Regulators of Financial Institutions Must Be More Responsive to Risk and Agile – to Prevent Future Bank Failures like Silicon Valley Bank and Signature Bank
By Shane Rogers FCA, MBA.
The title of this article is perhaps a bit provocative. Hopefully my regulatory friends do not bayonet me just yet. Let me say I am a big fan of financial markets regulation. Throughout my career in Banking and Insurance sectors globally, I have dealt with many financial markets regulatory agencies around the world. Regulatory agencies have many good and knowledgeable staff who are tough. Very tough. Regulatory toughness across financial markets builds resilience and confidence in terms of achieving standards, promoting good organizational behaviors and outcomes for clients and retail consumers. Good and tough regulation should be applauded. But are regulators agile enough? Are regulators flexing their muscles to get involved early to avoid disaster? Are they moving at the speed of digital business in 2023? Is a big stick or a sharp scalpel the right tool for regulatory action in 2023?
Boom to Bust in a Week
My point in this article is whether Financial Market regulators should be more proactive in using their powers and mandates to intervene in a financial institution, well before a crisis occurs. SVB is a case in point. While it is likely poor risk management practices were smoldering for quite some time, the bank ultimately went from boom to bust in less than a week. With the benefit of hindsight, it might be referred to as a bank with a different 3 Letter acronym, starting with W and ending with F, by some market observers. Despite heightened bank regulation post the global financial crisis, the regulators are clearly left with egg on their faces, that is unfortunate and the regulators themselves have a lot of explaining to do. It is hard to gloss over the contributing factors to the collapse of SVB: excessive government spending in recent years resulting in high inflation, needing interest rates to rise sharply to quell inflation but causing havoc with bank balance sheets and funding models. So, are the government and the regulators the heroes? Or the villains?
As a highly regulated financial institution SVB’s business mix, deposits, loans, capital structure and capital buffers etc. would have been reported to and discussed with the regulators routinely. Unless there was misreporting to the regulator, the regulators would have unfettered access to any aspect of SVBs operations and financial reporting they wanted. Further, the regulators would be able to peer review financial institutions such as SVB to sense check size, risk exposures, key financial and liquidity ratios etc. Post the great Financial Crisis, many large banks including SVB and Signature had on-site regulatory oversight which means that there were regulatory teams embedded in the organization and working alongside Management, Risk Management, Compliance, and Internal Audit to understand strategy, financial soundness, risk tolerances and internal controls adequacy. So, with all these regulatory boots on the ground (or as real -time virtual presence during the Covid pandemic) how could SVB and Signature bank still fail so spectacularly? What happened? As investigations take place in coming weeks and months there will be plenty of finger-pointing across the 3 Lines of Defense for the root causes of the bank’s demise, primarily at executive management level – CEO, CFO, CRO and Treasurer, the Board of Directors; and secondarily on the role of the Auditors – both Internal and External. Potential gaps or failures in regulatory oversight effectiveness should also be included in this list, for completeness.
The Need for Regulators to Be Open, Honest and Candid about their Operating Models
Let’s be candid, getting to the point where the Regulatory intervention strategy is to shut a bank down and pull the shutters down is not effective regulation and begs the question what could have been done earlier to avoid such an extreme outcome. This outcome is a disaster for the bank, its customers, its employees and the communities / business sectors that they serve. It also sends shock waves out across the entire financial system. I would love to see regulatory agencies getting to the management and board table much more quickly – perhaps using temporary administration to step in decisively to correct a deteriorating situation. With SVB and other bank failures, it will be interesting to understand the root causes of the failures particularly management and Board Member behaviors and their risk culture. The ability to prevent ‘a digital run’ on a bank also needs to be explored in terms of reaction times, strategy, regulatory and communication tools etc.
To get to this point, a lot of water must have passed under the bridge. Just like individual banks and insurers, regulators need to have well established and scrutinized key risk scenarios. Where were The Federal Reserve and the State Banking regulators 12 – 18 months ago when it was obvious that interest rates would rise dramatically to quell inflation? Surely, they must have expected such a rapid rise in interest rates to impact Bank’s liquidity and capital strength as rising interest rates savaged the value of banks’ holding of US government bonds. It was an Asset and Liability Matching (ALM) tsunami, visible for well over a year in the making. I ask myself if regulatory agencies are agile enough? Are they being sufficiently paranoid about the emerging risks and key risk scenarios across their banking and insurance portfolios? Are they proactively getting out in front of these risks with those financial institutions that are showing up on top of the “at risk” list. It may well be time for regulators to adopt different operational models themselves. Some overseas regulators use third party accounting and consulting firms to perform on-site reviews on their behalf – quickly (e.g., UK Section 166 reviews) and perhaps this could be a more agile and risk responsive model allowing for earlier regulatory intervention at times. Time will tell if this practice gains traction.
We should all be supportive of our regulators. You must be tough to be a regulator and it is a necessary cost of doing business and maintaining confidence and order in our financial markets. Many lessons will be learned from SVBs and Signature bank’s rapid demise in the past week or so. The primary starting point for those failures should be the Executive Management team, the Board of Directors, and the Risk Culture of each institution. Further, among the lessons to be learned should be some open, honest, and candid reflection on the regulatory agencies themselves. There are opportunities for self-reflection to drive more timely risk responsiveness and regulatory remediation. The regulatory big stick which we are all well used to, should at times result in earlier, direct action at “at risk” institutions. This includes addressing failures in executive leadership and risk culture at regulated institutions much earlier. Selection of Board members and executive management should receive much greater scrutiny from regulators. Banks and financial institutions cannot afford to have friends, politicians, or old school chums on the board of directors; independent board directors must be suitably qualified and provide top quality advice and show up to do the hard work required to steer a financial institution. Financial institutions need to operate in an open, honest, and candid way – all the time. Earlier regulatory intervention should be encouraged to protect depositors, investors, employees, and the public trust in financial institutions. Lets hope for some transparency on the lessons learnt from these recent bank failures within the regulatory community.
© Copyright 2023 – Shane Rogers FCA, MBA, all rights reserved.