Assessing the impact of SVB’s collapse, banks must remain agile

More than six months have now 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. 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 UK, 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.

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 simultaneously.

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 several 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 avoid over-leveraging deposits or the temptation to implement lower credit standards, while ensuring higher levels of liquidity and 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 significant interest rate losses for which they do not hold equity. It also limits the risk of banks taking substantial losses, more than their capital base, when conditions change, particularly in uncertain times like those we have seen in the last couple of years.

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 cannot 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 a strong technology infrastructure, a good balance between product expansion, market growth and risk management is achievable.

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 must 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.

Emma Hagan is Chief Risk and Compliance Officer at ClearBank overseeing all risk and compliance-related activities. Emma has over 15 years of experience in commercial and corporate banking in both first and second lines of defence.

A version of this article first appeared on AltFi.