Sunday, 19 March 2023

Credit Suisse –A series of Stumbles and Tumbles now threatening its existence


VIEWS EXPRESSED ARE PERSONAL


CREDIT SUISSE (CS) - A Global Financial Leader

Credit Suisse Group is a global financial services company with a history of over 160 years and a presence in more than 50 countries. CS is a global wealth manager, investment bank and financial services firm founded and based in Switzerland, growing to be large investment bank and wealth manager for the ultra-rich.

 

What happened last week?

On Tuesday, 14 March, Credit Suisse said in its 2022 annual report the bank has identified “material weaknesses” in internal controls over financial reporting and not yet stemmed customer outflows.

The reporting of material weaknesses came even as Credit Suisse was seeking to recover from a string of scandals that have undermined the confidence of investors and its clients. Customer outflows in the fourth quarter rose to more than 110 billion Swiss francs ($120 billion).

A week before this revelation Harris Group, one of CS’s major and long-standing shareholders, sold all its stake in CS, creating nervousness amongst investors.

 


Harris Group's CIO for International equities, David Herro, said this in a Financial Times interview:

“It has been a measurable drag on our performance... We meet every company we own, but you spend a lot more time with your problem children. Credit Suisse has been a drain of time and value for years.”

According to CS’s filings, depositor outflows have been much more severe than anyone may have realised. CS's most recent annual report shows how the bank lost a staggering $120 billion of client funds in just the last quarter of 2022.

Reuters reported that Swiss regulator FINMA is investigating comments made by Lehmann at a December 1st conference, in which he claimed that outflows had "completely flattened out" and "partially reversed."  This contradicted with CS’s regulatory filings, which showed a deluge of outflows even as the Chairman made those statements.

Bank run on CS seemed to be a top concern for Harris Group.  It is reported that CS is now offering aggressively higher deposit rates to attract new funds from wealthy clients to reverse the tide. Obviously, this comes at a higher cost denting its profitability and threatening the viability of its business model going forward.

Meanwhile the strategic investor, Saudi National Bank (SNB), expressed that it will not be able to provide further capital support due to regulatory constraints.

Over the past couple of years, CS's stock price has continued to slide due to its brush with one scandal after another.

 

But what ails Credit Suisse?

At the heart of CS’s woes is its “POOR RISK CULTURE” and this emanates right from the top.    The risk ethos was lamentable judging by CS's CEO and Chairman's conduct. CS’s CEO (Tidjan Thiam) was forced to resign following a corporate surveillance scandal in March 2020 and its Chairman (Antononio Horta-Osario) was forced to resign in January 2022 following breach of Covid 19 protocol on several occasions. 

CS has been stumbling from one scandal to another that illustrates its weak risk culture, poor risk management and an inadequate compliance framework.

Listed below are CS’s major scandals which reflect its poor risk culture and weak risk management and a monumental failure of all the three lines of defences.



The timeline of its repeated risk management failures demonstrates its poor Risk ethos and lackadaisical approach to Risk management.  The following is a brief summary of their blunders:


1.      Return of stashed money of Ferdinand Marcos – In 1995, CS was among the Swiss banks ordered to return nearly half a billion dollars stored in the accounts of Philippines ex- President Ferdinand Marcos, funds which the Philippines said was “plundered from the national treasury”, reported the AP at that time.  It was later revealed that Credit Suisse opened accounts for the dictator and his wife under the names “William Saunders” and “Jane Ryan”, which helped to “shield their funds from scrutiny”, said The Guardian.

 

2.      Sanctions breachesIn 2009, CS was fined $536m for violating US sanctions against Iran and several other countries, including Libya, Sudan, Myanmar and Cuba, between 1995 and 2007. 


3.      Corporate Surveillance Scandal - CS’s former chief executive Tidjane Thiam was forced to leave the bank in March 2020 after an investigation found that it had spied on two of its employees.  The bank hired private detectives to follow Iqbal Khan, its former head of wealth management who was leaving to join its arch-rival UBS, and on Peter Goerke, its former head of human resources. The private investigator hired for surveillance of the head of wealth management committed suicide.


      CS repeatedly played down the spying allegations but in October last year the Swiss Financial market Supervisory Authority (FINMA) said that the bank had planned spying operations on seven occasions between 2016 and 2019; and carried out most of them. 

