Silicon Valley Bank had no Chief Risk Officer for the last 8 months of 2022

Mark T. Williams, a highly respected professor at Boston University, and a former examiner at the U.S. Federal Reserve Bank, called the Silicon Valley Bank disaster “a colossal failure in asset-liability risk management.”

In simplified summary, the crux of SVB’s failure stemmed from the purchase of U.S. treasury bonds yielding around 1.8% annual interest.?On the surface, that sounds like a virtually risk-free asset deployment - as there would be few financial instruments safer than U.S. T bonds.?The U.S. Treasury have never failed to pay interest, nor ever failed to pay back the face value of a T bond at maturity.?

However, a series of events at SVB, leading to escalating customer withdrawal requirements, forced the bank to liquidate around $21 billion of these 1.8% bonds into a market that that was yielding close to 4% - resulting in loss on this transaction of close to $2B.?This compounded into a cascading effect of increasing withdrawal demands, that very quickly led to the bank’s failure – defined by it’s inability to meet customer liquidity requirements.?Unbelievably, the CEO of SVB, instead of showing confidence in his own bank, sold millions of dollars of his own stock just prior to its failure.?Adding fuel to the fire is an understatement.?

Why did the SVB failure happen??There are lots of reasons and even more speculations, but here is a primary cause upon which almost everybody agrees:

The face value of treasury bonds never changes.?If a bond is issued by the U.S. treasury for $100,000 it will return $100,000 on the appointed due date – be that one year from issuance – or 30 years from issuance.?However, especially for longer term maturities, the market value (resale on a bond exchange to a third party) of “Treasuries” can rise and fall significantly emanating from even a small change in interest rates.?For illustration here is an example: A $100,000 thirty-year bond yielding 10% per annum, would be, on the open market, worth many times the value of a $100,000 thirty-year bond yielding just 1%.?Both would return the same on maturity but on that path to maturity, the resale value will vastly differ.?

In the case of SVB, just to meet liquidity requirements it had no choice but to sell these “risk-proof” 1.8% yielding investments at a huge loss and the rest was history – and the rest was history very quickly indeed.

Would a Chief Risk Officer have identified SVB’s risk before it became unmanageable??In almost every expert’s opinion, the answer is yes.

Risk management is far more than just keeping an organisation out of trouble.?Just a few examples - It monitors adherence to financial and strategic goals.?It assures the company balances risk and reward effectively to optimise financial returns within its stated risk appetite parameters.?It can even identify that the right organisational structure is in place to meet company goals most efficiently.?

But in the case of SVB, it is a function that should have had a mechanism to identify when an asset on the books was worth far less in a potential liquidation situation than what the balance sheet says it was worth.?This “simple” identification, well in advance, could have staved off massive problems.?

Compliance, Risk and Internal Audit roles can often be left vacant as revenue generating roles are prioritized. SVB should be the case study for ensuring this does not happen again.