Six months on from SVB's collapse, banks must remain agile
Almost a year on from the collapse of several major banks, we still need to consider collapse contagion, writes ClearBank's chief risk and compliance officer Emma Hagan
More than six months have passed since the collapse of Silvergate Bank, Silicon Valley Bank and Signature Bank. But these were just symptoms of problems facing the banking sector that have been piling up for the last three years, mostly driven by the pandemic. Many countries are experiencing a lack of economic growth, high inflation and increasing interest rates. Many businesses are struggling, particularly SMEs. And thanks to the panic that brought down multiple banks, there is now a question mark over whether the banks that lend money are fit to safeguard it.
Following the collapse of SVB, three quarters of UK SMEs now want to spread their deposits around, so there’s a big opportunity for a different kind of bank to step up — one that doesn’t loan or invest, and instead focuses on safeguarding client funds and ensuring liquidity. In doing so, they can use the two things that broke the banking system — liquidity and credit — to help fix it.
Mitigating against economic headwinds
Banks usually collapse for two reasons: credit and liquidity. The former when they lend money they cannot recoup and insufficient liquidity, in cases of panic, when too many customers want to withdraw money from their accounts at once. Another factor to consider is trust — it should be acknowledged that bank runs are often triggered by perceived risk, rather than reality.
To mitigate against collapse (or fear of collapse), banks need to shift their business models to reduce exposure to excess credit and ensure liquidity of funds. Banks can manage credit risk through a number of strategies, such as setting high standards for lending, minimum credit scores for borrowers and effectively monitoring loan portfolios and changes in borrowers’ credit scores against current and forward-looking risks.
By focusing strategic priorities on financial resilience and the safety of customer funds instead of profit, banks not only avoid over-leveraging deposits, or the temptation to implement lower credit standards, but also ensure higher levels of liquidity, and in turn, trust.
While holding funds with a licensed bank means deposits are insured, this does not always reassure customers, perhaps because the promise of getting everything back in the future cannot be as reassuring as withdrawing funds today. By offering additional insurance, such as holding funds at the Bank of England or in other highly liquidity places, customers are reassured that their money is safe. In doing so, they also eradicate the extreme levels of fractional banking where banks have fixed-income securities with large interest rate losses that they do not hold equity for. It also limits the risk of banks taking substantial losses, more than their capital base, when conditions change, which is particularly true in uncertain times such as those we have seen in the last couple of years.
The gap between economic uncertainty and bank risk governance
Economic uncertainty and managing risk are an inherent part of the banking model as we know it. Banks have historically tried to manage risk by implementing a strong control framework to facilitate their customers’ journey, from onboarding to ongoing monitoring of their operations. As banks branch out to new products and services and scale, managing these controls becomes difficult, particularly without the right technology.
To manage risk effectively, many next-gen banking providers have developed their own banking cores, or partnered with risk management providers when they are unable to build their own. However, challenges arise for these players when compromises in the technology have been made in the rush to gain market share or to offer additional, embedded banking solutions they simply do not have the technology to support. With strong technology infrastructure in place, a good balance between product expansion, market growth and risk management is achievable.
Fail to prepare, prepare to fail
Unfortunately, it is likely that the bank collapses we saw at the beginning of the year will not be the last. However, the lessons of SVB, Silvergate and Signature may have been learned somewhat, with a shift in focus for banks and also a turning point in consumer awareness and diligence, akin to what we saw post the last financial crisis. Many banks have spent the last six months reviewing their risk governance model, re-focusing their growth activities and evaluating customer and prospect relationships. But this is just the beginning and the lessons need to stick to avoid another round of what we’ve seen recently.
Consumers, startups, digital asset companies and established financial service institutions alike will remain cautious in the near future, and look to differentiate their deposit accounts. The banks that can provide security for their clients — and make their customers feel secure — will continue to benefit from the inflow of deposits from those unsettled by recent events. Perhaps it’s time for a new type of bank.