@ the IERP® Global Conference, August 2023
In his overview, moderator Ramesh Pillai, Group Managing Director of Friday Concepts, said that there were lessons to be learned from the recent collapse of several banks in the US. “The recent collapse of Silicon Valley Bank (SVB) and Signature Bank sent shockwaves through the financial industry and caused many investors to worry about what the future would hold,” he said. “SVB was the biggest bank failure in the US; Signature was the second biggest since 2008. Some believed the collapses were due to unforced, self-inflicted errors leading to a crisis of confidence among investors. Others point to poor risk management at the Banks concerned.”
Reports on the banks’ failure pointed to mismanagement and a lack of corporate governance, said panellist Raja Shahriman Raja Harun Al Rashid, Senior Vice President, Risk Management & Compliance, Cagamas Bhd. The failure of the three small to mid-size banks triggered a sharp decline in global bank stock prices and the US had to respond swiftly to prevent potential global contagion like that of the global financial crisis of 2007-8, as the losses of these three banks alone were much larger than that of all banks during the GFC. SVB was primarily lending and taking deposits from the Silicon Valley technology industry companies which experienced significant growth during the Covid-19 pandemic.
“SVB failed when a bank run was triggered, after it sold its treasury portfolio at a large loss, causing depositor concern over the bank’s liquidity,” he said. “The bank had earlier shifted its portfolio to treasury bonds, and these bonds had lost significant value as market interest rates rose. To make things worse, deposit balances exceeding US$250,000 were not insured by the Federal Deposit Insurance Corporation (FDIC).” Following a bank run SVB was shut down due to liquidity and insolvency issues. Raja Shahriman explained that Signature Bank expanded its business into cryptocurrency in 2018, which resulted in the exponential growth of its deposits and significant exposure to cryptocurrency.
“The Bank failed due to turbulence in the market,” he said. “This was exacerbated by the failure of SVB a few days before.” The failure of both Banks was also due to the run experienced by the other, with depositors withdrawing their money beyond the banks’ capacity at that point in time. He stressed, however, that these were only some of the factors which caused failure; both Banks failed due partially to over-concentration in volatile sectors – the technology sector for SVB, and the cryptocurrency industry for Signature. “The management of Signature Bank did not fully understand the risks they were taking when accepting cryptocurrency deposits that exceeded 10% of its total,” he said.
When the technology and cryptocurrency markets were booming, SVB and Signature continued to concentrate on these two sectors to maximise profits. While it was not wrong to do so, what was wrong was that the boards and management ignored the rule of diversification for long-term viability. Cryptocurrency prices dropped significantly in 2022, and US tech stocks fell more than 30%. Depositors withdrew their funds – billions of dollars’ worth – resulting in the crunch. “When management does not fully understand the risks associated with the business, whether deliberately or not, it will result in poor risk management practices,” Raja Shahriman said.
Early warning signals were ignored because the company was making a profit. Additionally, in the case of SVB, its risk modelling and stress testing failed to anticipate the interest rate and liquidity risk shocks it would face when interest rates rose rapidly. In its report, the FDIC acknowledged that the failure of Signature Bank was caused by poor management and unrestrained growth. The lack of expertise on the board of SVB found it unequipped to challenge the management on risks affecting the bank; out of seven board members, only one had a little background of risk management. Also, SVB was without a Chief Risk Officer for eight months; one was brought in only in January 2023.
“It’s not that having a CRO could have fixed everything,” stressed Raja Shahriman. “But for SVB, during this leadership gap, the management would have been in the dark.” Yet another factor was the failure to identify social media as an emerging trend. “This is a real threat,” he warned. “In today’s world, do not take this lightly.” Exposure to social media would have amplified the Banks’ difficulties. Highlighting two more factors, he said that the lack of action by supervisors of the Banks, and their inaction even when shortfalls were identified years before the crunch, were also significant causes. There was no single reason for the failures; many factors came together to cause it.
His five key takeaways from the incidents were: never lose sight of financial risk management; be aware of and alert to any portfolio concentrations; stress testing to identify red flags is important; address key person risk and succession planning; and be aware that social media has changed the nature of risk. He urged risk professionals to make risk management reports a part of the board agenda, and suggested a relook and enhancement of ERM as it is interconnected with many other risks. He also advocated being aware of velocity or the speed of event occurrence, and being prepared to deal with it; and emphasised the importance of developing a risk culture, starting from the top.
