Much has been written about the SVB (Silicon Valley Bank) failure, the largest U.S. bank failure behind Lehman Brothers back in September of 2008. Articles have extensively covered how it happened and what the impact is to financial markets and the banking sector. But what is relevant to you?
Let’s explore the SVB failure from the perspective of the Chief Risk Officer. Specifically, we’ll touch on what should have been in place at SVB and what a Chief Risk Officer (CRO) should be doing today, in light of this incident.
What should have been in place?
- SVB had no Chief Risk Officer from April 2022 to January 2023. The bank’s failure is all about good risk management, and the top risk management position was mostly vacant leading up to last Wednesday’s failure.
- Basic risk management. Proper ALM (Asset and Liability Management) requires regular and ongoing financial modelling, including stress scenarios. These include changes in interest rates as well as stressed liquidity scenarios. This level of basic risk management was certainly taking place at SVB, but how was the output of this modeling used? What conversations and debates did it inspire, and what decisions were made?
- Recognition of a credible challenge. At some point, someone at SVB had to recognize they were facing a credible challenge to their viability. Did this happen soon enough? Could it have been the board, or the new CRO? Someone has to speak up early enough.
- Heightened risk management activities. Our risk landscape is always changing, and our risk management focus needs to change accordingly. Liquidity risk and Interest Rate Risk have been the top risks for financial institutions since the Fed reversed course on quantitative easing and began aggressively raising rates in early 2022. How would this change our risk management activities?
- Run additional ALM sensitivities and liquidity stress scenarios. Don’t settle for the basic ALM modeling scenarios when you know you are in a heightened risk environment. 2022 proved that a +300 basis point scenario was not a stress scenario. The Fed increased rates by 450 basis points in 2022 and early 2023.
- Consider interest rate hedging if you have the regulatory authority to hedge. Hedging against interest rate changes can be very effective with interest rate swaps. SVB had no interest rate hedging in place at the time of failure. Hedging could have offset the $1.8 Billion loss on sale of assets SVB experienced last week.
- Ensure that your liquidity contingency funding plan is current, adequate and tested. The various steps in the liquidity contingency funding plan are designed to provide adequate liquidity without insolvency.
- Appropriately manage the investment portfolio. SVB had investment portfolios with very long durations. The longer the duration, the more sensitive the portfolio’s valuation is to changes in interest rates.
- Take into account indirect risks as well as the direct risks. SVB was exposed to interest rate risk and liquidity risk, but what about reputation and compliance risk? Be careful of becoming myopic with heightened risks.
What should a Chief Risk Officer be doing today?
- Make sure your risk management activities described above are in place and operating effectively.
- Conduct heightened risk management activities based on the environment. As mentioned above, are you running additional ALM scenarios? Is the liquidity contingency funding plan adequate and have you considered hedging interest rate risk exposure?
- Communicate with your Members and answer their questions. This industry is built on trust and if you can strengthen that trust based on the confidence you have in your safety and soundness, you can avoid excessive withdrawal of member deposits which further stresses your liquidity position.
- When given the opportunity, review your Enterprise Risk Management (ERM) program with your regulators. This is an important time to demonstrate the effectiveness and strength of the credit union’s risk management.
- Consider a third-party assessment of your ERM program and risk management output. During this time of heightened risk, you want to be sure that you are addressing risks appropriately and that you are minimizing potential blind spots.
A properly functioning ERM program will proactively give leaders the information needed to not be in a position similar to SVB’s. A baseline outcome from ERM is the identification of your key risks, making decisions on how to manage those key risks, and ensuring the expected outcome of risk management activities are fulfilled. In short, what are the biggest risks and what are we doing about them?
With respect to what happened to SVB, Rochdale goes beyond baseline ERM by providing risk-adjusted capital adequacy calculations and ongoing management. This enhanced ERM discipline effectively addresses maintaining the right amount of capital in light of your risk profile and unforeseen risks.
Rochdale is prepared to help you today, with your SVB-related messaging, risk-adjusted capital adequacy, and a third-party review or implementation of your ERM program. Contact us today at sales@reimaginerisk.com.