make sure everybody is taken care of. And now we're moving on as businesses, as usual, there have to be consequences for bad behavior. And if bad behavior at its best, negligent behavior at its kind of worst, I guess. So I thank you for your answers. I appreciate them.

And we look forward to having further discussions with you on those issues in particular.

Thank you, Senator Caballero. I have a Senator Min, followed by Senator Leno and then a Assemble Member Dixon.

Thank you, Commissioner. So before coming to this body, I actually taught banking law. And while I don't have the time to really follow what's going on, I'm on a number of very active listservs. And I can tell you that until SVB's collapse or the days leading up to it, nobody was talking about the problem of uninsured deposits. And I think this really, to my mind, crept up on us.

And it is something where you know this, but maybe not everyone in the audience does that. Prior to 1933, when we enacted Federal deposit Insurance, we had banking runs and panics every 10 to 20 years. They crippled our economy. And that's just the nature of banking, because they're highly leveraged firms.

They have just a thin slice of capital. They have a high amount of credit risk. They also have a very steep maturity mismatch between their assets, which are typically longer, five to 30 year loans, typically, or bonds, and their liabilities, typically are deposits. So they're very short term. And so we know from countless experience literature that any bank, even a really well managed bank, can be rendered insolvent by bank run.

And you may remember It's a Wonderful Life, and that was an example of that. But I have heard from a lot of companies in my district, and I know this is a federal issue not directly related to you, but I just want to state this. I think our deposit insurance system is completely outdated for the needs of the 21st century. We are no longer an economy that's dominated by individuals. We're dominated by organized bodies of capital, whether they're LLCs or corporations or whatnot.

And those particular entities need payment services. They need a lot of things that banks offer, but they don't have any other options other than banks. And that $250,000 deposit cap means that they're forced into having a large amount of uninsured deposits. And I can just give you one example from my district, a company that has roughly four and a half billion dollars in cash equivalents, not in the banking system, because they don't want to put that much money in the banking system.

So those are in things like money market funds and other cash type equivalents, but they've still got to have about jones hundred million in the banking system. It actually was at SVB. And they had to have that because they needed to handle things like payroll and accounts payable and things like that. And so I think we really need to update that.

So I guess my first question for you, I have, a couple of these is just what percentage, if you're aware of, the California deposits among California chartered banks are uninsured right now? And if you don't have that, I'd be interested if you could get back to us with that.

I would want to give you an accurate number. I would say that, particularly in the case of Silicon Valley Bank

Well, we know they're over 90.

Yeah, the 93% is highly unusual.

But I guess I'm wondering how big a problem is this across the system of California and state chartered banks? And then also, if you have access to this data, just interested on a national level, among, all banks that are FDIC insured, how big that is? Because I don't have any sense of that. And I think that's important because this is a ticking time bomb. We know that uninsured deposits lead to bank runs. They always have. They always will.

And if we have a large percentage of uninsured deposits in our system, whether in California or federally, I see that as a huge problem. It's something we need to get a handle on.

So a second related question is can the state Legislature actually do anything about this, or is this purely a federal matter that preempts any action that we can take?

Well, first and foremost, I think it's very important to take into consideration there wasn't just one factor or one thing that led to this bank run. There were several different factors that all came together at the same time to create the perfect storm.

You had a high percentage of uninsured depositors. You had board management that failed to take into consideration risk management, interest rate risk. You had the rising of interest rates, which had a direct impact on investment portfolios that were like Silicon Valley bank invested in primarily mortgage and treasury backed securities. And then you also had, combined with all of this, how swiftly in this digital age one can withdraw deposits from a bank, and how fear can be spread through social media.

So all of these factors came together at the same time. And it's difficult to say whether one factor in and of itself would have led to it. But definitely with them all coming together happened at the same time.

Well, let me clarify just. Real quickly, Commissioner, also, whether your examiners have the ability under their existing Prudential authority to, you know, force a bank like SVB to wean itself off of uninsured deposits, I don't know if that's in your authority or not. I'm curious about that. And again, if you want to get back to us later. I'd just be curious.

Now, in terms of federal legislation versus state legislation,

Yes. And I would just say, first and foremost, I think any state legislation, we have to take into consideration the impact. And when I indicate the impact, the impact on our state because we don't want to create a situation where we have certain legislation in our state and it's not in other states, and it leads banksto go foreign shopping and go to other states that might be a little bit more lenient.

