“Don’t put all your eggs in one basket”
This article is a pure opinion piece meant to create more awareness of the need for banks to take risk management seriously at all levels, holistically taking into consideration all socio-economic factors, to avoid collapse.**
Did we ever imagine that there will be another financial meltdown like the 2008 crises? The Silicon Valley Bank of USA was shut down on Friday, 10th March,2023 by the Federal Regulators. As The New York Times and others have explained, the 16th Largest bank, the so called “Bank of Innovators” of USA, the collapse was due to a bank run precipitated by a decline in start-up funding, rising interest rates and the firm’s sale of government bonds at a huge loss to raise capital.
According to the FDIC, this is the second-largest bank failure in U.S. history, behind the collapse of Washington Mutual in September 2008. On 10th March, they took over SVB’s deposits and put the bank into receivership. The Federal Reserve also raised questions over the risk management failures at SVB.
Several questions come to our mind. Wasn’t SVB too big to fail? Were there no signs on the wall? Let us look at the story once again.
An unusual bank?
Silicon Valley Bank was founded in 1983 and grew to become the 16th-largest in the U.S, with $210 billion in assets. Its client list grew to include some of the biggest names in consumer tech like Airbnb, Cisco, Fitbit, Pinterest and Square. SVB was one of the leading lenders to the tech sector.
Brad Hargreaves, a startup founder who previously served on boards of companies that did business with SVB, said the bank was unusual, in that, it often played a dual role as corporate and personal lender to CEOs. Often, he said, SVB tied a company’s loan to an executive’s mortgage — and that a default on one would trigger a default on the other. At its peak, it had more than $200 billion in assets, but it had few individual customers and fewer than 38,000 corporate accounts. And its customer base was highly undiversified: Most of its deposits came from venture capital funds and tech and life-science companies, and most of its loans went to those companies too.
Why SVB failed
The bank ignored one of the fundamentals of finance:
It violated one of the elementary rules of finance: It did not diversify. SVB became the 16th-largest bank in the country by turning itself into the financial institution of choice for Silicon Valley venture capitalists and the companies they funded. This over-concentration in one sector made itself exceptionally dependent on the health of the tech industry and on the choices of a relatively small number of Venture capital firms and their founders. That dependence is what made the bank so successful but which ended up being destroyed by it. In effect, SVB put all its eggs in one basket. The concentration on the tech sector was good for SVB in 2020 and 2021and its total deposits more than tripled in two years. But when the tech boom turned to bust at the end of 2022, SVB’s customers—many of whom were startups that were not making money but spending it—started to withdraw money rather than deposit it.
The Asset-Liability mismatch:
SVB’s huge deposits taken in 2020 and 2021 were used to purchase long-term (mostly more than 10 years) treasuries and mortgage-backed securities that carried very low interest rates. SVB kept a lower level of deposits on hand and invested a greater percentage of its capital in order to try and pay its relatively higher rates. Although this was good since none of the assets it bought were at risk of defaulting, there was an exposure to interest rate risk. This is what actually happened and took SVB by storm. The result was that by the end of 2022, SVB was sitting on $16 billion in unrealized losses on its investment portfolio, meaning that on a mark-to-market basis, its assets barely covered its liabilities. SVB had more than enough liquidity to cover a normal rate of withdrawals, however it announced a plan to bolster its cash position, selling off some of its bond portfolio and raising capital by selling shares. This caused panic among its investors, who were a closely knit, social media savvy community who regularly share concerns. So when they started to share their worries on social media about SVB’s financial health, the situation ended in a bank run. If SVB had had a more traditional, diversified customer base, it might well have been able to weather the storm.