 4.      Archegos Hedge Fund default - The bank lost $5.5bn when Archegos Capital Management         collapsed in early 2021. The US hedge fund of Bill Hwang had placed highly leveraged bets on             certain technology stocks that backfired and the value of its portfolio with Credit Suisse plunged             leading to margin shortfalls and credit losses.

An independent report found that its losses were the result of “a fundamental failure of risk management and control at its investment bank, and its prime brokerage division.

5.      Greensill Capital collapse - The bank was forced to suspend $10bn of investor funds in March 2021 when the British supply-chain lender Greensill Capital collapsed.

Credit Suisse had “sold billions of dollars of Greensill’s debt to investors, assuring them in marketing material that the high-yield notes were low risk because the underlying credit exposure was fully insured”, said Reuters.  Several investors have sued the bank over the Greensill-linked funds, with the bank still in the process of trying to claw back money for clients. 

The bank said in September last year that it had returned about $6.3bn to investors, but has warned it may not be able to recover another $2.3bn of losses.

 

6.      Tuna Bond Scandal - CS was fined nearly $400m by global regulators in October 2021 after pleading guilty in a long-running scandal that pushed Mozambique into a financial crisis.  The Tuna bonds scandal resulted from Loans arranged by CS between 2012 and 2016 for the Republic of Mozambique to the tune of $1.3bn.  This was aimed at government-sponsored investment schemes including maritime security projects and a state tuna fishery.

But a portion of the funds were unaccounted, and one of Republic of Mozambique’s contractors was later found to have covertly arranged kickbacks worth at least $137m, including $50m for bankers at Credit Suisse meant to secure more favourable deals on the loans, regulators found.   The international scam resulted in the International Monetary Fund (IMF) to suspend its assistance to Mozambique, ultimately causing a financial crisis in the country.

7.      Chairman breaches Covid-19 rules - Antonio Horta-Osorio resigned as Credit Suisse chairman on 17 January 2022 after repeated breaches of Covid-19 quarantine rules, less than a year after taking up the role. 

An investigation by the bank’s board found that Horta-Osorio, had broken quarantine rules several times, “including on a trip to London last year to watch the Wimbledon tennis finals”, reported the Financial Times.

Credit Suisse immediately appointed board member Axel Lehmann as its Chairman, who had been “at the helm for only five weeks” before the massive data leak, said The Guardian.

 

8.     Data leak – February 2022 - CS has been known to have more than 18,000 accounts for an extensive list of clients involved in torture, drug trafficking, human rights abuses and other serious crimes.  The accounts hold more than 100bn Swiss francs, reported The Guardian based on a data leak. The leaks point to “widespread failures of due diligence by Credit Suisse, despite repeated pledges over decades to weed out dubious clients and illicit funds”, said the paper, which was part of a consortium of 48 media outlets given exclusive access to the data.

CS either opened or maintained bank accounts for an range of high-risk clients including “a human trafficker in the Philippines, a Hong Kong stock exchange executive who looted Venezuela’s state oil company, as well as corrupt politicians from Egypt to Ukraine”, said The Guardian.  The information was initially leaked to German newspaper Suddeutsche Zeitung by an anonymous whistleblower, who said Swiss banking laws were “immoral”. 

CS’s attempted to bolster its reputation by wooing new institutional anchor investor and strengthen its capital position.

 

In October 2021, Saudi National Bank made an equity investment of $1.5bn for a 9.9% stake in CS.  The capital ratios appear strong, though the haemorrhaging of its client deposits is its principal cause for worry. Despite continuing to lose its customer deposits, it maintained satisfactory liquidity ratios, and it carried low interest rate risk.



But the elephant in the room was the loss of stakeholder trust and confidence.  And that cannot be fixed overnight with a capital infusion when its culture is steeped in poor risk practices.

 

Is CS's business model broken?

CS’s declared its largest ever loss in 2022 (since 2008), as its business was severely affected by significant deposit and net asset outflows in the fourth quarter of 2022 (it reported a deposit outflow of $120bn).  Net revenues for 2022 decreased by 34% year on year, driven by declines across all divisions.


The net loss attributable to shareholders for 2022 was CHF 7.3 billion, compared to a net loss attributable to shareholders of CHF 1.7 billion in 2021. The net loss attributable to shareholders for 2022 included an impairment of deferred tax assets related to comprehensive strategic review of CHF 3.7 billion taken in the third quarter of the year.

All the divisions, except for the Swiss Bank, reflect poor profitability bringing into question the viability of its business model.


