Compliance expert and former head of compliance,Sylvia Yarbough, shares secrets and insights from the compliance team.
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I know all compliance and risk professionals have been watching the recent banking crisis unfold over the last few months. Those of us who have been here awhile are really scratching our heads wondering how we ended up here AGAIN. There are many articles in the media about recent banking problems, some more accurate than others. We industry veterans have had many discussions about this with our peers, so I thought I'd take a moment to summarize my assessment and opinion of the situation.
Summary of "March Madness"
We were all so focused on Silicon Valley Bank (SVB) that some of us may have missed other troubled banks:
On March 1, Silvergate Bank, headquartered in San Diego, California (California), with assets worth 11.36 billion (2022), announced that it will enter into voluntary liquidation. The company primarily caters to cryptocurrency users, and with falling cryptocurrency prices and the so-calledFTX Bankruptcy, a Bahamas-based cryptocurrency exchange, Silvergate has reported a 32% drop in deposits and heavy losses in its loan book.
On March 10, SVB staged a bank run that led to its forced takeover by federal regulators. SVB, formerly based in Santa Clara, California, with $209 billion in assets (2022), business model focused on the venture capital market. SVB was acquired by First Citizens Bank, headquartered in Raleigh, North Carolina (NC), with $109 billion in assets (2022).
On March 12, Signature Bank, based in New York, New York (NY), with $110.4 billion in assets, was forced to close its doors by New York banking regulators. Signature is involved in the cryptocurrency industry, with the cryptocurrency business accounting for around a third of its deposits. Its clients have withdrawn about $10 billion in escrow balances. Additionally, the Department of Justice was investigating the lack of proactive monitoring of money laundering transactions. It is in liquidation with the FDIC and is being acquired by New York Community Bancorp.
On March 16, First Republic, headquartered in San Francisco, Calif., with $212.6 billion in assets (2022), received $30 billion from eleven of the largest U.S. banks to stabilize the bank due to a deposit not liquidated. First Republic's business is commercial banking and wealth management services, with a focus on wealthy individuals.
It really was a very busy March. However, the question we all have to ask is, how did we not notice this and how many other banks could have similar problems? My colleagues and I discuss these questions in Banking 101 lessons, which include:
Banco 101
liquidity management
Yes, the good old liquidity management would be overseen by the Assets and Liabilities Committee (ALCO). Simply put, the maturity and returns on the bank's assets must match the bank's liabilities. With 15 years of low interest rates and market volatility in 2022, most banks have relied more heavily on mortgage-backed securities, treasury bonds/bills - which would normally be considered lower risk with a good return, although most which are very long periods. However, when added to an overall investment strategy to increase liquid (short-term) balance sheet deposits, the level of risk increases. The Fed's rate hikes each quarter resulted in significant unrealized losses on some banks' balance sheets. Those that are not sufficiently capitalized, like our 'March Madness' banks, may survive the hit. A traditional bank's investment portfolio is much more diversified between long-term and short-term investment assets, in addition to a solid loan portfolio.
diversification strategy
As with all businesses, banks need to look at their diversification strategy. In the case of March Madness Banks. We all see a common theme. These banks had concentration risk in one type of industry or business model. To make matters worse, these were all high end industries such as crypto or venture capital, or high net worth clients, unlike traditional banks which typically include a range of industries and client bases.
capital management
For nearly 15 years after the global economic crisis, banks should have been forced to provide adequate recapitalization under various stress scenarios – including interest rate shocks. Yes, we all know that mid-sized banks were no longer required to participate in the regulatory requirement in 2018. However, if we've learned anything from 2008, it would be good business practice to model these scenarios and see how an organization might handle a growing risk environment. At least most banks may have started looking into this when the Federal Reserve started raising interest rates to fight inflation. Where were the risk management teams? SVB didn't even have a chief risk officer for a year before it collapsed.
executive leadership
The creation and development of these "boutique" banks started in 2010. Most of these banks are playing in the hottest market at the time. They often have executives who are early in their careers or have been promoted within the same bank, so they may not have learned some of the lessons of traditional banking. It can be said that he held a top management or executive position during several crises in the banking sector. In the case of the former chairman of SVB, he rose through the ranks of SVB and became CEO in 2011, in a period of recovery emerging from the 'Great Recession'.
Management
The board of directors of these new institutions usually comes from or has ties to the sector that is the bank's primary focus. In the traditional banking model, you will find a Board of Directors with different backgrounds that bring a certain breadth to the understanding of various topics, including risk management. In the case of SVB, only one director had experience in direct investment banking.
consumer loyalty
Traditional banks are still hard at work on branding and customer loyalty. Some would say that such a thing is no longer real. However, companies, including banks, still spend a lot of their marketing money on the concept. The premise of most of these "boutique" banks is to offer unique services that will build long-term customer relationships. The reality we saw turns out to be completely different. Depositors in each of these banking scenarios were not loyal. It's private equity firms, tech companies, and crypto companies that are trying to grow and can't make a single mistake, including a banking partner that isn't fully operational. They will quickly move your funds to avoid a business disaster,
Where are the regulators?
