Tucker Carlson of Fox News enjoyed himself the other day (15 March), making fun of the very woke Silicon Valley Bank (SVB). The risk manager of the UK arm of the bank – which sold for £1 to HSBC – described herself as a “queer person of colour from a working class background.” What has that do with banking or risk management, Tucker queried; as he did other woke performances from both SVB and, its fellow failed bank, Signature Bank. Apropos dancing bankers. Apropos a seminar on gender-neutral pronouns hosted by Signature Bank’s president Scott Shay, and featuring Finn Brigham, who identifies as a ”genderqueer trans male.” I can’t define that for you.
I worked in the second half of the 1980s for State Bank Victoria (SBV not SVB) as chief economist. You can’t imagine a set of people less woke. Yet the bank failed in 1991. So it isn’t wokeness per se that brings down a bank. It’s inattention to risk management. However, wokeness, particularly when exhibited in the cause of diversity, equity and inclusion (DEI), surely doesn’t help. It can mean that focus is taken away from the main game. And it can mean that people are employed and promoted on the basis of irrelevant criteria such as skin colour, sex, sexual preference and having gender-bending proclivities.
Risk management is a serious business. In fact you can say it’s the only game in town when it comes to commercial banking. At its core, banking itself requires few skills. Money is accepted on deposit at one rate of interest and then lent at a higher rate. Costs are paid and profit is earned. In normal times, it’s hard to make a mess of that. Thus bankers on the whole are not the brightest kids on the block. They don’t need to be.
A true story. Waiting in line to get the bad news of my redundancy, following the failure of SBV, a fellow executive, older than me and also for the chop, spoke to me in his distress. He told me of his father saying to him, “you’re not that good at schoolwork son, a bank’s the place for you.” He wasn’t at all sure what he would or could do next.
Run of the mill banking is one thing, when it comes to bank risk management, bright people are needed. Muddling along with half a brain doesn’t do. Banks face two main controllable risks. I say controllable, because the risk faced by all banks if the economy completely collapses can’t be effectively mitigated. That’s why, sometimes, government and central bank intervention is required and warranted.
The two controllable risks are credit risk and interest-rate risk. The former is better known than the latter, but both can do banks in. The first is the risk of loans not being repaid, of acquiring poor quality loan assets. As I have seen firsthand, this can happen when corporate lenders are rewarded for simply making loans. Hence it’s best to keep their rewards in escrow until the loans are repaid or otherwise judged to be sound after a lengthy period.
Bad lending brought down the SBV, after its wholly-owned merchant bank subsidiary, Tricontinental, lent recklessly over some years. The fault ultimately lay with the chief executive of the SBV and his inner circle who exhibited too little oversight over Tricontinental and its head, Ian Johns, who was later convicted of receiving secret commissions. But, in general, properly controlling the quality of lending requires that incentives are right, that those making the assessments are at arm’s length from lenders, and that they are skilled, experienced and ethical. But it’s a tricky business, which in the end requires judgment.
As I understand the situation, it wasn’t poor quality lending that brought down SVB but inadequate attention to interest-rate risk. This really comes down to bad banking practice. It’s less tricky to get this right than it is to make sure the lending book is sound.
Ideally, banks should run their business so that their financial position is invariant to, or at least not too much affected by, interest rate changes. Years ago, savings-and-loan associations in the US got into trouble by making long-term fixed-rate housing loans funded by short-term deposits. Not a good position to be when interest rates rise steeply, as they did. When I worked at the SBV we suffered from interest-rate risk of Paul Keating’s making. He maintained a ceiling on housing interest rates of 13.5 percent when market interest rates were rising steeply, For a time in the first part of 1986, this meant that the bank had to borrow some funds at about 17 percent to fund housing loans at 13.5 percent. Not a profitable proposition.
Apparently, SVB (make sure you keep up with the order of letters) suffered an outflow of deposits. In the normal case — that is in the absence of a run — a bank would have sufficient liquid assets to sell to fund withdrawals. In this case, SVB reportedly had to sell bonds. Now, you have to question why a bank would build a sizeable bond portfolio at a time of very low interest rates and keep holding them as interest rates rose, unless it hedged its position somehow. Short-term securities would be the go. Little is lost in terms of revenue, while their value is largely impervious to interest rate increases. Bonds, on the other hand, fall steeply in value when interest rates rise.
A $100 five-year bond paying 1 percent becomes worth much less than $100 (about $80 I think) if interest rates rise to 5 percent. Thus SVB realised steep losses when forced to sell bonds. Makes no sense unless you’re incompetent, hired to satisfy DEI requirements. Or distracted, occupied by the skin colour and sexual wotnots of you and your colleagues.