So in some areas, it's important that whatever is set as a legislative bar, that it is nationwide and that each state is held to the same standard. And that's what, more than anything, I believe requires intense discussion. And one other area that I think gets left out of this is that our community banks and our regional banks are absolutely essential to our state's economy.

It is the community and regional banks whose average asset size is 4 billion that are lending to our small businesses, that are providing financial services to our rural communities who might not otherwise be able to receive these services and are the entities on the ground that are lending to our underserved communities. So what we might apply to a large financial institution with assets of 100 billion and over may not be the same standards you want to apply to the community and regional.

I do want to get to that in a moment. I just wanted to touch on uninsured deposits. And I'll just state for the record my view that uninsured deposits are a problem. I worry right now that they're driving consolidation into bigger banks and into banks that have sizable non bank balance sheets like JPMorgan, which has a lot of financial activities. We learned no eight, you don't want to have those too big to fail conglomerates.

Part of DoddFrank was getting out of that. But I think right now the incentives are, hey, you've got to have a big non bank balance sheet. That gets me to my next point, which is you talked about the 50 billion, 100 billion dollar thresholds. I think those are too big to fail. I think we've seen that. And of course, Senate Bill 21 55 at the federal level in 2018 got rid of that $50 billion threshold.

I just want to state my view that at a federal level, I think the additional stress testing, liquidity testing that would have accompanied that might have prevented some of the failures that we saw here and might have prevented SBV from failing. But I just want to close by asking you, you talked about the dual banking system. As you know, dual banking is kind of an accident, very unique to this country.

The 1863 National Banking Act was actually meant to kill off state banks. It was unsuccessful for a number of reasons we don't need to get into. But a lot of folks believe that dual banking is passed as prime, that state chartered banks, they serve only the purpose of regulatory arbitrage, choosing regulators. And I guess I'm just curious, I look at the report here. You had two examiners, the fed had 24. What value does the state make the case to me.

And one related question I want to ask you first before you get into that is what do our examiners get paid? And I think Senator Caballero asked that as well.

And how does that compare to the federal scale? Because are our examiners at the same level as the federal examiners?

Well, first, as to your first question, state bank regulators provide a very valuable input into examinations. It is the diversity of the voices that is absolutely significant. And state bank regulators, like smaller community and regional banks, are the feet on the ground to understand the values of that community. And it's very important that the values of that community are heard in that examination.

And so when we're looking at areas of management and governance, when we're looking at some of the areasthat we do directly regulate, we want to make sure that our community and regional banks are doing what they are tailored to do provide the support and the service to the community, such as we are. The other voice to make sure that the small business community receives the lending they deserve. The underserved, the rural community. And it's very difficult, for a, federal regulator, who has thousands of local communities to stand up for that local and regional community.

And in the case of the state reflect the values of the state. And we will provide you information about the salaries. But you did hit on a very important point. State banking regulators, for the most part, make less than federal.

I appreciate your comments and I certainly respect the work you're doing. But we're sitting here in the context of two major massive, three largest or two of the four largest bank failures in history. Clearly something went wrong here and these were state chartered banks. And you keep saying, I mean this respectfully community, smaller community and regional banks. And I think I'm there with you on the first one.

I'm wondering, and I don't know if I speak for my colleagues, I just speak for myself, whether it's appropriate for the state to be playing a major role on a bank that has over 10 billion or 50 billion or 100 billion in assets because at that point you lose that community flavor. You're talking about banks that really are too big to fail. You're talking about banks where the primary responsibility of regulators like yourself is safety and soundness. And clearly we did not do the job here and it's not you primarily.

But I'm just wondering if there are a lot of failures at the federal level, whether it is time to think about retooling California's state banking. But I'll just close with that. Thank you.

And one thing I think I should point out, even in banks like Silicon Valley Bank they serve a particular purpose that maybe your very, very large bank doesn't fill. In this case, the Silicon Valley Bank was a bank of early startups and in California. They did reflect the value that we find in Silicon Valley which has been innovator in producing drugs that fight cancer, that combat strokes, that are the foundation of the internet and that is a part of California's values as well.

So I do believe even min the larger bank situation where it is fulfilling a certain niche that California should do everything to hold on to that state bank that may reflect heart of the California value.

