On 8th March 2023, the Silicon Valley Bank (SVB) in the United States experienced a collapse as a result of liquidity challenges. During the Covid-19 era, the bank had utilized deposits it received from technology companies to take advantage of high yields on long-term investments. However, these long-term investments suffered significant losses due to interest rate hikes by the United States government in an effort to address inflationary pressure on the economy. When the bank had to liquidate these investments to meet its short-term liquidity obligations, the losses on the long-term investments had crystallized. The banks attempt to raise more funds from the market was seen as a sign of liquidity challenge and possible collapse. This triggered a mad rush on the Bank by these Technology companies to withdraw deposits. While experts in finance and investment have provided explanations for the collapse of SVB, it is crucial to focus on the lessons learnt from every happenings, whether good or bad. This article, therefore, highlights five (5) important lesson that every bank’s Chief Executive Officer (CEO) must learn from SVB’s collapse.
Cash is King: The first lesson to be learnt from the collapse of SVB is a reminder of the phrase “Cash is King”. This phrase serves as a reminder that liquidity (often referred to a “Cash”) should be the most crucial element for every bank CEO. A bank can operate for many years without making profits, as long as it avoids losses that could cause its Capital Adequacy Ratio (CAR) to fall below the regulatory limit. However, a bank cannot survive beyond a year if it fails to meet its liquidity obligations. When depositors are unable to access these funds, it leads to panic withdrawals, which no bank can withstand. While it’s important for banks to take advantage of investment opportunities to generate profits, this decision must be balanced against the ability to fulfill short-term obligations as and when they arise. Liquidity should be the top priority for every bank CEO as it provides financial security and flexibility. It should never be sacrificed for profitability because when short-term obligations arise, the bank may not survive long enough to enjoy its profits.
Asset Liability Management (ALM): The collapse of SVB also highlights the need for every bank to pay particular attention to its ALM. The second lesson that bank CEOs must learn is effective and efficient Asset Liability Management. Essentially, a bank’s assets are financed by its liabilities and capital. To wit, when liabilities are due, assets must be liquidated to meet them. ALM involves forecasting the bank’s cash flows and ensuring that its assets are sufficient to meet short-term and long-term liabilities as they become due. SVB’s collapse was partly due to its failure to ensure that its assets were sufficient to meet its short-term and long-term liabilities. The Bank did not anticipate the interest rate hikes, which resulted in the loss of value of their long-term investment assets leaving them illiquid to meet falling obligations. It is therefore imperative that bank CEOs simulate various scenarios and adequately stress-test their ability to meet short-term and long-term obligations. This will ensure that the Banks maintain adequate liquidity levels, which will enable them to survive any unexpected macroeconomic shock such as interest rate hikes. ALM must go beyond matching short-term liabilities to short-term assets and long-term liabilities to long-term assets. It must also consider the impact of macroeconomic factors on the value of assets and liabilities, as these factors can sometimes reduce asset value and make them insufficient to cater for liabilities as they become due.
Deposit Concentration and Mix: The collapse of SVB can partly be attributed to its heavy reliance on deposits from Technology companies in Silicon Valley. This deposit concentration posed a significant risk ton the Bank’s continuity drive. This is because any challenge faced by these firms in the Technology industry could directly impact the Bank. The liquidity demands placed on SVB’s assets because the Technology firms forced the Bank to liquidate its long-term investments before maturity, which resulted in massive losses. The lesson to be learnt from this is that CEOs of banks should pay close attention to deposit concentration and mix. Deposit concentration and mix refer to the extent of diversification of a bank’s deposits in terms of the contribution of individual customers, industries, and types of deposits to the entire deposit portfolio of the bank. Diversification is essential in mitigating risks, and it is crucial that banks diversify their deposit portfolios to avoid over-reliance on a selected group of customers, industries, or deposit types. It is not advisable for a bank to have more than 50% of its total deposits coming from less than 100 customers or 50% of its total deposits coming from less than 5 industries. Additionally, having more than 70% of the total deposits of a bank in a particular type of deposit is not recommended. Banks must continuously monitor their top 100 depositors, top 5 deposit contributing industries, and deposit mix to ensure that deposit portfolios are well diversified. This will help prevent situations similar to that faced by SVB.
Signalling Theory: The collapse of SVB could have been prevented if their attempt to raise additional funds from the market was successful. However, the attempt failed due to signalling effect. SVB had assured its customers that everything was fine until it attempted to raise additional funds at a bad time. The intention to raise additional funds was immediately after another bank had collapsed, which sent a negative signal to customers, and subsequently the panic withdrawals and the eventual collapse of SVB. The lesson to be learnt from this is that an organization should communicate effectively to its stakeholders particularly its customers. SVB should have clearly communicated the purpose of the additional funds it needed to raise to customers and provided more transparency about its intentions. This would have prevented customers from interpreting the it as a sign of impending collapse. CEOs of banks must be mindful of their actions and the possible interpretations stakeholders may give to such actions. They must clearly communicate the purpose of their actions and promptly address any misunderstandings to ensure stakeholders are not misled into taking actions that could have negative repercussions on the Bank.
Profitability with Prudence: Undoubtedly, profitability is crucial for business growth and survival. It is also essential to understand the limitations of taking advantage of profit opportunities. Using short-term funds to capitalize on profit opportunities in long-term investments is a fundamental mistake, as evidenced by SVB’s collapse. As CEOs of banks, the lesson to learn is to evaluate which profit opportunities are worth pursuing and which ones are not. It is prudent to consider the probability of a risk crystallizing and finding a way to mitigate it before taking advantage of the opportunity to make profit.
The situation with SVB is similar to the experience of many Ghanaian banks in 2022, when the government issued bonds with interest rates ranging from 20% to 30%. Although these banks were aware that the high bond rates could result in possibly very high national debt to GDP ratio, several banks took advantage of the opportunity to make significant profits. Many projected that 2022 would be their best year yet in terms of performance. However, when the government of Ghana was unable to fulfil its debts obligations, it proposed a Domestic Debt Exchange Programme (DDEP). As a result, all existing local Cedi bonds previously issued at high rates were exchanged for new bonds at low rates. The outcome was that banks that had previously taken advantage of the high bond rates were now forced to take high impairment charges.
Outlook for Bank CEOs
The Banking industry in Ghana remains one of the most profitable sectors of the Ghanaian economy. It is incumbent upon bank CEOs to learn from their own mistakes as well as the mistakes of other banks, both within and outside the Ghanaian banking industry. Banking can be a highly rewarding enterprise, but it is also inherently risky. While no bank is immune to the threat of a bank run by customers, by heeding the lessons of banks that have suffered such a fate, it is possible to avoid recurrence.