The Balance Sheet shows a decline of CHF 225bn in its total liabilities, confirming a massive decline in its customer deposits of CHF 155bn in 2022.



 As CS continues to raise new deposits to stem the deposit outflow at substantially higher interest rates, its profitability is likely to diminish further.  The future of CS was hinging on the Restructuring Plan of Ulrich Korner that he unveiled last year. But the events of last week will make it difficult to see through.

 

Strategic Review - Restructuring Plan

Ulrich Korner’s three-year recovery plan involves 9,000 job cuts, dismantling the investment bank (Credit Suisse First Boston) assembled over five decades and returning Credit Suisse to its origins as banker to the world’s ultra-wealthy. That entails spinning off CSFB, an American investment bank it acquired in 1990 with a view to listing it in 2025, and selling parts of its securitised products group unit to Apollo Global Management, which it has confirmed that in an advanced stage of execution.

The CEO is seeking to protect the best-performing investment bank parts, such as advising on mergers and acquisitions, while pivoting the parent company further toward wealth management.

 

However, all of this may not come to pass!

On March 9, the US Securities and Exchange Commission queried the bank’s annual report, forcing it to delay its publication. On Tuesday, 14 March, Credit Suisse said in its 2022 annual report the bank has identified material weaknesses in internal controls over financial reporting and not yet stemmed customer outflows.  The bank also said customer outflows had stabilised but “had not yet reversed”.

Meanwhile, panic in the US market spread following the collapse of Silicon Valley Bank, Signature Bank and Silvergate Bank.  The contagion spread to other regional US Banks as stocks of these banks lost between 35% to 80%, and there was significant deposit flight from these regional banks to larger US Banks.

Amid all this turmoil, CS’s shares drop by as much as 30% after its largest shareholder Saudi National Bank said it could not provide more support because of regulatory constraints. Several Banks started to cut their counterparty limits to CS.  The cost of insuring CS’s bonds against default for one year surged to 836bps, a level not seen for major international banks since the financial crisis of 2008.


This prompted Credit Suisse to ask the Swiss central bank for a public statement of support. Swiss National Bank issued a statement that it was prepared to provide liquidity if needed. Credit Suisse secured a $54 billion lifeline from the Swiss central bank to shore up liquidity, the first major global bank to get emergency funding since the 2008 financial crisis.  




The Swiss authorities provide assurances that Credit Suisse has met “the capital and liquidity requirements imposed on systemically important banks”.

CS has substantial liquid assets to call upon and access to central bank lending facilities, and is less sensitive than many rivals to sharp moves in interest rates. However, CS's business model is fundamentally broken following a series of scandals severely denting its reputation, one that would make it hard for it regain the trust of its investors and customers.

A disorderly failure of CS would cause a crisis similar to that experienced in 2008, a situation all Central Bankers wish to avoid.  Swiss National Bank will be at the forefront to prevent such a crisis.

There is a growing speculation that UBS, its rival, in advanced stages to acquire part or whole of Credit Suisse.  


A 160+ years of CS’s Banking history is likely to come to an end.


VIEWS EXPRESSED ARE PERSONAL

 

Sunday, 12 March 2023

The Sudden Demise of Silicon Valley Bank


VIEWS EXPRESSED IN THIS ARTICLE ARE PERSONAL

Silicon Valley Bank (SVB) was established in 1983, in Santa Clara - California, to provide banking services to the mushrooming technology ecosystem that was taking hold in the Silicon Valley. SVB became one of the several new banks launched in California that year.

SVB offered technology companies a range of banking products and sevices: deposit services, loans, investment products, cash management, commercial finance and fiduciary services. Because tech start-ups tend to have more cash in the beginning, and most of the SVB’s income was traditionally made on the deposit side of the business, as a good portion of these deposits were non-interest bearing.  Driven by a boom in venture capital funding, many of Silicon Valley’s customers became flush with cash over 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the bank’s deposit balances than tripled to $175 billion (aided by a small acquisition of Boston Private Financial Holdings).

 


By 2022, SVB the 16th largest bank in the US and to give a comparison, the deposits of SVB were of similar magnitude to that of HDFC Bank in India!  SVB was also rated a buy by many equity analysts until a few weeks back and was also listed in America’s best banks list by Forbes for 5 years in a row.



On Wednesday, 8th March 2023, SVB announced a share sale of $2.25bn ($1.25bn to public, $500m of private placement and $500m of Mandatory convertible preferred stock) to shore up its capital.

