This article first appeared in Forum, The Edge Malaysia Weekly on May 15, 2023 - May 21, 2023
The recent failures of Silicon Valley Bank (SVB) in the US and Credit Suisse in Europe have shaken customer confidence in the banking and financial system as a whole, sending a clear signal to banks worldwide that there is a danger to being complacent.
Unlike the Lehman Brothers’ collapse in 2008, SVB’s collapse — the second largest bank failure in US history — was not due to poor credit risk management. It could be attributed to several reasons: (i) SVB’s inability to effectively deploy huge deposits into effective interest-yielding assets, which caused an asset-liability maturity mismatch; (ii) concentration risk in tech sectors, which are facing liquidity constraints due to the “funding winter”; (iii) game-theory-driven bank run on deposits; and (iv) the rising interest rate as an external macro trigger.
Meanwhile in Europe, Credit Suisse’s series of issues and scandals involving alleged misconduct, money laundering, sanctions busting and tax evasion have been brewing for years — leading to snowballed losses of CHF7.3 billion in 2022, and its eventual failure and acquisition by UBS in March this year.
Although our local banking system is designed to be more robust, there are critical lessons that can be learnt, so as to prevent similar incidents from occurring in Malaysia.
Malaysia has many traditional banks in the market, but we are also expecting five new digital banks to start operations in the near future. While exciting, their arrival might not come without prominent confidence concerns. Digital banks are usually smaller and newer to the game, without any physical presence that gives the sense of trustworthiness. They are also most often loss-making in the initial years. According to Boston Consulting Group’s Fintech Control Tower tracking, only fewer than 5% of the over 250 digital banks globally are currently profitable.
That being said, the context here in Malaysia is slightly different. First, Bank Negara Malaysia has been prudent in shaping its policies and conducting tight supervision of all Malaysian banks. For example, Bank Negara actively regulates all banks on the Liquidity Coverage Ratio (LCR) requirement for sufficient liquidity buffers as well as concentration risks into selected sectors. In the case of the US, where there are more than 5,000 banks, smaller banks like SVB received less regulatory oversight and were exempted from certain strict requirements applied to larger banks. SVB’s LCR was estimated at 75% as at end-2022, which was below what is considered safe.
Secondly, unlike the SVB case, where more than 90% of the bank’s deposits were uninsured, Malaysia’s Perbadanan Insurans Deposit Malaysia estimates that 97% of depositors are protected in full, even with the RM250,000 cap, thereby reducing the likelihood of Malaysian banks experiencing an SVB-like overnight bank run on deposits.
These are undoubtedly commendable measures, but even so, Malaysian banks cannot afford to rest on their laurels.
1. Get the basics right — recognise that banking is a risk management game
Banks must actively manage various asset-liability risks, for example credit risk, interest rate risk as well as liquidity risk.
SVB held a large proportion of assets in what was deemed as the “safest” asset from a credit risk standpoint (the US Treasuries), but the very long duration securities were funded by short-term deposits. The liquidity need to sell the bonds before maturity at lower prices (caused by the rapid interest rate hikes by the US Federal Reserve) resulted in significant unrealised losses, which could have been avoided if the bonds were held to maturity.
Most banks would probably conduct interest rate, credit and liquidity risk stress testing individually. But what banks need to do more is balance sheet modelling and stress testing across risk-types to have a more complete understanding of the interconnectedness of all risks.
2. Reevaluate portfolio concentration — too much of a focus strategy is a double-edged sword
Focus has been one of the three generic competitive strategies in the classic Michael Porter framework. The focus strategy served SVB well for a long time as it was celebrated as a bank that thrived in the tech start-up sector, which was booming for decades. However, banks must remember that they are in the business of managing risks, and should consider focusing on a few sectors and avoid concentrating risk in too narrow a segment.
Apart from tried-and-true analysis of concentration risk, banks should also perform network analyses, like those used for financial crimes, to determine linkages in the deposit book and identify nodes that are connected or have influence over others. In the case of the SVB bank run, influence was concentrated in a few venture capitalists that accelerated the run-off by advising their portfolio companies to move their money. Having this critical information mapped out in advance will allow banks to enhance the monitoring of those influencers and proactively manage such events.
3. Grow sustainably — look at both sides of the balance sheet
The current era of “funding winter” and potential global recession means the pursuit of growth at all cost is no longer tenable. Banks (even more so fast-growing digital banks) should revisit the strategy of burning excessive cash for customers and growth.
The traditional use of attractive deposit interest rates as an acquisition and growth lever might not be sustainable, especially in the current climate of rising interest rates.
Banks need to consider both sides of the balance sheet. For example, excessive growth on deposits without a good strategy to deploy the funding effectively might spell doom. A cautionary tale is the demise of Australia’s first licensed neobank, Xinja, which could not lend out its huge deposit balance effectively.
Banks should place emphasis on building and leveraging ecosystem advantage (whether through their own affiliate companies or partner companies) as well as developing unique products and propositions that would acquire customers.
4. Have a crisis playbook fit for the social media age
SVB represents the first major bank failure in the social media age. The fact that the US Federal Deposit Insurance Corporation took over SVB in the middle of the day rather than waiting for close of business shows how quickly the situation changed. The pace and collective response of depositors was enabled by social media, digital communication and digital banking. This made the speed of the crisis closer in resemblance to a massive cyber breach than to a bank run from decades past.
SVB seemed unprepared to respond to such events in a coordinated fashion, both internally and in communication with its investors and depositors. Customer comments indicate that client-facing and investor-facing staff were unprepared to deal with the resulting enquiries or manage the high volume of withdrawals. A failure to provide answers to key investors and depositors was a fundamental contributor to the speed of SVB’s demise.
Banks must establish, review and regularly exercise playbooks for a liquidity crisis. These playbooks should enable banks to better position their approach to key areas such as liquidity raising, internal organisation, operational resilience, as well as investor, regulatory and customer communications. Just like a cyber event or operational incident response, banks should regularly conduct “war gaming” exercises to ensure a coordinated response across departments in the event of a similar crisis.
5. Be swift in resolving issues
Issues surrounding Credit Suisse had been known for years, highlighting the need for structural fixes. But banks, especially larger ones, tend to act slower given their scale and internal bureaucracies.
To prevent crises, boards and management teams should not treat critical risk issues as the sole responsibility of their risk committees. Instead, they need to also include it as one of their top priorities, building an action plan with clear timelines that promote accountability.
When news of these bank failures broke — almost back to back — no doubt many customers and investors were caught off guard. And rightly so, because banks are institutions in which people place their confidence and trust. For that, banks owe it to their stakeholders to do all they can to ensure their systems, processes and strategies are resilient against unforeseen risks. The crisis is a stark reminder of the price of complacency, but out of it have emerged lessons that Malaysian banks should give serious consideration to. The consequences of ignoring them, as we have seen, can prove fatal.
Ching-Fong Ong is managing director and senior partner at Boston Consulting Group. Isaac Tan is a partner at Boston Consulting Group.
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