This year has already seen four bank failures, starting with the spectacular collapse of Silicon Valley Bank in March, and the latest domino to fall was a Midwestern regional bank. The total number of bank failures this year meets the mark for the highest number of bank failures since 2020 — and the year’s not out yet. Financial services consultant Cindra Maharaj shares her views on what our current economic moment tells us about existing risk management frameworks.
The banking crisis has placed a spotlight on the urgent need for new thinking and new oversight mechanisms within the U.S. financial services sector. One of the most important issues that this year’s events have revealed is the critical need for institutions to adopt more prudent risk management practices.
After years of low interest rates and beneficial monetary policy, mid-tier banks began to look at deposits as a cheap source of funding, which drove immense growth. But as the interest rate environment changed and depositor behavior evolved, some of these institutions — not subject to the same regulatory scrutiny as the Global Systemically Important Banks (G-SIBs) — struggled immensely. They were left without a diverse funding stack, including stable long-term debt, or the ability to raise funding in the short- to medium-term via secured funding desks.
With U.S. interest rates rising at the fastest pace in history, several institutions did not have the risk management infrastructure in place to anticipate challenges within their own balance sheets and with credit markets more broadly. The Federal Reserve has already weighed in on what went wrong, and regulatory changes are widely expected.
The onus is now on all financial institutions — particularly smaller regional banks (which, by the way, are not immune to failure) — to reevaluate their current risk management strategies against the backdrop of an increasingly challenging environment. Transparency will become a bigger priority as banks take a hard internal look at their governance and oversight structures, risk identification mechanisms, risk mitigation strategies and crisis planning.
As financial services institutions navigate the shifts and shocks that have defined this challenging period, they must focus on building organizational resilience in these key areas.
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These events have led many to call into question if financial institutions have the right systems in place to demonstrate resilience during periods of volatility. Larger banks have robust data infrastructures that allow them to make timely and well-informed decisions on a day-to-day basis. As technology continues to evolve at a rapid pace, information and misinformation spread as quickly as it takes someone to hit share in a social media post. Reliable, real-time data has become even more critical for banks to better assess their overall risk landscape and have full confidence in the decisions they make that can ultimately affect liquidity.
Banks must determine if they have the right data management systems in place to weather market headwinds. To assess their internal data management capabilities, organizations should better understand their asset liability management (ALM) processes. There are a number of important questions bank leaders should be asking:
- Are we getting our data from various sources and integrating that data in different formats? Do we have a system of checks and balances in place to validate the integrity of our data, ensuring that it is both consistent and reliable?
- Do we have the ability to consume and analyze data quickly and accurately enough to make well-informed and expeditious decisions? Are we investing in the right business intelligence tools that allow ALM practitioners to dedicate more time to assess the liquidity or capital position of their organization?
Data management goes beyond fixing data quality and involves facilitating the right policies, ensuring accountability and establishing higher standards for data quality. Building a culture that fosters more advanced levels of data management will help ensure that these efforts are implemented throughout the organization in a sustainable manner, creating new opportunities for growth out of challenging situations.
Organizations need connective tissue across risk functions
It’s not just about having the right data in place. A bank’s governance framework can be the key to ensuring that individual risk stripes, business lines and management stay connected and grounded in the bank’s risk appetite. This happens through business-as-usual tools that drive transparency and incentivize the correct behaviors, such as funds transfer pricing and informed management oversight for review and challenge.
We’ve seen a growing disconnect between risk functions, which has led to failures to effectively manage risks that have been exacerbated with new technology, 24-hour banking and social media. Banks face an immense need to build more connective tissue across these important functions. This allows institutions to connect their risk management strategies with external factors and mitigate interdependencies between risks.
An effective and connected governance framework allows true alignment across culture, activities and behaviors in a way that supports the firm’s risk tolerance and strategic plans. Leaders must also think about how the changing business landscape is impacting their company’s culture and employee attitudes toward and awareness of risk. Organizations must take steps to incentivize and reinforce behaviors that align with their risk mitigation strategies.
Routine stress testing and scenario planning
Stress testing and scenario planning are best practices that should be built into the fabric of every institution — not just those required to use them. They play a key role in helping banks prepare for potentially harmful situations that could have negative impacts throughout the institution and tarnish their reputation.
With the anticipation that more regulation is on the horizon, among the expected regulatory changes that will come next, enhanced prudential standards may very well serve as a starting point for regulators. This foundational set of requirements for large banks determines which institutions have to conduct stress testing and scenario analysis. The nature and timeline of the most recent bank failures revealed the need for all banks to revisit how they adequately identify and assess risks and shape scenarios that drive their liquidity, capital stress tests and resulting buffers. Financial institutions will be focused on identifying emerging risks faster, enhancing playbooks to support a timelier response across the stress spectrum and ensuring management has fit-for-purpose reporting with up-to-date insights for effective decision-making.
Lessons learned — for all industries
The banking challenges we’ve seen this year should serve as a warning to organizations across all industries. In today’s world, in which speed of information has become of utmost importance, leaders and board members must have access to internal data and information in real-time.
Organizations must take steps to protect themselves against avoidable risk by implementing a proper infrastructure and routinely re-evaluating the way they identify and manage potential risks. Without the right mechanisms and oversight in place, it’s not possible for any organization to react appropriately to rapidly unfolding events.
Cindra Maharaj is a partner and corporate treasury and risk expert in the New York office of Baringa, a global management consulting firm. Before that, she was a senior manager at EY.