SVB said that due to the restructuring of the Balance Sheet it sold its AFS securities portfolio of $21bn to raise cash and to reposition its asset sensitivity to interest rates.  This resulted in a realised a loss of $1.8bn due to the sale of its securities and it was seeking to bolster its capital position and improve its asset-sensitivity to rates.

The timing of the stock offer coming on the heels of the collapse of another Californian Bank (Silvergate Bank - that serviced cryptocurrency users), meant that the news of SVB’s stock offering was received with apprehension and, its stock price plummeted at open on Thursday, dropping from $268 to $176.  By market close on Thursday, the stock fell further to close at $106, recording a whopping 60% drop within the day! 

On Friday, 10th March 2023, trading in SVB stock was halted as it lost more than 60% of its value. Before the end of the day, the California Department of Financial Protection and Innovation closed SVB and named the FDIC as the receiver. The FDIC in turn has created the Deposit Insurance National Bank of Santa Clara, which now holds the insured deposits from SVB.   FDIC deposit insurance covers up to $250,000 per account but the average balance of SVB customers were ~$4million.  So, based on high level estimates, FDIC insurance would cover less than 10% of the insured customer deposits. It remains to be seen how the issue of unsecured depositor payout is resolved.

Within a couple of days, SVB’s market capitalisation of ¬$16bn was totally wiped out, as if it was struck by a lightning!  And a total of $100bn was wiped out from market capitalisation of the banking sector due to fear of contagion.

What were the key issues?


Its normal for Banks to engage in maturity transformation to make a spread by borrowing short term and lending long term, with established limits for such asset-liability mismatches. 

Asset Liability Management (ALM) entails managing mainly these types of risks amongst others:

·       Liquidity risk

·       Funding risks arising from refinancing risk, funding concentration etc.

·       Interest rate risk in the Banking Book (Trading Book managed with VaR limits) while IRRBB is managed with Earnings-at-risk (EAR) measured as a % of Net interest income over 12 months and change in Economic Value of Equity (EVE) measured as NPV of future cash flows with limit for delta.

·       Capital ratios and other related risks e.g., leverage

 

Robust ALM policies ensure mitigation of the above risks, and these are typically mitigated by a multitude of ALM strategies with an appropriate risk appetite thresholds and early warning indicators for each of these risks.

While Basel 3 has an outlier limit of 15% for change in EVE, they have not prescribed any limit for EAR for the outlier test and left this at national regulator’s discretion.

 

SVB, based on publicly available information, did not employ sufficient mitigating strategies for:

·       Interest rate risk in the banking book (IRRBB), as it invested in a long-dated fixed rate securities (USTs, MBS and CMOs with greater than 10 years maturity at a yield of ~1.9%), probably under the assumption that the risk is well covered by non-interest-bearing deposits, without validating those assumptions for customer behaviour in higher interest rate environment i.e., failure to validate and stress the assumptions for customer behaviour under different interest rate environment.  As evident from the customer behaviour, over $45bn of non-interest deposits declined with 2/3rds of it moving to interest-bearing demand deposits. Such a move would cause a massive shift to SVBs cost of funding leading to earnings drag on their low yielding fixed income portfolio (estimated drag of $2bn p.a.).

·       Deposit concentration to a single industry segment, though it did carry a large stock of Liquid Assets Buffer, it failed to diversify its funding base and with most of its funding in demand deposits, it was disaster waiting to happen


While it’s possible to hedge interest rate risk with derivatives and mitigate liquidity risk with sufficient levels of liquid asset buffers, it is impossible to hedge sector concentration of funding sources while sector itself is undergoing stress, which in SVB’s case was funding source (tech and VC segment).

 

What went wrong with SVB?

SVB’s Key metrics were robust and on surface the key metrics were strong!

 



SVB was rated BBB by S&P and most leading investment banks and equity brokers had a buy rating on the stock with a target price ranging from $325 to $400 (Wednesday close was $268), implying a potential gain in value of 20% - 50%!

 

But, the devil is in the detail!

 


SVB’s investment in Fixed rate securities portfolio grew significantly in 2021, by a whopping ~$82bn, mostly in long-dated fixed rate securities (maturity > 10years).  The overall yield on these securities were ~1.9% when its cost of funds was less than 10bps.  What seemed to be a great idea in 2021 when Fed Funds Rate were 25bps, quickly unraveled as FED raised rates through beginning of 2022, from its lows to end the year at 4.5%.  The inflation expectations and interest rate forecasts were completely undone by the Russia-Ukraine war causing supply disruptions across several economies, fueling a runaway inflation.  This led to many Central Banks raising its policy interest rates sharply and continually to tame inflation, though the inflation still remains stubbornly high.  The mantra of higher for longer came into being, i.e., interest rates will remain higher for longer.

