Despite being a major lender in the tech industry for decades, Silicon Valley Bank’s (SVB) risky investments and lack of proper risk management protocols led to its downfall. Yes, government policies were not favorable to banks as the Federal Reserve raised the interest rate to 4.75% over the past 12 months. But according to analysts, the implementation of a robust internal risk management program that is not just a formality could have prevented the SVB insolvency.
SVB’s depositors were at significant risk, as only a small portion, less than 5%, of the bank’s deposits were covered by the FDIC insurance policy. For several months, the warning signs of interest rates increasing had been ignored by investors. So, shortly after declaring the need to raise $2.25 billion, the bank encountered the largest bank run in the history of the US. In a single day, investors and depositors pulled out $42 billion from the bank, which was almost a quarter of the bank’s total deposits. As such, The California Department of Financial Protection and Innovation closed the SVB on Friday, 10 March 2023, and allowed FDIC to take over.
From our analysis, this catastrophic failure underscores the importance of effective risk management practices and the need for a strong risk culture in the banking industry at all times. Without a proper risk assessment, monitoring, and mitigation measures, banks are vulnerable to unexpected losses and insolvency.
The Danger Of Inadequate Risk Management Expertise On Bank Boards
Banks have historically prioritized financial performance over risk management, leading to a lack of emphasis on risk governance at the board level. But today, It’s become a common notion that managing risks in banks should be board-level responsibility. Nonetheless, the lack of risk management expertise is pervasive in banking. Without adequate risk expertise on bank boards, institutions may be ill-equipped to navigate complex risk landscapes and make informed risk-related decisions.
An analysis of SVB’s Risk Committee by Clifford Rossi, a risk management expert, revealed that of the seven board members assigned to this committee, only one had any background remotely related to risk management. In fact, SVB operated without a Chief Risk Officer for eight months in 2022. This lack of expertise is alarming, particularly given the nature of SVB’s business, which primarily serves the technology and innovation sectors.
To mitigate the risks associated with a lack of expertise, banks can take several steps. For example, they can recruit board members with the necessary risk management expertise, provide ongoing training and education to existing members, or partner with a great internal audit firm to oversee the bank’s risk management function.
Closing the risk expertise gap in bank boards is a long-term process that requires a strategic approach. If there is a lack of necessary risk management expertise among the board of directors, banks can establish a separate risk advisory board made up of industry experts with specialized knowledge in risk management. This advisory board can provide guidance and recommendations to the board of directors on risk management strategies and emerging risks.
Managing Concentration Risk
SVB invested heavily in longer-term bonds that were highly sensitive to changes in interest rates. This created a concentration risk in the bank’s investment portfolio. When interest rates rose sharply, the value of these bonds dropped significantly, causing substantial losses for the bank and a subsequent bank run.
This serves as a stark reminder of the importance of managing concentration risk through diversification and risk management strategies. Proper management of concentration risk can help to protect investments and ensure long-term financial stability. Failure to do so can lead to disastrous consequences.
The Power of Objectivity and Independence in Mitigating Risks: Why You Need an Internal Audit Firm that Values Them
Just 14 days after KPMG LLP provided a favorable audit report, Silicon Valley Bank experienced a collapse. This audit firm has been with SVB for over 28 years, including the glorious days. What could have gone wrong? There could have been unforeseen factors that led to the bank’s financial difficulties or weaknesses in the bank’s risk management processes that were not identified during the audit.
However, this situation emphasizes the need for ongoing review and evaluation of internal controls and risk management programs, even when an audit provides positive results. It also spotlights the importance of partnering with an audit firm that provides an independent and objective perspective on a financial institution’s operations in order to identify risks and control weaknesses. This objectivity is important in ensuring that the audit process is free from bias or undue influence.
How RADD LLC Can Help Financial Institutions to Build A Robust Risk Management Programs
The financial industry is full of uncertainties. That means you have to navigate it with all eyes open and get support from experts. Let RADD LLC guide you in building a risk management program that fits your unique needs and goals. With our help, you can proactively manage risks and protect your institution from potential harm.
At RADD LLC, we recognize the challenges facing internal auditing teams. Unfortunately, many institutions are facing budget constraints and are being forced to make difficult decisions, including staff reductions. We also understand the importance of objectivity and independence, and we will work closely with your team to ensure that our recommendations are unbiased and in line with industry best practices. Talk to us today.