March 23, 2023 | Maria Fritzsche
Estimated reading time: 5 minutes
How to protect financial institutions from collapse
Since the first announcement of Silicon Valley Bank’s collapse, it has been difficult to ignore the news. Firms from all around the globe are affected. In North America, a wide variety of firms are affected, from solar firms, biotech to cryptocurrency, and payment providers. But what could have saved the bank and what will happen next?
Until recently, Silicon Valley Bank Financial Group (SVB) was one of the most admired financial institutions among startup founders and the tech community. It was ranked as the 16th biggest lender in the US at the end of 2022, with SVB asset management managing around $209 billion. It is the biggest bank to fail since the 2008 financial crisis.
These events shake up the entire industry, increase fear among depositors and are likely to prolong the tech winter. Therefore, it is now more important than ever to reassure and build trust with shareholders and investors. Here are some factors to consider.
1. Stay on top of current events and consider going beyond the regulators’ obligations
The effects of scaling back the Dodd-Frank Act in 2018 have largely been reported on since SVB’s collapse. The Dodd-Frank Act was enacted in 2010 following the 2008 financial crisis with the goal of, amongst other things, protecting consumers and taxpayers from predatory lending. The amendment to the Dodd-Frank Act in 2018 raised the threshold for increased supervision and scrutiny of banks from 50 billion to 250 billion in assets. It followed the flawed logic of “too big to fail”. This amendment meant that SVB avoided increased supervision. However, the San Francisco Federal Reserve Bank noticed issues with SVB more than a year ago, such as their over-exposure to changing interest rates and hence potential cash flow issues in the event of a crisis.
The bank became dependent on the low interest rates as it invested deposits into US government bonds, which is seen as one of the safest investments. Those “safe” investments were often part of the reasons why SVB sought exceptions to regulatory supervision prior to the 2018 legislative changes.
However, in order to combat inflation, the Federal Reserve bank increased interest rates and the SVB bonds value fell. Nevertheless, the bank continued to buy government bonds, and the regulator allowed this to happen. When the bank’s clients wanted to take out their money at the same time, the bank did not have the necessary funds.
The regulators’ lack of interference at this critical stage of interest rate increases, suggests that relying entirely on regulators to warn a firm of problems is not a sustainable option. Financial institutions should focus on obtaining all relevant information and making well-informed judgments.
2. Consider all scenarios and be pro-active in risk management
The media and the government well documented the interest increases mentioned above, so why did the bank continue to buy government bonds and put itself at risk? A possible answer could be the lack of a Chief Risk Officer (CRO) for almost eight months in 2022. The absence of a CRO for this length of time should have been a big matter of concern for senior management, as they could have warned of the risks as part of its obligation to oversee the risk management department, and report to the board, the regulator and the chief executive.
Risk managers should be proactive and assess all scenarios. It is important to understand what motivates their depositors’ behaviour across different product types and market segments in a wide range of economic conditions. For example, in the case of SVB, a move to shorter-term investments could have benefited SVB as it could have taken advantage of the rising interest rates instead of collapsing with them.
3. Regulatory change is coming
Based on the magnitude of this collapse, its global effect and the reputational distress that it is causing, for the US financial sector in particular, it is a reasonable assumption to conclude that further regulatory change is coming.
Senator Elizabeth Warren aims to repeal Trump’s financial deregulation of the Dodd-Frank Act.
In general, US regulators are in the spotlight as three major banks have closed in the last few weeks: Silvergate Bank, SVB and Signature Bank. Whether these shutdowns can be attributed to regulatory failures as well as the bank’s failures remains to be seen. However, events such as these demand calls for change. An increase in volume of regulatory news and regulatory change is to be expected in the coming weeks.
How to prepare for the inevitable changes?
The SVB collapse has again shown how important it is to have a good understanding of what is happening in the financial sector across the globe. The events in recent days have demonstrated how quickly things can escalate. Regulators and depositors are likely going to focus on these developments and make changes with a significant impact on financial services and beyond. Using a strong compliance tool that supports compliance teams efficiently, such as CUBE’s Automated Regulatory Intelligence, can restore trust with stakeholders and investors at a time of uncertainty and fear.
Considering upcoming regulatory changes are inevitable as depositors want to see their investments protected, it is likely to increase the compliance burden on financial services. New rules mean more work for compliance teams. The ever-increasing compliance burden can be challenging to manage, especially when done manually or when using outdated technology. To navigate any new changes, automated regulatory intelligence (ARI) products are an efficient solution to ensure your business is operating to the best possible standards.
CUBE can help future-proof and steer through regulatory changes. All regulatory obligations can be found in one place, in any language, reflective of your business needs and filtered to focus on the regulations and content that matter to you.
Contact CUBE to keep ahead of upcoming risk management changes.