 

Now none of this new!  The Savings and Loans Crisis (S&Ls) in the 1980s was triggered by a similar reason, when Paul Volcker hiked policy rates aggressively to tame inflation.  S&Ls had issued long-term loans at fixed interest rates that were lower than the newly mandated interest rate at which they could borrow. When interest rates at which they could borrow increased, the S&Ls could only attract more deposits by offering higher interest rates which led to liabilities that were higher than the rates at which they had loaned money. The end result was that about one third of S&Ls became insolvent.  History repeats itself!

 
How did it impact SVB?

Fixed rate bond prices fall in value when interest rates go up as the market yield adjusts to the new normal. The Interest rate risk manifested itself by way negative market value on SVB’s Available for Sale (AFS) securities portfolio of $26bn, and this fed through to its equity via Other Comprehensive income leading to erosion of its equity capital and capital ratios.  Despite this, SVB had strong capital ratio of ~16% at the end of December 2022. 

 

The Held-to-Maturity (HTM), the larger portion of their investment portfolio at $91bn, does not require a mark-to-market as per accounting standards.  To that extent, the drop in value in this portfolio (estimated at $17bn) remains buried, and it flows through gradually into P&L in the form of negative interest earnings over the life these securities i.e., a slow bleed of ¬$2bn each year, if interest rates were to remain elevated through this period, which is typically unlikely, and hence the negative earnings drag would moderate over time.  Unlike AFS securities, HTM securities cannot be sold as sale of even a single security taint the portfolio resulting in redesignation of the portfolio to AFS.  This will lead to the recognition mark to market through OCI which will deplete its capital base, thereby wiping the entire equity (as the estimated MTM on HTM is a negative $17bn.

 

If there is a potential buyer of SVB, they would write down the HTM portfolio, which would result in a negative equity position!  And if there are further asset write-downs, it’s inconceivable that depositors would be made whole.  A recovery rate of ~80c is the most likely outcome for the unsecured depositors, absent any form of a bailout.

 

So, where did it go wrong for SVB?

There were four main reasons for the sudden collapse of the Bank:

1.      Interest Rate Risk in Banking Book (IRRBB) not managed robustly - Significant exposure to Fixed rate risk and soft assumptions for non-maturing deposits. With a portfolio yield of 1.9%, as Fed Funds rate increased from a low of 25bps in January 2022 to a high of 4.25% in December 2022, bonds prices slumped leading to build up of losses in the bond portfolio.  Meanwhile the cost of funding increased as customers shifted their deposits to higher interest accounts from non-interest-bearing accounts. For AFS securities the MTM losses impacted OCI leading capital shortfalls.  While negative earnings drag on the HTM securities would bleed through P&L over time.

2.      Depositor concentration – While SVB had some diversification with 38k customers with balance over $250k accounting for almost $150bn in deposits, it had concentration from source of these funds to the tech firms and VC funding client segment.

3.      External factors resulting in cash drain for tech firms, as VC capital funding activity slowed while techs firms cash burn increased leading to withdrawal of deposits causing liquidity squeeze.

4.      Poor management decision to sell AFS portfolio and crystallise the loss through P&L of $1.8bn and simultaneously launching a stock offering of $2.25bn, when none was required, on a day when another Bank had collapsed (Silvergate Bank that serves crypto currency), thereby causing a market panic followed by loss of customer confidence and a digital Bank run!

 

Detailed analysis

While all banks invest their surplus liquidity in Treasuries and bonds, SVB was an outlier with its investment strategy with its portfolio increasing to 57% of its total assets against an average of 24% for US Banks.

 

SVB was a bit slow to react to the shifting sands in the business environment of its client segment.  The VC investment activity slowed in 2022 and the cash burn of tech firms increased since Q3,2021.  It missed the alarm bells, and these were sounding louder since Q2/2022, by way of increasingly negative client funds position as shown below:

 




 This general weakness in SVB's client segment, together with the rising interest rates right through 2022 resulted in a significant shift from non-interest-bearing demand deposits to interest bearing deposits, as shown below:

  

The decline in deposit balances and a shift to interest-bearing demand deposits meant that SVB was beginning feel the pain of liquidity and earnings squeeze as it would have to offer higher interest rates to attract deposits which would cause a spike in its cost of funding.  This alone would cause an earnings drag of ~$2bn p.a., wiping out its profitability entirely.

