Secure your treasury to avoid bank failure risks

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A string of banking failures has emphasised the need for best practice in managing the treasury function.

SVB’s clients “lemmings” 

Silicon Valley Bank went all in on the tech sector. As the industry boomed and attracted investors’ cash, much of this was deposited with SVB. Its deposits tripled from $62 billion at the end of 2019 to $189 billion at the end of 2021.  

Looking for returns, the bank invested in long-term US treasury bonds and US government agency mortgage-backed securities. But when interest rates started rising last year, and its client base became more strapped for cash, the bank was forced to offload some of its bonds at a loss.  

That spooked SVB’s depositor base, which was heavily concentrated among fintech start-ups and early-stage firms that acted as a herd and withdrew their deposits en masse in a classic bank run.  

Growth hides a lot of sins, and a lot of time growth has this tsunami of those sins following it.

David Koenig, Chief Executive of The DCRO Institute

The resulting disaster exposed SVB’s ‘original sin’ of failing to manage its liquidity risk, according to Moorad Choudhry, the former head of business treasury, global banking and markets at Royal Bank of Scotland.  

“The original sin was their concentrated funding base. They had a concentration by type of customer, by type of deposits and by tenor,” Choudhury says. “They all acted in the same way, all at the same time and they all followed the same run like lemmings over the cliff. 

“The interest rate rises were the catalyst that exposed the original sin which was very poor liquidity risk management.”

Diversification is essential

The sight of Silicon Valley Bank’s (SVB) shell-shocked customers scrambling to meet their vital expenditure in the days after the lender collapsed delivered a stark reminder of the importance of effective treasury management.  

US banking regulators stepped in to shut down Silicon Valley Bank on 10 March after customers withdrew a staggering $42 billion of funds in 24 hours in a lethal bank run that caused the largest bank failure since the 2008 Global Financial Crisis. 

SVB was the bank of choice for a swathe of US tech start-ups, their founders and venture capital backers, many of which had concentrated their funding in just one or two banks. In one example, Roku, the video-streaming business, had $487 million, or 26% of its cash, deposited with SVB when the run began.  

“SVB was the bank for fintechs. A fintech bank might be your friend, but if they are a narrow niche bank and the fintech sector is in trouble, your bank is in trouble,” says Choudhry.

Panic set in among the tech start-ups that banked with SVB as they were left facing the prospect of being unable to access their funds. The sudden failure of SVB exposed the poor cash management practices of companies that had succeeded in raising vast piles of cash but had spent little time thinking how to manage it.

A cautionary tale

“If you are flush with cash that is not really what you are thinking about,” David Koenig, Chief Executive of The DCRO Institute, which trains board directors, says. “In the kinds of companies that had their money with SVB, the focus is not on their treasury function.”

Koenig recalls a meeting with a group of businesspeople from Silicon Valley in which he suggested that growth for growth’s sake is not necessarily good. The response, he says, was: “If you ever made a statement that growth isn’t a good thing, you would be thrown out of every meeting here.”  

He continues: “Growth hides a lot of sins, and a lot of time growth has this tsunami of those sins following it. Treasury functions matter because if it is not done well, it potentially cuts off the growth and if there is this tsunami behind it, it can take you away as a business.”   

Indeed, Choudhry says the “core discipline”, particularly in companies that rely on high revenue and low margin, is being conservative and keeping the cash safe, rather than seeking out higher returns.  

“My approach is to be conservative first and foremost and preserve the cash,” he says. “Making anything on the top of that on higher interest rates is a bonus that shouldn’t be the driving force. The minute you lose sight of that, you can’t blame anyone other than yourself when things go wrong.”  

Even though the Federal Deposit Insurance Corporation protected all deposits with SVB in a bid to stabilise the banking system, and the Bank of England sold its UK business to HSBC, the crisis should be a wake-up call for accountants to review their company’s counterparty credit risk.

Counterparty risks

Treasury teams are already acting. A Gartner survey of more than 250 finance leaders in March found that more than one in four CFOs plan to diversify their deposits across more banks in response to the unfolding crisis. 

The top actions CFOs are taking, or planning to take, include assessing their own funding sources for risk, educating the board on potential exposures and evaluating customer exposure and payment risks.

