“Ain’t no use jiving, ain’t no use joking
Everything is broken
Seem like every time you stop and turn around”
Something else just hit the ground Bob Dylan: Everything is Broken
The recent collapse of several US banks, including Silicon Valley Bank, Signature Bank, and First Republic Bank, has sent shockwaves through the financial industry, creating acres of press coverage, speculation, and fear. These failures are stark reminders of the critical importance of robust treasury and risk management practices. Adam Gable, Product Director, Product Management, Risk, Temenos, delves into the key internal and external factors that led to these bank failures, discusses why existing regulations fell short in preventing them, and highlights the significant challenges banks face in managing critical risk functions and exploring the necessary tools and processes to protect against similar catastrophes.
Key Factors That Led to Recent Bank Failures
However, like most ‘unpredicted events,’ cars do not crash for no reason, buildings do not collapse without a cause, and Earthquakes can be predicted (to a certain extent).
In interviews with The Financial Times — including some conducted before SVB failed — more than a dozen bankers, regulators and executives offered their views of the failures in the aftermath of its collapse. As the The Financial Times said: ‘Almost all now agree on one thing — the crisis that brought down the bank had been hiding in plain sight.’
One of the primary external factors contributing to the bank failures was the rapid increase in interest rates. As central banks tightened monetary policy to combat inflation, it had a cascading effect on these banks. Rising rates impacted their loan portfolios, bond holdings, and funding costs, leading to substantial losses.
According to another report in The Financial Times: ‘The world’s most powerful financial watchdog has warned of “further challenges and shocks” in the months ahead, as high interest rates undermine economic recoveries and threaten key sectors including real estate.
In his regular update to G20 leaders ahead of their recent summit in New Delhi, Klaas Knot, chair of the Basel-based Financial Stability Board, said: “The global economic recovery is losing momentum, and the effects of the rise in interest rates in major economies are increasingly being felt.” “There will certainly be further challenges and shocks facing the global financial system in the months and years to come.”
Knot said risks in the financial system were still evident, even though contagion from the events of February and March had been limited. The banks which suffered the most had systemic faults in their makeup, which made the failures almost inevitable. So, what were they?
Business Model Vulnerabilities
Silicon Valley Bank, Signature Bank, and First Republic Bank shared a vulnerability in their business models. They had significant exposure to specific sectors, such as technology and real estate, which were highly sensitive to interest rate changes. When these sectors experienced stress due to rising rates, it directly affected the banks’ financial health.
Lack of Risk Diversification
Diversification is a fundamental risk management strategy. These banks failed to adequately diversify their risk exposure, relying heavily on specific types of assets or customer segments. When these assets underperformed or faced challenges, the banks suffered severe consequences.
Regulatory Framework
Despite regulatory efforts, existing rules and regulations failed to identify and mitigate the risks effectively. The 2018 banking legislation that eased restrictions for banks with less than $250 billion in assets is now being questioned, as it may have contributed to insufficient oversight. That is no surprise to many of us!
Cliff Edge Regulations
Regulators must address the “cliff edges” issue in the regulatory framework. As banks approach certain asset thresholds, they should face increased scrutiny and risk management requirements to ensure a smooth transition to a higher regulatory regime.
Digital Age Challenges
The speed at which digital banking operates, combined with the influence of social media, can trigger rapid panic and deposit withdrawals. Banks need innovative stress-testing approaches that account for these dynamics. Banks should diversify their asset portfolios and explore hedging strategies to protect against interest rate volatility. Proper risk diversification can help mitigate losses during economic downturns and, to a certain extent, mitigate the likelihood of ‘runs’ on banks caused by negative social media posts.
Continuous Monitoring
Implementing real-time monitoring systems can help banks detect early warning signs of financial stress. This allows for proactive risk management and timely decision-making.
These were all disasters which could have been avoided. History has been allowed to repeat even when the participants were warned that stormy waters lay ahead.
The Financial Times said: ‘That such apparent dangers went unheeded has dismayed the survivors of previous moments of financial peril. “I generally don’t second guess what someone should or shouldn’t have seen when I have the benefit of hindsight,” says Lloyd Blankfein, who was chief executive of Goldman Sachs during the 2008 crisis. “I’ll make an exception in this case because the [problems] were very apparent.’
The recent bank failures underscore the need for banks to re-evaluate their treasury and risk management practices. The rapidly changing macroeconomic climate and vulnerabilities in business models highlight the importance of diversification and risk hedging. Furthermore, regulatory frameworks should be re-examined to ensure they are robust enough to prevent systemic failures. Banks must adapt to the digital age by implementing innovative stress testing and monitoring tools to navigate the challenges of a fast-paced financial environment.
Strong treasury and risk management practices are essential to protect against similar scenarios and ensure the global financial system’s stability. Bob Dylan may have been a bit too pessimistic in his 1989 song Everything is Broken – it certainly looks that way – but in financial services, some forward planning will always catch the worst that may befall us!
Courtesy : https://www.temenos.com/news/2023/09/25/the-importance-of-strong-treasury-and-risk-management-practices-in-the-face-of-recent-bank-failures/