Silicon Valley Bank (SVB) Regulatory Failure: A Compliance Officer’s Assessment
Monday, June 19, 2023
Silicon Valley Bank (SVB) Regulatory Failure: A Compliance Officer’s Assessment
The sudden and shocking collapse of Silicon Valley Bank (SVB) in March 2023 has sent shockwaves through the financial world. As a compliance officer, it is imperative to assess the events leading up to SVB's downfall, identify regulatory shortcomings, and draw lessons for the broader financial services industry.
The Unprecedented Collapse of SVB
SVB, renowned for its specialization in financing technology startups, was once a thriving financial institution. However, March 10, 2023, marked a dark day in the bank's history as it became the largest bank failure in the United States since the infamous Lehman Brothers collapse in 2008. The abrupt closure of SVB triggered a bank run as panicked customers withdrew their funds, eroding trust in the institution.
Read also about other bank collapse in article: Credit Suisse: A Compliance Officer's Assessment of the Unfolding Tragedy
Regulatory Lapses: A Risk & Compliance Perspective
The failure of any financial institution raises questions about the effectiveness of regulatory oversight. After the 2008 financial crisis, both the United States and Europe implemented stricter regulations to prevent a recurrence. Unfortunately, some of these regulations were relaxed during the Trump administration, exposing vulnerabilities.
Under the previous regulatory framework, SVB, with assets totaling $212 billion at the end of 2022, could have been subject to stricter oversight. However, the threshold for enhanced scrutiny was raised from $50 billion to $250 billion in assets, potentially preventing regulatory intervention that might have saved SVB from its demise.
Early Warnings Ignored
Reports indicate that the San Francisco Federal Reserve Bank had identified issues with SVB's risk management practices more than a year before its collapse. Concerns included the bank's management of interest rate exposure and its ability to withstand a financial crisis. Despite these warnings and the bank's assets quadrupling to over $200 billion between 2017 and the time of the alerts, corrective actions were not taken.
Prudential Regulations: A Regulatory Failure
SVB's failure is emblematic of a broader regulatory and supervisory failure in the United States. The bank, along with other financial services institutions, successfully lobbied Congress to relax regulations. This allowed them to adopt held-to-maturity accounting practices and exemption from Basel 3 liquidity coverage ratio (LCR) requirements, among others.
Under the original LCR Basel 3 rule, SVB would have needed substantial high-quality liquid assets (HQLA) to maintain an LCR ratio over 100%. However, regulatory relaxations permitted SVB to lower this requirement to 75%, potentially leaving it vulnerable to liquidity crises. Compliance-wise, SVB's compliance with these relaxed regulations raises questions about the effectiveness of risk and compliance management.
ESG Neglect
Despite its commitment to Environmental, Social, and Governance (ESG) investments, SVB's own ESG efforts appeared to wane in 2022. The absence of a Chief Risk Officer (CRO) and an apparent non-functional CRO role left the bank exposed to risks it might have otherwise mitigated. ESG initiatives, once the bank's pride, seemed to take a backseat in a critical period.
External Factors: Inflation and Interest Rates
SVB's demise can also be attributed to external factors, primarily the rapid hike in interest rates by the US Federal Reserve Bank. Interest rates surged from 0.25%-0.5% to over 4.5% within a year, straining the ability of financial institutions to refinance and impacting the value of assets and loans.
Moreover, the inversion of short-term and long-term interest rates in the US posed a challenge for SVB. The bank's practice of borrowing short-term and investing in long-term assets squeezed its profit margins, forcing asset sell-offs and contributing to its downfall.
Lessons for Compliance Officers
As compliance officers, several key lessons emerge from SVB's catastrophic collapse:
1. LCR Ratio Revisions: The LCR ratio should distinguish between short and long-dated securities and account for potential losses. Regulatory requirements must evolve to consider maturity and potential losses in calculating the LCR ratio.
2. Balanced Regulatory Framework: The regulatory framework for short-term deposits needs recalibration to strike a balance between protecting assets and avoiding bankruptcy for medium and large corporations. Current thresholds may be inadequate in addressing modern financial challenges.
3. Effective Risk Management: A functional Chief Risk Officer (CRO) role is essential for effective risk management. ESG initiatives should not be compromised, even in times of organizational change.
4. Robust Supervision: Regulatory bodies must maintain vigilance and robust supervision over financial institutions, regardless of their asset size. Regulatory thresholds should be carefully evaluated to ensure the effectiveness of oversight.
In conclusion, the SVB regulatory failure serves as a stark reminder of the need for vigilant risk management, effective compliance, and responsive regulation in the financial services industry. Compliance officers must stay attuned to evolving regulatory landscapes and prioritize risk mitigation to prevent future catastrophic collapses like SVB's.