Thank you, Commissioner.

In the interest of time, I do want to get to other questions and comments and we do have Senator Niello followed by Assembly Member Dixon. And I will point out that to Senator Min's question the public report that's been given to us does have some information on one of the questions you asked on page 22.

Thank you.

Madam Chair, my comments aye going to be somewhat redundant but more specific to issues that have been brought up. Regulatory tools can be useful, but only if they're utilized and acted upon given factual situations. You've made reference to risk management and interest rate risk more specifically. At least my understanding of the situation with SVB is that they had a risk management position that was unfilled and the office of the CEO had taken essentially responsibility for risk management that in itself cries out of a potential problem.

Then with that framework of risk management the bank bet on a coincidence of an inverted yield curve with their excess assets and essentially bet at all on an assumption because of the inverted yield curve that interest rates would stay the same or go down. And when it became obvious that the Fed was going to react to emerging inflation, though they reacted too slowly. The almost always indication of a Fed's plan to raise interest rates does indeed increase interest rates.

So there was an action on a sometimes accurate phenomena in the face of an always accurate phenomena and they went in the absolutely wrong direction. And this was a factual situation that anybody looking at the bank could see, number one, insufficient, arguably incompetent risk management which lee to a disastrously incorrect guess on interest rates. Not just partially, but essentially if I understand correctly, betting the farm.

And the other circumstances that you mentioned certainly contributed to the perfect storm, if you will. But I would suggest that given the direction they were going in the direction that rates were going in that problem was bound to happen irrespective of any social media wildfire that spread it so quickly. So what was in all of that fact situation that neither state nor federal regulators acted on it? Or is it just management incompetence that you don't have the capability to countermand?

I think there are many things, I think that in this situation. There was too much of a focus on working in consensus with our federal regulators because we did not have the resources nor the expertise to do the higher level DoddFrank liquidity stress testing. I think there is also a culture that might be appropriate for a smaller community and regional bains in which you want to work with them to help them remediate deficiencies, but that is not appropriate for regional bank of this asset size. So I do agree with everything that you have said and I do know also how difficult it is to take aggressive action.

When you don't know if it's going to turn out well. And that aggressive action could come in the form of a cease and desist. It could come in the form of a consent decree that could also result in a run on the bank and heighten the fears of the public. But sometimes you have to take aggressive action even if you don't know what will be the end result or whether you will be blamed or not.

Just one follow up comment. One didn't need to perform a stress test on SVB in 2022 or late 2021 to see the circumstance of the incongruous nature of the bet on interest rates verging the emerging reality of where they were going. You didn't need a stress test to lee that, plus the fact that there was incompetence at the top relative to managing that particular situation.

I agree.

It just seems to me that the problem was probably obvious and either nobody else saw it either, or there wasn't anything that you could do about it, regardless of the tools that you have.

Thank you Senator Niello.

Next we have Assembly Member Dixon.

Thank you, Chair. And thank you, Commissioner.

Basically some follow up questions to this. So we know the Federal Reserve is involved and our own local state regulator. Let me just ask some operating questions, process questions. How well do you work together? Do you talk to one another? Do you compare Jones on potentially problematic situations?

Yes, we work together very well. However, in this particular situation, there were two entities of the Federal Reserve which further delayed a lot of implementation. So first I mentioned there was the SF Fed, which we worked together with them on a regular routine basis. When this bank went to the 100 billion mark, it was then transferred into the Federal Reserve's LFBO program, which was a different team, a highly trained team in DC. The transition between the regional and the DC highly trained team did not go as quickly, as efficiently, as effectively as one would desire.

And one of the reasons why is because this was the first regional bank that came under the program and process and procedures weren't as clearly in place for ramping up. So even though we work very closely with the regional, there was another element min this particular exam that has not been in our other exams because the asset size of our banks is on an average 4 billion.

Okay, again, process here. So you're all smart, intelligent banking experts, subject matter experts. So you see a bank that had been assets growing from 50 million to 100 million to 200 million in a period of two to three years. Is that typical or is that unusual?

That is highly unusual.

I thought your answer would be so doesn't this trigger certain stress alarms to say in this transition that government being government takes a little longer than anybody expected? Who is really the owner of the responsibility during this transition process?

