Just when the risk of further economic disruption seemed to dwindle within the past two weeks, we’ve seen the collapse of two regional banks in the US and stock prices of other financial institutions tumble, as well as the sale of Credit Suisse. Concerns of a banking crisis are spreading globally, despite measures taken by central banks to calm the international financial market. This all began with Silicon Valley Bank (SVB), which would go on to become the second largest bank to fail in U.S. history and the biggest bank failure since the financial crisis of 2008.
How could this have happened without notice? Why weren't issues recognized and flagged prior to this catastrophic failure? What needs to change to prevent this from happening to others?
Let’s look at 3 key factors that may have contributed to the fall of SVB.
1) Lack of diversification. SVB had become the go-to lender to tech start-ups – hopeful unicorns, SXSW tech celebrities, innovators and fast-growing VC firms. The bank was lending to new and emerging companies and those startups were jumping at the opportunity to bank among fellow tech elites. By the end of 2022, SVB had $209 billion in assets and ranked 16th among American banks - with a significant percentage coming from that demographic.They served mostly non-profitable growth tech companies that rely on venture capital and did not qualify for traditional loans. This level of concentration left SVB vulnerable to the volatility of that one industry.
The funds received by the startups from venture capitalists were deposited with SVB, where they were used to purchase long-term government bonds. With concentration in one sector (in this case, tech companies), a disruption in that industry can lead to significant net deposit outflows in tougher economic conditions. This may require banks to sell assets to cover withdrawals. To compare, larger banks like J.P. Morgan or Citibank have a more diverse customer base. Regulation also mandates that these larger banks avoid concentration in a particular industry, sector, borrower, or geographic region - therefore promoting more diversification.
2)Lack of a sound portfolio management strategy. SVB received deposits from start-ups when they raised money from VCs and were doing well in a strong economic environment. Their deposits grew from $89 billion in 2018 to $189 billion in 2021 as tech companies were flush with cash. SVB put some of the deposits in cash and invested in long-term treasury bonds, offering modest yields and low risk, a standard strategy before the Federal Reserve started raising rates over a year ago. SVB may not have adequately accounted for a scenario where interest rates could rise as quickly as they did. As rates rose, SVB’s bond holdings became less valuable as newer government bonds were carrying higher interest rates. The bank probably did not adjust its investment strategy rapidly enough to account for the lowered bond prices in the event of needing to raise cash to cover a withdrawal spike in a short period of time. SVB supposedly had almost 90% of its deposits uninsured by the FDIC, a percentage significantly higher than traditional banks, again because of the concentration of commercial depositors.
3)Lack of confidence by customers and shareholders. The Federal Reserve tried to contain a possible financial contagion and Treasury Secretary Janet Yellen assured the market that the banking system was resilient, but it did not stop customers from panicking. SVB received so many requests for withdrawal - some customers hoping to save their cash while others were looking to move money elsewhere. The maturity of those long-term bonds did not coincide with the sudden demand for withdrawals and thus SVB had to liquidate bonds for nearly a $2 billion loss. And yet, SVB was still unable to meet withdrawal requests. As word spread among the tight-knit tech start-up community, even more customers wanted to get their money back fearing their deposits would be lost. If customers didn’t want their deposits back all at once, it would not have been an issue; but the widespread concern from founders, VCs, and tech media fearing its insolvency resulted in a run on the bank.
We know hindsight is 20/20, but there are some actions banks can take to lessen the risk and minimize the likelihood of a recurrence.
1)Stress Testing. A stress test is a hypothetical analysis of credit risk, market risk and liquidity risk to determine whether a bank has enough capital to withstand an economic or financial crisis. In the U.S., the Dodd-Frank financial regulation that was put in place after the 2008 crisis included a bank stress test. This stress test is an evaluation of capital and assets requiring banks of a certain size to report results into regulatory bodies. Those that fail the stress test are required to take steps to increase their capital reserves. As a part of a 2018 change to the Dodd-Frank financial regulation, regional banks like SVB weren’t conducting the level of risk analysis you’d find at bigger banks and are not held to the same standards from a federal regulations perspective. This may have led to them taking on more risk than appropriate. Some banking experts believe that had there been better oversight of SVB’s management of their investment portfolio, including regular analysis of their interest rate risks, this would not have happened.
2)Liquidity and Cash Management Planning. Timing was a big issue at play for SVB. New deposits from their customers plummeted by $30B between March and December of 2022 as VC funding decreased. At the same time, unprofitable tech customers burned through cash and withdrew their money to fund their operations. To help offset the significant decline in deposits and meet withdrawal requests, SVB had to sell its bonds for a huge loss that led to further fear of the bank's solvency from their customers. They needed to stress test their liquidity and matching their risk profile with the duration of the bonds they held (i.e. how much money they could lose in the short term if the value of those bonds decreased due to various scenarios like interest rate hikes, etc.). SVB may have lacked visibility of their liquidity position and the risks associated with their bond portfolio in a rising rate environment. Having the ability to see your entire balance sheet and investment portfolio allows you to monitor your liquidity more effectively. With a deeper view into your investment portfolio, you can monitor maturity and interest and perform what-if scenarios to determine the optimal balance of cash on hand to satisfy your expected customer withdrawals while intelligently diversifying investments in the right assets at the right duration.
3)Succession and Workforce Planning. SVB was reportedly missing key personnel (including a head of risk management) in the middle of the fastest and most aggressive rate hike cycle in recent history and leading up to their solvency crisis. This could have potentially affected the bank’s ability to hedge risk in the context of rate hikes. Companies need to be able to plan for broad and narrow hiring needs. Workforce planning allows for scenario (“what-if”) modeling for attrition for critical roles and helps identify key talent to retain while creating a hiring plan to fill gaps. Organizations that manage risk effectively understand the importance of succession planning for key roles, know who can be promoted to step up in the event of workforce changes and have a plan if there is a need to hire quickly or find an interim resource.
How can Anaplan minimize the risk for your bank?
Trust is paramount in banking. Customers need to be assured that their deposits will be returned to them whole or with a modest amount of interest. Anaplan can help your bank with customer trust by empowering you to make better decisions.
Anaplan connects your business planning across your bank (unifying finance with non-finance data) so you can see your entire balance sheet, monitor your liquidity, manage your portfolio, and mitigate your risk. The speed to develop scenario plans compared with spreadsheets and other point solutions comes from Anaplan's ability to connect all of your businesses for a complete picture of your organization in real-time enabling you to pivot with market conditions and make fast decisions confidently. With a clear view into your investment portfolio, maturity, and interest, you can perform what-if scenario analysis to determine the optimal balance of cash on hand to satisfy your expected customer withdrawals. This helps improve your returns and satisfy your customers. Generated management reports and dashboards provide internal stakeholders with instant information on the financial health of your bank and can also ensure you satisfy regulatory requirements. Anaplan can also help with workforce planning through the platform’s unlimited dimensionality, which allows for detailed HR analysis on top of finance dimensions – in one place.
It may have been a chain of poor decisions, bad timing and unnecessary panic that led to the demise of SVB. Nevertheless, it’s likely that the banking industry will face changes as regulators begin to investigate the collapse of SVB and implement steps to better protect the banking system in the future. We expect more to unfold in the near future as the banking industry continues to navigate the effects of SVB on the financial market.
Additional Resources:
- Blog:Stress Testing: From a regulatory burden to a financial planning opportunity
- Webinar:Forecast Uncertainty: Rapid Scenario Planning with PwC(Timestamp: 8:00-14:30 min)
- Web:Anaplan for Financial Services Companies