Second panellist Ahmad Shukri, CRO, Bank Rakyat, remarked that such incidences have plagued the financial sector since 1997. “Did the Banks have the right strategy or governance processes? CROs should be doing root cause analysis in the wake of the SVB failure,” he said, adding that people around the world were scrambling to understand what was happening because the financial industry is interrelated, and what happens in one country will influence things in another part of the world. He identified asset liability management and stress testing as critical factors in any situation. Stress testing was imperative, to gauge the level of risk exposure of the organisation, he said.
Giving a quick overview of how banks manage daily disbursements and maintain liquidity, he said that contingency planning for a standby line of credit was important, and that there were many tools a bank could use to meet liquidity requirements. Underscoring the importance of diversification, he said that banks should not put all deposits in one place. This caused the failure of SVB and Signature Bank, he opined. Social media also played a role; it caused people to panic. “From Signature Bank’s perspective, their losses in the mark-to-market position of their assets actually caused a loss of confidence in the Bank,” he pointed out.
“How we control and respond to social commentary is very important,” he continued. “A strong, immediate response to social media is a must for any organisation, not just banks.” Commending Bank Negara’s robust and vigilant monitoring of financial institutions, he said this has helped by setting off warning signals, and should be appreciated by the Malaysian market. Financial institutions here are also required to put in place mitigation plans for bank runs, etc. but he stressed that proper communication was still necessary to announce if the bank was raising funds, so that there would be no misconstruing of information that could result in a loss of confidence.
To a question from the floor on whether there should be a shift in executive compensation structures to discourage excessive risk-taking and short-terms gains in banks, Ramesh said that Bank Negara’s existing regulations already require boards to look at compensation plans especially in relation to key risk takers and decision makers. He pointed out, however, that excessive risk-taking was difficult to define because risk-taking was a personal decision, and that it was ultimately up to the organisation which was seeking funding, if they wanted to take on such risk or not. “All the bank does is price the risk,” he said.
On whether generative AI could be used to predict risks and prevent shortcomings, Raja Shahriman said that AI, without validation and accuracy, could cause other issues. Ahmad agreed, adding that although AI could help, it should be not be overly relied upon. Ramesh said that AI could be relied upon but there were limitations, besides being expensive. “But risk management is not about the mathematics of risk,” he said. “It is about the psychology of risk…While AI can help by generating a long list of potentials, it cannot really help you in value-based judgement.” Another question was about what happens to the economy as a whole, when a bank fails.
Ahmad said that it could cause a loss of confidence, particularly if exacerbated by comments on social media. “The normal course of business is disrupted because of ripple effects,” he said. “It can cause additional cost to manage issues.” Raja Shahriman noted that most crises started with a bank crisis; it was therefore important for banks to stabilise so that their deposits were not affected. “Banks…spur economic growth and create jobs,” he said. “Most of us have deposits in just one bank so if that bank collapses, it is disastrous. If banks are not safe and sound, there are a lot of repercussions.” Ramesh said that during the financial crisis, banks were owed a lot of money which they could not recover.
“They could not function; they could not lend. If the banks can’t lend, how do you grow?” he said. “The ripple effect is that the bank starts to panic, and cuts back. The public starts to lose confidence in the banks, and pulls its money out…there is now a liquidity crisis. It comes down to perceptions.” One mitigative measure may be for the central bank to require businesses to be more agile, but regulators should not be expected to forecast potential impacts. “Whatever industry you are in, don’t expect the regulators to identify your risks,” he cautioned. “Bank Negara can identify environmental risks but your organisational or strategic risks are your own.”
What would businesses need to do, so as not to suffer the same fate of SVB and Signature Bank? Raja Shahriman advocated developing the appropriate culture; Ahmad urged constant vigilance, and keeping abreast of potential risks and mitigative measures. Ramesh suggested scenario planning, preparation and anticipation; making sure the business knew its stakeholders, and what their reactions would be. In the case of SVB, stakeholders withdrew their money because they thought the Bank was collapsing. “SVB was financially sound,” he said. “Its collapse was caused by a crisis of confidence.” It was imperative to understand the impact of social media messages. Businesses – not just banks – should practise environmental scanning, scenario analysis and back testing, have early warning systems in place, and avoid any form of concentration risk.
