SVB and Risk Management in the Current Climate

Introduction

The Treasurer of a bank once told me, "The management of interest rate and liquidity risks is at the heart of the Treasury function." Plenty has been written about the recent demise of Silicon Valley Bank (SVB), and a further interrogation is not warranted here; however, consensus has centred on these two aspects of asset and liability management (ALM) as being notable contributors to the ultimate failure of the institution.

This note aims to serve as a reference point for our clients, outlining the critical internal risk management strategies and practices that can help avert a crisis with a particular focus on stress testing and scenario analysis.

Interest Rate Risk in the Banking Book

Banks should have an internal Interest Rate Risk in the Banking Book (IRRBB) risk management framework that sets out inter alia the Bank's risk appetite and risk approach vis-à-vis IRRBB, as well as how it measures, monitors and reports this risk. The IRRBB framework should include the assumptions applied in IRRBB calculations as well as documenting any behavioural assumptions – for example, with respect to non-maturity deposits (NMD) – applied, including the governance arrangements under which they fall.

A key aspect of understanding the level of IRRBB exposure is via the application of shock scenarios under both economic value of equity (EVE) and net interest income (NII) methodologies. The shock scenarios prescribed under prevailing regulation should be supplemented by additional bespoke stress scenarios undertaken as part of ongoing risk monitoring as well as in a firm's Internal Capital Adequacy Assessment Process (ICAAP) to further evaluate IRRBB and assess vulnerabilities in the bank's asset and liability structure.

IRRBB often receives less attention when compared to, say, credit or liquidity risks. This has been exacerbated by the benign interest rate environment that has existed for many years, until recently. Developments at SVB demonstrate the risks of oversimplifying or dismissing IRRBB.

New regulations on IRRBB are complex and prescriptive but apply to small banks as much as larger institutions. Based on global regulatory developments, we can expect further developments in the way of regulation in this area.

Liquidity Risk

Many banks have embedded robust liquidity risk monitoring and measurement practices that are both proportionate and relevant to their own business models and circumstances. Such internal frameworks must include regular liquidity stress testing in addition to the scenario analysis carried out as part of the periodic Internal Liquidity Adequacy Assessment Process (ILAAP) in order for the firm to understand, on a regular basis, the adequacy of its liquidity resources and the evolution of the liquidity risks to which it is exposed.

This concept has become ever more relevant in the wake of the recent turbulent economic environment, on the back of rapidly rising interest rates, and considering major industry events (such as the collapse of SVB, and Credit Suisse’s non-viability), which all point to a shift in both the underlying liquidity risk environment and the liquidity behaviour of sources of funding such as customer deposits.

Adequately understanding critical drivers of liquidity risk, such as funding concentration risk, and evaluating the likely adequacy and availability of liquidity resources in uncertain economic conditions are vital aspects to be considered as part of stress testing exercises.

How We Can Help

Firms may face a variety of challenges when defining or developing their internal risk frameworks for either or both of liquidity risk and IRRBB, or they may require support to ensure that their risk management practices remain fit-for-purpose in the current climate. At Katalysys, we have a deep understanding of liquidity and interest rate risk, and the measurement, monitoring and management thereof. We have supported many clients with the development of their internal risk frameworks with respect to a range of ALM risks, and we continue to assist clients with the ongoing enhancement of their ICAAP and ILAAP and associated stress testing requirements.

We also provide liquidity and IRRBB tools as part of our k-ALM® Solution, further enhanced through our k-ALM® IRRBB and Liquidity Stress Testing modules. All k-ALM® products are offered as cloud-based solutions to clients to support their risk management practices as well as enhancing strategic decision-making.

Our team has supported a wide range of clients, from those seeking first authorisation to well-established firms. Whether you need:

• liquidity stress testing or IRRBB solutions;

• ILAAP or ICAAP enhancement, support or review; or,

• an independent assessment of your internal IRRBB framework and processes,

We have the knowledge and technical skills to help. Some of our recent projects include:

• Ad hoc liquidity stress testing exercises;

• k-ALM® Liquidity Stress Testing implementations;

• IRRBB Risk Management Framework review and enhancement to meet regulatory expectations;

• Behavioural modelling of NMD and application to IRRBB calculations; and,

• k-ALM® IRRBB implementation including multi-currency, multi-scenario analysis under both EVE and NII assessments.