Silicon Valley Bank (SVB) was a well-established financial institution with $209 billion in assets under management (as stated in their 2022 financial statements) that collapsed into insolvency in a matter of days.
How could this have happened so quickly and suddenly? The truth of the matter is it shouldn’t have been a surprise. There should have been multiple early-warning indicators showing this was going to be a problem, allowing for action to course correct.
It was reported that investments made by SVB were adversely affected by rising interest rates, causing the value of the assets to be worth less than it originally paid. This caused people and organizations with money deposited in the bank to panic and request mass withdrawals. This further drove down the value of the bank, and the bank was unable to satisfy those withdrawals. It was deemed insolvent and taken over by the FDIC (Federal Deposit Insurance Corporation) to manage the disbursement of funds.
The Warning Signs Were There
SVB understood their risk profile, as detailed by examination of its 2020 and 2021 annual reports. Both documents listed the following:
Market and Liquidity Risks
- Our interest rate spread may decline in the future. Any material reduction in our interest rate spread could have a material adverse effect on our business, results of operations or financial condition.
- Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
SVB listed these aspects as risks and was aware they could negatively impact the organization. Additionally, financial institutions are subject to annual assess stress-tests requirements, having to perform either DFAST (Dodd-Frank Asset Stress Test) or CCAR (Comprehensive Capital Analysis and Review). These tests require the organization look at its assets and make predictions on what happens to their valuation in the event of adverse economic situations (e.g., changes in disposable personal income, unemployment rate increases, and interest-rate increases) and report results to regulators. The decrease in asset valuation due to rising interest rates should have been made apparent in these tests, requiring action by SVB or direction on action by the Fed.
Prevention Was Possible
Financial institutions determine what risks to take on based on limits described in their risk appetite statements. This document details the acceptable amount of risk the organization is willing to take on to achieve its strategic objectives and is approved by the C-suite and board of directors.
Risk thresholds can be defined and aligned to prescribed limits and used as warning indicators for alerts to adverse situations. Key risk indicators can be set up to provide frequent, timely measurements on conditions to provide insight to potential breaches of thresholds. Identifying metrics that can be easily measured and captured — and incorporating them into risk analysis — is of the utmost importance. Had SVB set up a KRI around interest rates with an early-warning indicator of 1% and a severe-warning indicator of 2.25% would have allowed for time to take action to reduce losses and improve liquidity.
What the Financial Sector Can Expect Now
Expect regulatory and reporting requirements to dramatically change over the next 18 months. Organizations are going to be put under the microscope by examiners and required to provide more detailed evidence to back up their financial stability. There is a high probability that asset stress-testing reporting requirements may move from an annual basis to a semi-annual or quarterly requirement. Up-to-date compliance software that provides a single, integrated view is imperative for managing risk assessments, KPI/KRI collection and monitoring, risk-appetite alignment, and internal and external reporting. With insight like that, SVB might still be standing.
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