Silicon Valley Bank’s Risk Management Debacle

Silicon Valley Bank’s Risk Management Debacle

How and why did it happen?

Having witnessed the largest bank failure in American history that of Washington Mutual, firsthand, the collapse of Silicon Valley Bank (SVB) brings back painful memories of how quickly seemingly well-managed banks may run into difficulties owing to unexpected occurrences, poor governance and handling of significant risks like in the case of Washington Mutual, ultimately doomed SVB.
Although SVB catered to the venture capital crowd and IT businesses and Washington Mutual focused on the home lending business, both were far too concentrated in their own industries. Never in its history has SVB anticipated a run of $42 billion in a single day, equal to almost a quarter of its total deposits. So, why did the FDIC suddenly seize control of SVB?
Anatomy of SVB’s failure
What ultimately doomed SVB is now clearer. The bank technically failed because it experienced a liquidity crisis, or an inability to generate enough new cash to cover its expenses. Imagine getting into your car for the day and hearing a clunk, followed by the complete and total shutdown of your vehicle. The transmission needs to be replaced, and the mechanic estimates that it will cost you $3,000. Feelings of despair wash over you as you take stock of your financial situation and find that you have just one hundred dollars in your bank account, no available credit on any of your credit cards, and no financial support from family or friends. A personal cash flow emergency. Multiply it by a billion to get a sense of the magnitude of the problem that SVB faced when a sizable portion of its depositor base disappeared.
SVB reported $120 billion in investment securities at the end of 2022, which accounted for 55% of its assets and was more than double the average for US banks. In addition, 75% of their holdings were in HTM securities, most of which were US Treasuries and mortgage-backed securities (MBS). Credit risk is low for both Treasuries and MBS, but there is significant interest rate risk associated with both. These investments had a weighted average tenure of around 6 years, which means that for every 1% increase in interest rates, the value of these assets would decrease by 6%. Prior to the Fed’s rate hike plan, when yields were low, banks like SVB were particularly interested in finding ways to profit from riding the yield curve.
Lackluster risk management
It is now clear that SVB’s methods for managing liquidity risk were inadequate. The best banks will use a variety of techniques, such as scenario exercises and stress tests, to learn how vulnerable their liquidity risk profile is to different kinds of shocks. The Liquidity Coverage Ratio measures the proportion of high-quality liquid assets (HQLA) to stress net cash outflows over a 30-day horizon and is applied only to the largest banks (LCR). These financial institutions must also determine a similar ratio based on the consistency of their funding over the course of a year. As SVB wasn’t big enough to be subject to LCR regulations, we’ll never know if they were compliant or not; nonetheless, the magnitude of the bank run suggests that it wouldn’t have made much of a difference.
There was a clear absence of risk management oversight from the board and the risk team at SVB, which only made matters worse. SVB’s risk committee was given a charter outlining all the necessary parts of risk management. There was, therefore, a discrepancy between their words and their deeds. When SVB’s ChiefRisk officer left in the spring of 2022, it wasn’t until January of the following year that they hired a replacement. Due to a lack of direction, the board and the risk management team may not have been aware of the growing exposure in the portfolio or of the inadequate measures taken to control market and liquidity risks.
The shocking failure of SVB shows that, despite our best attempts to control the banking sector after the 2008 crises, banks nevertheless fail on occasion. Poor investment strategy, risk management methods, and board risk oversight combined with an unprecedented confluence of events concentrated in a volatile area to bring down SVB. Concerns raised by regulators about the accumulation of unrealized losses at many banks as a result of sharply increased interest rates on fixed asset investments are warranted, especially given the potential for a large bank run on SVB to spark a chain reaction in which other institutions with large unrealized losses experience similar events. The Federal Deposit Insurance Corporation (FDI) and other banking regulators must act quickly to address any immediate contagion threat from SVB’s failure, while also conducting a more in-depth, long-term examination of the ability of boards to effectively oversee and banks to competently manage complex and integrated risks.
SVB, one of the stellar performers
 That it is the financial backer for approximately half of all venture-backed firms in the United States.
 One who has assets worth more than $200 billion in the United States
 With a solid Return on Equity of 14%
 Being recognised as Forbes Best Banks 2023 as late as February 23rd, for the fifth year in a row
 Having earned a stock price appreciation return of 420% between March 20 and December 21
How did it happen?
 The bank’s deposits increase by 90%, or an additional US $ 88 billion, in 2020 and 2021 as a direct result of the artificial liquidity pumped in post-Covid.
 When the digital startup industry began to slow down in 2022, SVB experienced a severe shortage of funds as many of its customers withdrew their money quickly. Noninterest-bearing deposits at SVB decreased by 36% to US $45 billion on December 22 and total deposits decreased by US $16 billion (or 9%) from December 21.
 With the intention of restoring system liquidity:
To compensate for a decline in deposits, the company borrowed about US$14 billion in short-term funds and US$3 billion in long-term funds in 2022. Second, the liquidity situation likely worsened after December ’22, prompting the group to sell securities worth US$21 billion at a loss of US$2 billion, and the meltdown was triggered when the parent company of SVB attempted to sell SVB shares for US$2.25 billion.
Why did it happen?
 To put it succinctly, the funding freeze in the technology startup industry is to blame for the EPIC Asset – liability mismatch.
 The current market value has been severely damaged as a result of SVB’s unwise act of investing the additional US $ 88 billion that they received throughout 2020-2021 in long-term government bonds at approximately 1.6% due to recent rate hikes.
 To meet its present liabilities (demand deposits), SVB had to rely on external funding/capital, an effort they tried and failed at terribly.
 One other major factor is that SVB had too much of its business depending on the IT startup industry and had not diversified sufficiently.
 In my opinion and based on the data at hand, this is not so much a systemic problem as it is the result of poor decision-making about the allocation of money and a lack of diversification on the side of a single organisation.
 These are basic tenets of Finance
Dr. Syed Roohul Andrabi holds an MBA and a Ph.D. in Risk and Compliance, and he is a Senior Analyst/ Subject Matter Expert at KPMG Global Services for the United States and Canadian markets.
Farhat Shah is an Assistant Manager with ICICI Bank Ltd. She holds an MBA in Risk Management.

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