During the transition process? When it goes up to what we call the LFBO program. It is the Federal Reserve that's in the lead for the purposes of what we call the DoddFrank stress testing. However, as has been pointed out, even before the liquidity stress testing, we at DFPI had seen deficiencies.

But did you transfer those concerns on, too?

They were transferred on.

Okay. All right. I know in the interest of time, I want to try and get to a couple of questions here, just to follow up on the senator's comments about the rising interest rates.

Isn't that the grove of the Federal Reserve Board to be communicating with the federal banking system that, 'hey, watch out, rates are going up, the asset values are going to be shifting. Better check the credit worthiness and the stability of all these financial institutions.' Isn't that an automatic regulatory monitoring process?

Yes and that was communicated to Silicon Valley Bank on more than one occasion.

But they didn't respond. They didn't answer because in the report is indicated a number of approaches on the risk management side, on perhaps, as you say, on this side, the fact that they didn't change their ways or procedures. They just kept doing business the old fashioned way, the way they'd been doing it. And it wasn't anybody saying, halt stop. This is a serious situation and it's leading to running off the cliff.

I believe the bank was more concentrated on earnings, profit, and gain than they were on risk management.

Well, I think that's apparent. Well, we clearly are seeing where there's some flaws min the structure of how this works. I guess I'm just shocked that Silicon Valley Bank really kind of acted on as well as no one was telling them what to do and what to stop. One other final question. It's in our in that we're in budgetary time, and you mentioned that you only have the 2 Members of your staff that are in this role, compared to 20 at the federal level.

Have you put in for additional resources, human resources? Have you been rebuffed? Have you asked for ten more prior to this? I mean, prior to March, had you been seeking more human resources to assist you in this examination process prior to.

The run on this bank? In my opinion, there wasn't as much a focus on the need to add additional staff because of the number of federal resources and the training and specialized team that the federal regulators had to offer. Subsequent to this and through our review within our existing resources, we have added additional staff and all of our remaining banks that would fall 10 billion and above. And in particular, any bank that had a high level of uninsured deposits banks that are concentrated in their depositors in a particular sector.

Are on an early warning system. High priority lists that are monitored on a daily basis.

Is that new? Is that what you're saying? It's new

To the extent that we. Have enhanced our monitoring and taken in all the lessons learned from the Silicon Valley Bank failure.

Okay, one final question. Roles of responsibilities between your office and the Feds.

Is it clear who does what or what? How does this get lost? Something like this get lost?

I think part of as we're moving forward, in any bank examination and have an enhanced team with additional levels of supervision from the state level to spot this and ensure that there are aggressive action that in the beginning of any exam from now on, it's going to be very clear in the scoping and planning for the exam what our roles are going to be and where, if necessary, we will exercise independent action.

All right, thank you. No further questions. Thank you.

Thank you.

Seeing no further questions, I have a couple of questions and then some comments. Just generally. One of the recommendations is to develop stronger, more effective systems to remediate deficiencies promptly. The Federal Reserve report, however, discusses that there is challenges for regulators in taking aggressive action against a bank that is profitable and at least appears to be in a healthy financial condition.

Can you discuss specifically how DFPI will implement this suggested change and how DFPI alanis to compel in a situation versus enforced right? Because it looks like it's doing okay, but you have to get them to compel. The argument has to be compelling enough for them to make the changes, to respond promptly to some of the problems identified by the bank examiners.

Well, I think first and foremost, timelines have to be adhered to and there has to be consequences if there is not remediation within those timelines. That's the first thing. So that's where the enhanced monitoring comes in. I also believe in hindsight, not just California, but all other state banks, and our federal regulators have the realization that what was okay under the traditional models is not okay now.

So prior to this date, if a bank had a certain number of deposits covered according to the traditional formula, then they received one rating satisfactory. If a bank showed significant Bains, they were perceived to do okay. But now I believe that there is a heightened awareness that you have to look beyond the traditional formula. You have to look beyond the gains.

And you have to also ensure that your simulations take into consideration things that could happen in the future as what happened with Silicon Valley. bank so maybe under the traditional formula, you might have looked at mortgage back and treasury securities as being the safest investment. But that's for long term. In the short term, with rising interest rate states, it can have a dramatic impact.

And lessons learned. It will change the formula nationwide. I believe in how banks are evaluated and more emphasis will be placed on solid risk management, which is basic banking. You in the areas of safety and soundness than what has been more of an emphasis on earnings and gains.