It looks like our friendly regulators are struggling too. Most of those who survived the dark days of Dodd-Frank may have retired and/or been asked to step away from such aggressive regulation. However, 2023 should be a wake-up call – those who forget the past are doomed to repeat it. Yes, it's a different flavor of the banking crisis. Some banks operate in spaces where regulators are still struggling to understand risk and therefore cannot comment on expectations. Some regulators feel they lack the authority to push hard where they see problems. All regulatory agencies need to organize the club and figure out how they need to adapt to a more flexible structure.
It's not about the last law passed that needs to be fulfilled. In the beginning I was involved in the Comprehensive Capital Analysis and Review (CCAR) and it was the most awful process. It was more like an exercise to do than a tool to use. Regulators need to turn these rules into tools, not obstacles, that banks can use to understand potential risks and develop contingency plans to address them. If done well, all banks would be ready for an environment of rapidly rising interest rates. This was one of the most common economic scenarios years ago. However, banks had to complete, submit, approve and file.
Regulators need to learn more about the changing industries in which these 'boutique' banks operate. Venture capital banks, technology, crypto, etc. are building entire business models in these industries and most regulators have very little knowledge of these industries and the potential risks. If we had another recession, there's a good chance the SVB would have collapsed anyway, as the venture capital market has slowed down or completely dried up, so regulators should have been on their radar for some time.
Another problem is the practice of regulators to employ a bank chairman active on the Federal Reserve Regional Board, as in the case of the former chairman of the SVB. Becker was a Class A director on the board of the Federal Reserve Bank of San Francisco from 2019 to March 2023. There are advantages to having CEOs active on these regulatory boards. But how many would say now that his role on the board helped mitigate red flags from regulators? Regulators tend to frown on any perception of impropriety or nepotism in the financial services industry. This might be an opportunity to look into this practice.
Outdated FDIC Insurance Program
When it comes to FDIC insurance, over the past 15 years with extremely low interest rates and up until 2022 during the stock market boom, the consumer had more money to invest and save. It's true that $250,000, the FDIC insurance limit, covers the average consumer. However, in each bank's regulatory filing, deposits covered and not covered by FDIC insurance are reported. Banks are required to provide this information, so who on the regulatory side pays attention to it, especially as the growing banking population has an extremely disproportionate ratio of uninsured deposits to insured deposits.
Consumers don't want to lose their money, so when they have the slightest inkling that something might be in their bank, they rush to move the funds, resulting in a bank run. These current bank runs are caused by the same concerns that occurred in 2008 and 1929 on Black Monday that led to the founding of the FDIC. It doesn't take another banking crisis to go back and look at the FDIC model and set additional parameters, which could include more proactively notifying customers about the risk of their deposits, raising deposit insurance limits or imposing a cap on individual deposits held. in a bank. Not sure of the answer, but we all know that after 50 years, the FDIC program needs to be reexamined in current and future scenarios proactively, not reactively.
In today's rapidly changing media consumption environment, everything is interesting today and gone tomorrow. I sometimes wonder if the media reports problems or creates them. It is often difficult to say. If SVB could quietly raise capital, it might not be a mid-month headline. However, these days, companies cannot quietly do anything without leaking it to the media. If banks are questioning their investment in public relations, I would strongly suggest they double down on - I hate to say this - good Spin Doctors. Often, a lack of public understanding of the complexities of running a bank and the regulatory underpinnings that underpin it can lead to bank failure or bankruptcy. The media simplifies things down to a line or two that a less experienced audience doesn't understand, and the result is panic.
Would SVB, given the opportunity, consider discreetly contacting regulators before this situation becomes public? As in the First Republic, they may have gotten some of the biggest banks to bail them out or bring about their own liquidation, like Silvergate. We have no influence in the media. However, some level of control over the message and how the issue is addressed and communicated to the media would have less of an impact. Some "too big to fail" survived 2008 solely because of their ability to manage rotation.
In short, there are many more banks at tipping point based on the next interest rate announcement. My overall hope is that your internal risk management and executive leadership are working with regulators and looking more closely at strengthening your balance sheets. If a rise in interest rates isn't enough of a problem for the bank's balance sheet, what if we go into a full-blown recession? In fact, too-big-to-fail banks cover it. They were forced to surrender. However, they are among the top 8 of the approximately 4,200 FDIC-insured commercial banks in the United States.
*Note for non-college basketball fans, March Madness refers to NCAA basketball tournaments starting in March.