5,821 days. That’s the time that separates Silicon Valley Bank’s (SVB) collapse and the failure of real estate investment trust New Century in 2007, notably the first domino to fall in the Global Financial Crisis (GFC) of 2007-08.
Last week’s events represent a sobering reality check. In 2023, banks can still be broken, collapsing spectacularly when sudden or sustained pressure is applied to a critical facet at a critical moment. This is despite a decade-long program of vast, global regulatory reform to improve transparency and resiliency.
A perilous path
A Google search of "SVB collapse" currently yields 228,000,000 results, soaring higher by the day.
The cause of the 40-year-old bank's failure and its associated timeline are already well-known. The inevitable end of the “low for long” era – where interest rates were negligible, even negative in some countries – proved to be SVB’s Achilles’ heel. The progressive rate hikes instigated by the Federal Reserve to combat inflation, starting in mid-March 2022, triggered a chain of events leading to SVB’s eventual demise. Let’s examine a couple of standout factors.
Firstly, interest rate risk is a familiar element and assuredly not an “unknown unknown.” The FDIC’s Banker Resource Center carries a concise definition:
Interest rate risk is the exposure of a bank’s current or future earnings and capital to adverse changes in market rates. This risk is a normal part of banking and can be an important source of profitability and shareholder value; however, excessive interest rate risk can threaten banks’ earnings, capital, liquidity, and solvency. Therefore, it is important to effectively identify, measure, monitor, and control interest rate risk exposure through effective policies and risk management processes.
For an industry awash with complex terminology (and complex financial instruments), the FDIC guidance is noteworthy for its clarity. For SVB to have failed due to rate increases strongly suggests inadequacies within the bank’s internal risk management function.
Of note, SVB went without a Chief Risk Officer (CRO) from April 2022 to January 2023, the firm’s risk committee convening 18 times in 2022 vs. seven sessions the prior year. It’s troubling in retrospect. SVB navigated increasingly stormy, risk-filled waters without a qualified steersperson. It was perhaps never a question of if SVB would hit a large obstacle but when.
This leads to a second point related to regulatory oversight and the ability of industry supervisors to identify potential issues (minor or major) at the earliest opportunity. Granted, the FDIC acted promptly, but it reacted to events already occurring. Could more have been done from a regulatory intervention perspective? This question must be thoroughly explored and adequately answered.
As companies in Silicon Valley were founded, funded, and developed into future publicly traded enterprises, SVB grew in parallel. However, the firm was regulated as a regional bank by remaining a technology-focused specialist player. Even as it grew into the 16th-largest bank in the US, SVB avoided the stricter regulatory requirements placed on larger competitors in the US and internationally.
The GFC’s post-crisis period was characterized by a slew of regulatory reforms and consumer protections enacted to prevent repeated events that sparked severe economic strife worldwide in 2008. The industry implemented scenario analysis and stress testing, conducted frequently, among the regulatory interventions, to accurately understand the effects on banks’ balance sheets and their resilience to sudden systemic shocks.
It must be noted that 2018 saw a partial rollback of the very regulations designed to protect the banking sector – firms, customers, shareholders, stakeholders and others – from catastrophe.
The limited repeal of the Dodd-Frank Act was passed in 2018 with the Economic Growth, Regulatory Relief and Consumer Protection Act. A critical feature of the latter was the easing of small and regional lenders’ oversight, justified on lowering compliance costs for banks with more modest assets. This lifted regulators’ “systemically important” threshold from $50bn in assets to $250bn. Banks under $250bn in assets would no longer be subject to the comprehensive annual stress testing mandate.
When these changes were implemented, SVB’s assets were in the $50bn range. Within four years, they reached $220bn, still shy of the trigger point mandating stress testing.
Operating without a CRO for nine months, did SVB perform comprehensive stress testing regardless of asset thresholds? This remains to be proven (or disproven). However, once the Fed began its rate hikes in March 2022 – a move replicated by central banks worldwide, not an isolated decision – SVB should have taken action to model the effects of interest rate increases on its portfolio.
A fundamental tool is a gap analysis to determine interest rate risk and evaluate the degree of exposure. It helps prevent banks from misjudging their liquidity by measuring the gap between assets and liabilities. If SVB did, in fact, use stress testing and gap analysis, it appears to have been too little too late.
Assessing an uncertain future
SVB’s collapse has captured the banking sector’s attention, and the ramifications are clear. If SVB could fail – a bank named among Forbes Financial All-Stars last month – other lenders could fall, too.
SAS’ risk and resiliency prediction from weeks ago rings prophetic: Asset liability management (ALM) will take center stage in 2023. The current crisis necessitates thoroughly examining portfolios to identify and shore up areas of concern. Stringent risk management, underpinned by robust and capable analytical models, particularly around ALM, scenario analysis and stress testing will help banks accurately assess and address their balance sheet challenges.
SVB will forever be known as the bank that failed in 48 hours. Other firms must heed its salutary warning and seize the opportunity to get their risk management houses in firm order.
This article was originally published on Finextra and is republished here with permission.
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