Topics: Risk Management,Strategy
Topics: Risk Management,Strategy
April 18, 2023
April 18, 2023
One of the earliest lessons my father taught me was that a smart man learns from his own mistakes, a wise man learns from the mistakes of others, and a fool never learns. In pursuit of wisdom, we can gain valuable insights and lessons from corporate governance and risk management failures.
As a former chief risk officer (CRO) and early advocate of enterprise risk management (ERM) who has served on public and private company boards, I am disappointed and saddened by what happened at Silicon Valley Bank (SVB). The collapse of SVB wiped out more than $40 billion in shareholder value, disrupted the venture capital and banking industries, and forced unprecedented government and private sector interventions. The underlying problems and sequence of events that led to SVB’s collapse have been well documented in the press.
What can we learn from the SVB failure? For banks and non-banks alike, there are key takeaways and questions for the full board and for each committee.
SVB’s business model was singularly focused on the venture capital community, providing banking services to technology companies, their investors, and their employees. While this focus represented a competitive advantage—half of all US venture capital-backed start-ups were customers—it also created strategic risk concentrations (e.g., deposit concentration) that seeded SVB’s downfall.
The board of directors is ultimately responsible for the overall performance and risk management of a company. Key takeaways and questions for the full board include the following:
SVB’s high risk profile was hidden in plain sight. In addition to strategic risk concentrations, the bank’s financial risk exposures were clear. For example, at the end of 2021 SVB’s 10-K report showed that for a 200-basis-point rise in rates, the bank would suffer a $5.7 billion decline in the economic value of equity. When the US Federal Reserve increased rates by 425 basis points in 2022, SVB’s economic losses wiped out its $15 billion in tangible equity.
The risk committee is responsible for providing oversight of ERM. Key takeaways and questions for the risk committee include the following:
(Of note: The 2022 NACD Public Company Board Practices and Oversight Survey found that nearly 24 percent of companies had a permanent risk committee. This was up from 16 percent in a similar survey three years earlier.)
As a public company, SVB had an obligation to provide risk disclosures. For interest rate risk, the key section is Item 7A in the annual 10-K report, which provides information on how rate changes would impact net interest income and economic value of equity. In SVB’s 2021 10-K report, Item 7A showed that rising rates would benefit earnings but damage equity (i.e., short-term gain, long-term pain). Astonishingly, in the 2022 10-K report the bank only showed that rising rates would benefit earnings. The quantitative analysis of how rates would impact equity was omitted.
The audit committee is responsible for providing oversight of financial statements, internal controls, and risk disclosures. Key takeaways and questions for the audit committee include the following:
The SVB board had six committees, but its risk committee was the only one without a chair in 2022. Moreover, none of the risk committee members had direct risk management experience. (This is the same criticism of JP Morgan Chase & Co. with the London Whale incident.) Banks with more than $50 billion in total assets are required by regulators to have a CRO that reports to the board risk committee. SVB had more than $200 billion in assets. But this governance structure doesn’t work without effective leaders at the board and executive levels.
The governance committee is responsible for overseeing corporate governance practices and ensuring that qualified directors serve on the board and its committees. Key takeaways and questions for the governance committee include the following:
Inexplicably, SVB decided to accept bet-the-bank financial risks to earn an extra half of a percent in investment yield. They invested in long-term treasuries and mortgage-backed securities to boost earnings, but that created a significant duration and liquidity mismatch with the bank’s deposits.
The compensation committee is responsible for overseeing executive compensation, human capital management, and succession planning. Key takeaways and questions for the compensation committee include the following:
The SVB failure is a disaster that could have been avoided. We will get more information as the investigations unfold. However, we already know enough to derive important lessons and ask critical questions on board risk oversight.
James C. Lam, NACD.DC, is president of James Lam & Associates, a risk management consulting firm; a board director; and an NACD Directorship 100 honoree.
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