What happened with SVB?

Silicon Valley Bank is an American bank specializing in financing start-ups in the new technology sector. At the beginning of March, it was the 16th largest bank in the United States in terms of assets under management. Silicon Valley Bank closed its doors on Friday, March 10, the largest bank failure in the United States since the collapse of Lehman Brothers in September 2008, which precipitated the subprime crisis.

This double announcement triggered a bank run (or banking panic): many customers, having lost confidence in the bank, withdrew their funds... or tried to do so! The American authorities proceeded to close the Silicon Valley Bank on Friday, March 10 to limit the hemorrhage.


The unspoken from Risk & Compliance perspective

Any failure of a financial institution raises the question of regulation. After the 2008 financial crisis, stricter regulations were put in place, both in the United States and in Europe. Some of these rules have, however, been relaxed by the Trump administration. Only banking institutions with a balance sheet of more than $250 billion are subject to strict oversight. The threshold was $50 billion before 2017. With the rules previously in place, the U.S. regulator likely could have intervened early and thus prevented the failure of Silicon Valley Bank, which had a balance sheet size of $212 billion at the end of 2022.

Recent reporting has indicated that, more than a year ago, the San Francisco Federal Reserve Bank did notice problems—including how the bank managed its exposure to changes in interest rates and whether it would have enough cash in a crisis—and warned S.V.B. about them. (Between 2017 and the time of those warnings, the bank’s assets had quadrupled to more than two hundred billion dollars.)

After the financial crisis of 2008, Congress passed the Dodd-Frank Act, which imposed stricter regulations on the banking sector; in 2018, Congress scaled back Dodd-Frank, raising the threshold for increased scrutiny of banks from fifty billion in assets to two hundred and fifty billion.

Nevertheless, SVB’s collapse raises certain questions about the regulatory, risk and compliance management framework for a broader spectrum of Financial Services Firm:


Prudential regulations

SVB is clearly the product of a US regulatory and supervision failure. Togerther with other Financial Services Institutions (FSIs), SVB successfully lobbied Congress to soften regulations, which allowed them to rely on held-to-maturity accounting, and to be exempt from Basel 3 liquidity coverage ratio (LCR) requirement. SVB also got also exempted from other enhanced prudential standards that apply to systemically important banks. In short, the LCR Basel 3 rule clearly requires holding sufficient high-quality liquid assets (HQLA) to manage expected net cash outflows under a 30-days stress scenario. Under the original requirements of the LCR rule, SVB with USD 250 billion in assets or 10 billion in foreign exposure had to maintain LCR ratio over 100%. After the softening of regulations under the Trump Administration that was labelled a “Job killer” then, SVB was able to reduce the LCR requirement to 75%. Compliance wise, the bank would have needed over USD 18 billion or more to get a 100% LCR, and USD 36 billion or more to maintain a 125% LCR that is required for US global systemically important banks.


ESG

SVB was highly rated for its ESG investments. The bank had announced a USD 5 billion program to support sustainable businesses among its clients' portfolios. The bank also was involved in a USD 11.2 billion community plan. Overall SVB was praised for its successful ESG program.

But SVB neglected its own ESG efforts for most of 2022. The bank didn’t have a Chief Risk Officer (CRO) at that time. CRO role was apparently not functional. It was instated merely to just tick a box. Appointing a new CRO was not a priority for SVB.


Inflation and interest rates hike

SVB’s failure is also tied with two other external factors. The first one is the rapid hike of interest rates. The US Federal Reserve Bank, alongside other central banks, has raised rates from 0.25%-0.5% to 4.5%+ in less than 12 months. Higher rates have an impact on credit conditions. It makes it harder for FSIs to refinance themselves damaging the value of their assets and loans.
The second factor is that short-term interest rates rise above long-term rates, as it was the case in the US. SVB was mostly taking funds on short-term deposits to invest them in long-term investments. This situation created a squeeze in SVB’s profit margins shrinking its balance-sheet. It forced the bank to sell-off assets including longer-dated bonds at a loss to fund the deposits its customers were withdrawing from the bank. The rest is history.


Lessons for a Compliance Officer: