I wrote earlier this week that the failure of Silicon Valley Bank and others are symptoms of a much bigger gray rhino challenge: the inevitable turbulence that comes with cyclical monetary tightening.
But the steep rise in interest rates was only one factor leading to a crisis of confidence and bank runs. There were failures in risk management particular to the many of the banks involved, including industry over-concentration, maturity mismatches accentuated by accounting sleights-of-hand, heavy crypto exposure, failure to hedge interest rate risk (accentuated by rules that made it harder to do so), rapid growth, and general management failures including misreading of customers’ increased cash needs as interest rates rose and investment flows slowed.
Additional information about SVB no doubt will come to light when the U.S. Federal Reserve releases initial results of an investigation by May 1 and in what likely will be the first of many Congressional hearings March 29.
It’s too soon for a definitive list, but as early autopsies of Silicon Valley Bank and others accumulate, several key takeaways already have emerged. It’s not too soon to talk about some of these.
Guardrails Are Useful Even in Good Times
There’s a good reason why policy makers erect guardrails in the aftermath of a crisis: to protect depositors from future crises. Just because times are good doesn’t mean we don’t need them any more.
Sen. Elizabeth Warren and others have soundly and correctly criticized the rollback in 2018 of regulatory and supervisory measures put in place in 2010 intended to prevent another Great Financial Crisis. Approved after heavy lobbying, the 2018 legislation eased requirements for medium and smaller sized banks.
In 2018, Warren had warned , “Washington is about to make it easier for the banks to run up risk, make it easier to put our constituents at risk, make it easier to put American families in danger, just so the C.E.O.s of these banks can get a new corporate jet and add another floor to their new corporate headquarters.”
One might think that U.S. policy makers had learned their lesson after deciding in 199 to repeal the Glass-Steagall Act, which had been passed in 1933 after the 1929 stock market crash showed that maybe it wasn’t such a great idea to allow commercial banks to speculate the way investment banks did.
It’s Not the “Seeing” –It’s the Responding
Just as there was no shortage of warnings about the consequences of over-lenient loosening banking regulations at the behest of bank lobbyists, there was no lack of red flags that could have changed both management’s and regulators’ behavior.
Since the failure of SVB and other banks, there has been a lot of pearl-clutching about regulators not identifying problems soon enough. To be sure, it’s clear (in hindsight, which always seems to involve 20/20 vision) that regulators did not push hard or fast enough for changes that could have altered the course of events.
But it’s simply not true that regulators were unaware of risk management problems at SVB.
The Fed had issued “matters requiring attention” citations –not as severe as an “enforcement action” but still not exactly a ringing endorsement– in January 2019. In 2021, the San Francisco Fed issued six citations related to concerns about cash flow availability in case of crisis. In June of that year, however, the Fed nevertheless allowed SVB to buy and merge with with Boston Private Bank & Trust Company.
“By July 2022, Silicon Valley Bank was in a full supervisory review — getting a more careful look — and was ultimately rated deficient for governance and controls,” Jenna Smialek wrote for The New York Times. “It was placed under a set of restrictions that prevented it from growing through acquisitions. Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose.”
The bank reported that at the end of September 2022, its portfolio of held-to-maturity bonds was worth $15.9 billion less what its balance sheet reflected. At the time, SVB’s total reported equity was $15.8 billion. You do the math.
JP Morgan analysts issued a warning about Silicon Valley Bank in November 2022.
By the beginning of this year, a “horizontal review,” a Fed assessment meant to gauge the strength of SVB’s risk management identified even more shortcomings. But that was too little, too late.
The board and management also clearly were aware that something was not right. The board’s risk committee met 18 times in 2022, compared to just seven in 2021. (Noah Barsky’s analysis for Forbes of the bank’s 2023 proxy filing is well worth the read.)
Their response? Selling shares at various points in months leading up to the collapse and paying employee bonuses just hours before the FDIC seized it. Hmmm.
Chief Risk Officers Are Not a Luxury
One of the things that has a lot of people in the risk management world scratching their heads is why SVB went for eight months without a chief risk officer during the months leading up to its demise. For one thing, federal regulations require banks with assets of $50 billion or more to have both a risk committee and a chief risk officer. Ben Cohen’s brilliantly titled Wall Street Journal article, “It’s the Most Thankless Job in Banking. Silicon Valley Bank Didn’t Fill It for Months,” does a good job of explaining why this under-appreciated role could use a lot more love.
More to Come
There will be many more lessons coming out of this debacle. Many of them will be lessons that banks that did not fail already heeded.
Nevertheless, these lessons are worth repeating because no matter how much any of us would like to do so, we simply cannot take for granted that leaders and organizations will pay attention to what’s obvious.
A not-so-little reminder like this bank drama might help to jolt leaders and organizations into action when they might otherwise have fallen short.
This article is part of my LinkedIn newsletter series, “Around My Mind” – a regular walk through the ideas, events, people, and places that kick my synapses into action, sparking sometimes surprising or counter-intuitive connections.
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