Four Flaws That SVB Crisis Highlights In The Banking Sector, According To BCG
The collapse of SVB is a wake-up call for banks to improve balance sheet modeling and have a robust risk management program.
The collapse of Silicon Valley Bank and the crisis are a wake-up call for banks to improve balance sheet modeling and have a robust risk management program, according to Boston Consulting Group.
In a note today, the global consulting firm said the fallout has highlighted four flaws in the typical bank risk management approach that other institutions, even those that have different profiles from SVB, should address.
Stress Testing Across Risk Siloes
BCG said while Silicon Valley Bank would have "probably" conducted interest rate, credit, market, and liquidity risk stress testing, it failed to "understand the spill-over implications across different risk types."
"Specifically, there were challenges in addressing interest rate risk via unrealized losses in the value of long-term assets due to rising rates and liquidity risk via rapid deposit outflows. This hit SVB harder than other banks because its deposits were concentrated in the most impacted sectors."
It said that banks need to urgently build balance sheet modeling, stress testing, and also reverse stress testing, i.e., consider what it will take to "break the bank".
Liquidity ≠ Cash
BCG said SVB had plenty of high-quality liquid assets, but what it lacked was the ability to convert the liquidity to cash to meet payment obligations in a period of market stress without resorting to a fire sale of assets and a subsequent immediate recognition of large losses.
"This event should encourage banks to pressure test their asset monetization assumptions in their liquidity stress testing framework (i.e., ability to convert high-quality liquid assets buffer into cash and broader impacts of doing so) and their contingency liquidity plans," it said.
Concentration Risk In Deposits Should Be Better Understood
An underestimation of the deposit decline velocity was a major contributor to the underpreparedness of SVB, says BCG.
"SVB’s deposit base was concentrated in a specific sector where account balances were declining rapidly. A ‘run on the bank’ turned into a ‘sprint on the bank’ due to the interconnectedness of the client base, the actions of key influencers, and the pace of action in a digital ecosystem (digital banking and communication channels)," it wrote.
Banks must assess the concentration risk across industries, geographies, and archetypes in their deposit portfolios and, as a result, more aggressively challenge net liquidity outflow assumptions in times of market stress, BCG said.
A Crisis Playbook Fit For The Social Media Age
BCG wrote that SVB represents the first major bank failure in the social media age. "The fact that the FDIC took over SVB in the middle of the day on Friday rather than waiting for the close of business shows how quickly the situation changed."
It wrote that the pace and collective response of depositors were enabled by social media, digital communication, and digital banking. "This made the speed of the crisis more resemble a massive cyber breach than a bank run from decades past. SVB seemed unprepared to respond to such events in a coordinated fashion—both internally and in communication with their investors and depositors."
Banks must establish and regularly exercise playbooks for a liquidity crisis. "Just like a cyber event or operational incident response, banks should regularly conduct ‘war gaming’ exercises to ensure a coordinated response across siloed and currently unprepared areas of the bank in the event of a similar crisis," it wrote.