Brief Introduction

Silicon Valley Bank [SVB] was a state-chartered commercial bank headquartered in Santa Clara, California. It was the 16^th largest bank in the United States. 

SVB operated branches in California and Massachusetts. The bank composed the primary business of SVB Financial Group, its publicly traded bank holding company which, with other subsidiaries, operated offices in 13 additional U.S. states and over a dozen international jurisdictions.

Anatomy of Silicon Valley Bank Failure-An Insight from Risk Management Perspective

The Silicon Valley Bank [SVB] crisis is a classic case of Risk Management failure. To get a better understanding, let’s start from their balance sheet-Asset component that has been classified into two components.

1. AFS [Asset that the firm expects to transact over some time]
2. HTM [Held to maturity assets that are expected to be held for long-term investment]

HTM securities comprised mostly of U.S Treasuries and Mortgage-backed securities that constituted 75% of the investment portfolio.

Although Treasuries and MBS are safe investments from a credit risk perspective, they pose substantial interest rate risk. The weighted average duration of these investments was about 6 years, implying that if the interest rate rose by 1% or 100 basis points, the portfolio valuation would decline by 6%. 

Anticipating a much lower interest rate in the future the quest for unrealized gain was very much in focus. However, things did not turn up as per expectation and US federal reserve started hiking the interest rates [0.25-0.50 percent in March 2022 to 4.5-4.75 percent in recent times] the result which caused valuation to bleed. 

As interest rates rose quickly in 2022, they created an impact over two dimensions.

1. The valuation of the Investment portfolio declined heavily [Bond portfolio inverse relationship with the yields].
2. Impact of the interest rate hike also led to a slowdown in startup funding which impacted the deposits in a negative manner. 
   

Identifying Links – Interest rate risk creating a pathway to Liquidity crunch

In the above context, we are clear that “Interest rate risk” resulted in “Unrealized Loss” over the investment portfolio. These unrealized losses when reported under “AOCI” [Accumulated Other Comprehensive Income] impacted the non-regulatory Total common equity (TCE) ratio.

Silicon Valley Bank’s TCE ratio was greatly dented by “unrealized losses “and the bank was forced to sell “AFS” assets at a Loss, that created the ignition to withdraw deposits once the word got out. 

‘’The ignition to withdraw deposits accompanied with Impacted deposits’’ both were indirect manifestation of Interest rate risk that led the pathway to Liquidity crunch or crisis when on 9^th March,2023 the withdrawal of $42 billion was requested by the customers.

An assumption that such amount of cash withdrawal in a single day is not possible was violated, this shows the unanticipated Liquidity risk. In addition to this, the crisis was fuelled to a great extent when the interest rate risk was not even hedged properly.

Board member & Senior Management Flaw

A more interesting flaw that exaggerated the Risk Management Failure was the deficiency of Risk Insight by the senior management.

SVB was without the expertise of risk advisory for almost 8 months, as the senior most risk officer was not in the system. The changing risk dynamics was neglected and it clearly depicted no risk management framework in context to risk management hierarchy.

Only 1 board member was exposed to SVB’s risk committee. In addition to this none of the members had any exposure to senior risk management role. Without proper experience the board did not have the understanding of changing dynamics, or we may say the board members were not skilled enough to proactively manage the changing risk dynamics.

Conclusion

The Silicon Valley Bank crisis is an example that depicts the importance of Risk Management role. The crisis when seen from the risk management perspective gives an insight of how the “Combination of Interest rate risk and Liquidity risk” without efficient and proactive risk measures caused the collapse of the entire system. 

Some proactive measures that the SVB risk management department must have taken was that when 75% of investment portfolio was exposed to interest rate risk, they must have proper hedging strategy in place. Also, the monitoring of changing dynamics must have been proper from the Senior management with “few people in Senior management and Board members with expertise in Risk role should have been introduced”.