Thank you. Along the lines of timeliness, I was concerned to learn that it took seven months to develop an MoU as an informal, not formal, but informal enforcement action related to the governance and control issues, and that the MoU was still not even completed by the time that SVB failed. Can you help me understand what factors and conditions cause such a delay for an MoU to be finalized?

I think there were several things in this case, and I mentioned some of them. One was the transition from the regional Fed up until the more specialized team in DC. I don't think there was a desire to move forward until there was more enhanced testing to present a full picture of the entire examination. In my opinion, there should have been an MoU issued much, much earlier, and it was not.

And as I mentioned previously, there is a reluctance, which after this, the reluctance is definitely going to change, to do even more public action, which might be a consent decree or a cease and desist for fear of being the one who started the run. And that's why in many cases. It's very difficult for many Bank regulators to just downgrade a bank, knowing what the impact might have on investors.

But now when you lee the other end of it, of what happens when you don't, and don't get min there early and move aggressively moving forward, at least I can say for DFPI, we will move more aggressively in this case. But as I said, one size doesn't fit all.

So what we might apply to a smaller community bank and one of our larger banks of 50 billion and over might not be the same exact practice, but we have to be in an atmosphere and a culture to cut through all the government bureaucracy sometimes and do what needs to be done.

Thank you.

And I appreciate that delicate balance between being too aggressive and being the at fault of a bank run, but also understanding that a lot can change in an economy min seven months. And I think as legislators, we all see that. We all feel that. We know very quickly how that can change. And so when we hear of MoUs that take that long in a situation where there's an appearance of a healthy financial state, however, there are indicators that keep coming up.

And certainly through this testimony, we've heard the word unusual multiple times, how we find a fine balance to recognize the unusual, the uncommon, be precise in our action, not too aggressive, but not under aggressive, and also understand that time matters. So I appreciate hearing that. I think generally, as we think about what's happened and certainly with the evidence that is shared to us by both the Fed report and our DFPI report.

I think that, at least for me, I recognize that there aye substantial differences between the role of the Fed and the state. For one. It was not lost on me. The recognition that the fed spent 25,000 staff hours in just 2022 examining Silicon Valley Bank while the state spent 3000 hours. For lot of folks that are listening, that are everyday folks, that's a lot of hours. That's a lot of full time jobs just to have the lens on this.

And so I think we ask ourselves what this looks like in the future. But it's also an important recognition that the federal resources aye focused on a bank this size and that is experiencing this in a way that the state are not. And I'm not sure that it is the intention of the Legislature to make the state role identical to the Fed because it is not necessarily allowed. Right.

I think that it's also important for me to recognize that now that our two largest state chartered banks have failed, that we may not have the same level of oversight, particularly because there are costs related to bank oversights that are paid by the banks themselves. This does not come at a General Fund, this is the banks themselves. And so when you lose some of these big banks, it means that some of that is going to be spread out on smaller bains to be able to have the bank examiner cost. And that's something that is just an important recognition in this entire discussion.

I certainly feel that, as has been stated by my colleagues, that we recognize that the federal government has a greater role in this has had will always haney a greater role than the states. And despite being a state chartered bank, it really was the federal examiners that had more oversight.

I think it's also something that's important for me is at least that the own Federal Reserves Report takes responsibility, primary responsibility for the failure of supervision, not for the failure of management. And I think that that has been shared amongst colleagues related to SVB. So there's certainly more discussions. I appreciate the recommendations that you have brought forward because even if there is shared responsibility, I think it is always our job to look at where we can do better.

And I will tell you that as a representative of the people of California, in those hours where we saw what was happening with Silicon Valley Bank in our state, the number one thing I heard from legislators who serve on this committee, who don't serve on this committee, is payroll. How are we going to ensure that people in this state who are working get paid? And so I say that because when we translate some of these regulatory conversations, these conversations about where the responsibility might be placed and who has more authority than other and what's preempted and what is not.

For everyday Californians, this was about the money that either was going to be paid for them that was put in a bank that we all believe and trust in, in a system that we believe and trust in. And that was what's at stake when you are looking at the welfare of your everyday living in this state. It is, I think, something that's very big, and I don't want that to get lost.