 
What could SVB have done differently?

In some ways, SVB brought this collapse upon themselves!

1.       It was ill-advised to sell the AFS Securities portfolio ($21bn) and crystallise the loss through P&L

Their March 8th presentation shows that they had ample liquidity and the ability to meet their cash needs through available REPO lines:

 



By selling the AFS portfolio of $21bn, SVB crystallised a lost of $1.8bn. This MTM loss was already feeding through to their equity via the OCI line. And liquidity could have been raised via REPO, without having to report a huge headline loss of $1.8bn. Yes, there would be some collateral haricut but that’s not a huge constraint for SVB.  They could have closed the interest rate risk on the portfolio by hedging with fixed pay Interest rate swaps. 

 

The AFS security sale process to make it asset sensitive is a red herring! Their intent was to raise cost free equity to shore up their net interest income and this whole asset side restructuring seems like smokescreen for that. They were looking improve net interest income by raising equity to camouflage the negative bleed on the HTM portfolio.

 

2.       The need for capital is questionable and the timing of capital raise was awful

SVB had strong Capital Adequacy Ratio at 16% and hence there was no need for a capital raise, at least at this moment.  And the timing of the announcement was awful, coming close on the heels of another bank failure in the Valley (Silvergate).

 

Unfortunately, the capital raise never got done. The bank chose to announce its balance sheet restructuring the same day that Silvergate Capital announced it is going into voluntary liquidation. As a result, customer fear turned Silicon Valley Bank’s manageable deposit outflows into a flood. 

 

Founders Fund, the venture capital fund cofounded by tech billionaire Peter Thiel, on Thursday advised companies to withdraw holdings from SVB, due to concerns about financial stability, Bloomberg reported. Stability concerns reverberated across the banking sector, hitting banks base in the Western U.S. particularly hard.

 

We’ve never really had a bank run in the digital age. Here’s how it looks:

People posted screenshots of Silicon Valley Bank’s website struggling to keep up with user demand.



 

 

Is there a risk of a contagion?

There has been a panic reaction in the market with more than $100bn wiped off the market capitalisation of banks in two days!

 

Though, my view is that broader risk of contagion across the banking sector is unlikely.  Some of the smaller banks and fintechs may witness a flight of their higher value deposits which could potentially lead to failure of some of the smaller banks but banks with diversified business model and large customer base will remain unaffected as there is ample liquidity in the banking system.

 

What are the lessons?


Each crisis brings with it an opportunity to introspect and learn.  So, in summary these are the learnings from the SVB saga:

1.       IRRBB - Without a doubt, Regulatory oversight on IRRBB is likely to be the main theme for 2023. Global regulators and central banks will have an increased focus on IRRBB and banks will do well to revisit their IRRBB model assumptions and validate them, and set risk appetite limits for both EAR and EVE and a regular assessment with interest rate simulations.

 

2.        Don't put all your eggs in one basket – This one applies to both assets and funding sources.  Investments should be laddered to allow for 15% - 20% to mature each year to manage both liquidity and rate risk.  There should also be maturity tenor limits, more so when the funding source is largely short-term.  EAR and EVE limits should be set in line with the ability to absorb shocks.  Diversification of funding sources is key and its should be not just by number of customers but also across industry segments, and maturity profile.


3.    Never go for a capital raise if you are solving for liquidity – Liquidity risks cannot be met with capital.  The solution for liquidity risk is to hold liquid assets and reduce refinancing risk by having a proper asset-liability gap limits.

 

CONCLUSION

 

The pressure to enhance shareholder value drives banks to take risks that appear low at inception but is not always fully tested for severe stress scenarios.  Regulatory oversight together with stronger governance where the board members have a very good understanding of risks provides a good level of safeguard in most banks. But quite often, I see a great focus on P&L performance and there is very little probing on the Balance Sheet and Notes to the accounts, where many skeletons can be buried! (e.g., MTM on HTM bonds).

 

Banks are in the business of taking risks, but they have a primary fiduciary duty to keep their depositors’ money safe.  


VIEWS EXPRESSED IN THIS ARTICLE ARE PERSONAL.