The Big Irony:
SVB preferred to work with tech companies. A bitterly ironic fate for a bank that had financed so many tech companies. Its demise was accelerated by another digital innovation: online banking. In traditional banking, it took a long process and days, withdrawing or transferring huge amounts from your bank. In the old days. With my experience, anytime a customer wants to withdraw or transfer an amount which was not in its normal pattern, we quickly revert to the customer, to ensure everything was in order. The bank’s Treasurer had to come in since it was unanticipated. This enabled the bank to make proper arrangements and even sometimes play some delay tactics to forestall disaster. Today, you can do all that with a few clicks on your phone. Can you imagine that SVB depositors and investors tried to pull out $42 billion—almost a quarter of the bank’s total deposits on Thursday, 9th March, 2023! The next day, regulators shut it down.
Didn’t the alarm bells ring?
There was no Chief Risk Officer (CRO) for 8 months: SVB’s Chief Risk Officer stepped away from her role in April 2022, and the bank did not hire a replacement until January 2023! It is unclear how the bank managed risks in the interim period between the departure of one CRO and appointment of another. A CRO’s job usually anticipates and manages regulatory, operational, competitive or other risks faced by the bank. CROs report directly to the Risk Sub Committee of the board and the CEO of the Bank. This means that the role of the CRO was underrated especially when interest rates started spiraling from the beginning of 2022, when venture capitalist also pulled back, influencing deposits at Silicon Bank.
A good track record turned sour
For ESG investors, SVB appeared to be having a good track record. But did it? Reports indicate that SVB was a big lender to renewable energy companies, a favorite among ESG managers on the lookout for low carbon footprints. But when it came to governance risks, fund managers seem to have overlooked it. The fact that there was no CRO for eight months should have been taken more seriously by the regulators. SVB’s spectacular collapse shows there was a serious governance issue.
“Negligence” from External Auditors
KPMG, one of the “Big Four” audit firms, issued a clean audit report on the 31 December 2022 accounts of Silicon Valley Bank on 24 February 2023, while employees received their annual bonuses on March 10, 2023, hours before the government took control of SVB. It is claimed that this was negligence to the catalog of audit failures. KPMG may have ignored the going concern assumption of the SVB for the risk of default and financial stress along with other reasons.
Quote from 9th March edition of Bloomsberg News:
“SVB marketed itself as a bank for tech entrepreneurs, a business model that resulted in a dangerously concentrated loan portfolio exposed to a highly volatile sector, especially as interest rates rose. The bank ultimately lacked the liquidity to deal with the risks lurking in its loan portfolio.
For investors, exposure to SVB was rendered all the more risky by the absence of rigorous regulatory oversight, as US watchdogs focused their attention on lenders judged too big to fail.
SVB’s spectacular collapse shows there was “a massive governance issue,” Alp Ercil, whose Hong Kong-based fund Asia Research & Capital Management controlled $3.5 billion in assets as of January, said at an event in Singapore.
“And it’s going to be a huge case study that hopefully Wharton will write on the ‘G’ component of ESG,” he said.
Conclusion:
As a gentle reminder to Banks, CFOs, CROs, and Board members, we hope that there is constant monitoring and measurement of their risk appetite while investments strategies with hedging techniques in relation to the micro and macro-economic factors. Further, Banks should measure their financial stress, liquidation and default risk and should do risk assessment vigilantly. We also hope external auditors are more diligent in reviewing the ESGs of financial institutions, to avoid embarrassment, suspicions and banks runs.
Sources:
Bloomsberg news, 9th March 2023
https:www.linkedin.com/in/Zahid-munir
https:www.linkedin.com/in/kenkang
https/fortune.com/author/prarthani-prakash
ABOUT THE AUTHOR
Alberta Quarcoopome is a Fellow of the Institute of Bankers, and CEO of ALKAN Business Consult Ltd. She is the Author of Three books: “The 21st Century Bank Teller: A Strategic Partner” and “My Front Desk Experience: A Young Banker’s Story” and “The Modern Branch Manager’s Companion”. She uses her experience and practical case studies, training young bankers in operational risk management, sales, customer service, banking operations and fraud.
CONTACT
Website www.alkanbiz.com
Email:alberta@alkanbiz.com or [email protected]
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