Min some of this discussion that I ting is aimed at, of course, ensuring that the people that we represent still feel confident and secure, that if they have to go pull out money, their money is going to be there, that their paycheck is going to be a paycheck that will have cash funds to receive it. And those are really critical things. So I thank you for your work and the information and for all the department's information. You are our head and lead here in the state.

But I know that the Department as a whole has been engaged in this. So thank you and I will haney it off to Chair Grayson.

Thank you. Chair limon. And thank you, Commissioner Hewlett, for being here and testifying, answering questions just before we go to public comment.

Just again, a reminder that SVB failure was on the part of a part and bank management that failed us, that failed Californians and failed the banking system. They were given warnings and they were given the opportunity to fix and to align and get right in policy and failed to do so. So the failure of this bank is on the shoulders of the management and the board of that bank.

Having said that, it would be remiss for me to not acknowledge the fact that the pain of SVB failing has not gone away and remains with us as a community, as a California family and community. Having lost $9 billion in community benefits, much of what would have gone toward affordable housing and other great needs that we have here in our community.

Having said that, and I do want to be expeditious here, is there anything on the federal level that inhibits or prohibits the state from providing greater oversight? Let me possibly rephrase that.

Compared to the supervision policies of the Federal Reserve or the FDIC, does the DFPI request any unique information or do you have the ability to request unique information or ask any unique questions of banks pursuant to the department's supervisory activities?

There is nothing that prohibits us from doing an in depth investigation and requesting information from the bank in terms of conducting our duties under an examination and in some ayes, as I mentioned, we have the financial institution area in which we have authority to do an investigation. We also have authority under the securities area, over any individual. So under financial institutions, our authority is over the licensee, which is the charter in the security area. We have the authority over any individual that could be involved in any security violation, and we have full authority there as well.

So that's a perfect segue into the last point question I want to ask.

It's more of a question statement. We can get back together afterward on it. And I do appreciate the hypersensitivity you have in the responsibility as a financial regulator in who you're dealing with. And the fact is, this is the money of Californians in large part when it comes to state charter banks admittedly red flags were popping up for months prior to SVB's collapse or insolvency regulatory actions were taken. Thank you very much.

But the bank's management response, if I may take the liberty, as an observation, was seemingly irreverent to both the state and federal regulatory agencies.

What could have been done or what should have been done to address the timeliness or the lack of timeliness on SVB's part? In other words, the question is, does the agency have the tools to deal with a financial institution that seems to be non responsive or not responsive enough, or being responsive in a timely manner to actions that are being taken by a regulatory agency?

Restrictions and conditions could have been placed upon that bank through a consent decree that would be yes. It's difficult in that type of situation if there is not agreement with your federal regulatory partner, particularly when you're just two examiners. However, technically, DFPI could take independent action, separate and distinct in the form of a consent decree, or can just do an out and out, cease and desist.

I appreciate that. And again, just want to thank you for coming today and testifying before the Joint Committee. And I want to thank Chair Limon and the Senate committee as well for joining.

With that, it is time to go to public comment. If we don't have any other questions. I see none.

I would like to go to public comment as a reminder, please state your name, your organization, and please keep your comments brief, meaning to about a half minute, if you will, please. Is there anybody yes, please go ahead.

Good afternoon, Madam Chair. Mr. Chair and Members. Robert Harrell. I'm the Executive Director of the consumer federation of California. Want to thank the committees for the hearing. Good background paper. I would note that. I think it would be helpful, actually there's a number of questions, a couple of which have come up during the hearing. It would be great to get DFPI's written answers to those questions. Perhaps the committee could ask for that. I think that would be helpful to see in writing some of their responses.

Also appreciate the questions by the Members of the various committees. Senator Niello, to your point, it looks like they didn't really have a good risk management plan even when they were at 50 billion, let alone when they grew rapidly after that. That's pointed out in the background and in some of the other materials there.

So for CFC, what it really does is it calls into question the utility of a state chartered banking system, especially when you start getting beyond and I don't know what the magic number is, 50 billion or 100 billion. So I think that's an issue the Legislature ought to take a serious look at. Thank you.

Thank you so much.

Any other persons wanting to make public comment? Seeing none. Seeing none.

I want to thank everyone for participating in today's hearing and you can find the materials related to today's topics on the committees, both committee's websites. And I look forward to continuing to work on this issue and partner with the DFPI. Commissioner, thank you so very much. And Mathis meeting is Jones adjourned.

Thank you.