The crisis exposed the risk of trusting too much in one bank when the macro-economy is uncertain, says Laurent Descout, the chief executive of Neo, a digital bank. Treasurers need to go back to lessons learned in 2008 – always have more than one depositor.  

“The tale of SVB should be a cautionary one for treasury teams about the risks of putting all their eggs in one basket,” Descout says. Treasury teams will look to diversify with several banks.  

“This means that should one bank get into difficulty, they have cash at hand to make vital payments, while not having to manage too many banking partners,” he adds. 

Be conservative first and foremost and preserve the cash. Making anything on the top of that on higher interest rates is a bonus that shouldn’t be the driving force.  

Moorad Choudhry, former head of business treasury, global banking and markets at Royal Bank of Scotland

And the speed at which SVB unravelled highlighted the need to monitor counterparty credit risk on an almost real-time basis. Those companies that look at counterparty risk day in day out were able to spot some of the signs that trouble was brewing at the bank.

“If you are taking this seriously you have got to do it on a regular basis looking at your counterparty risk. It is no good looking at it once a year because things can move a lot quicker than that,” Robert Waddington, director of PwC’s treasury and commodity group, says.  

He urges his clients to get on top of treasury management processes when they are flush with cash.  

“Now is the time to do it because there might be a time when it is tight and you don’t want to be putting in your processes, controls and operations to get a good cash flow forecast in place when you need to know it urgently,” he says.  

To understand counterparty risk, treasurers need to question their banks more about their investment policies. One of the critical errors made by SVB was that it had invested in longer-term government bonds, which take a decade to yield results.

“The corporate treasurer needs to really understand the balance sheet structure if they want to be safe,” Choudhury, who is also a fellow of The DCRO Institute, says. This includes looking at the funding structure and the basic asset and liability position of the bank.  

“If you don’t have the time or the wherewithal or the expertise to do that, then at the end of the day you should go with a bank that has a diverse customer base,” he adds.

Cash flow and forecasting

The banking crisis triggered by the collapse of SVB, Signature Bank and First Republic and high-profile banks such as Credit Suisse being sold at fire sale prices is just the latest in a series of shocks corporate treasurers have had to absorb.  

A looming recession and rising interest rates around the world have, once again, underscored the importance of cash flow and working capital in business. And upheaval caused by Brexit, the Covid-19 pandemic and the war in Ukraine has led many finance functions to tighten their cash management practices.  

Research published by American Express in March found that finance teams were spending more time and resources on forecasting that any other discipline.

The survey of finance leaders at larger UK businesses found that finance teams have increased how frequently they rebudget or reforecast: one-third are expecting to do this monthly in the year ahead, compared with 28% who did this as frequently before the pandemic. 

For many high-revenue, low-margin businesses in retail and transportation, business models “changed overnight” when lockdown measures restricting the movement of individuals were imposed by the government, says Zoe Harris, Deloitte’s head of treasury strategy and operations.  

As such, the pandemic increased attention on cash forecasting and cash management among those companies’ finance teams.   

“Businesses that had less of a focus on cash management or cash forecasting, because they have always been cash rich, were suddenly unsure of what their cash revenues were going to be over the next period of time and therefore already putting in place those cash forecasting processes,” Harris says.

She adds that businesses with robust procedures, processes, policies and governance in place will be better able to “absorb that shock and know exactly what we are going to have to do to absorb that shock then they are in a better, stronger place”. 

Research by software provider Blackline found that understanding cash flow in real time will become more important for companies over the next year. However, nearly all the 1,483 executives surveyed admitted that they could be more confident about the visibility they have over cash flow. 

“Cash flow forecasting is never going to be perfect, but you have go to undertake continuous improvement,” Waddington says. “Some of the better organisations I work with put metrics in place around improvements, or league tables within their companies if they have different divisions around how they are performing as a group.”

How CFOs plan to mitigate risk related to bank failures 

39% Educating the board about exposure and potential risks  

38% Assessing risk and viability of existing fund sources 

34% Assessing customer exposure and payment risk  

30% Assessing third-party supplier risk 

28% Diversifying deposit base across more/new banks 

20% Mitigating current exposure to failed banks 

18% Reviewing investment policies 

17% Improving cash visibility 

17% Assessing and rebalancing counter party risk 

15% Communicating to shareholders to explain bank exposure and relationship flexibility 

10% Communicating to vendors/customers regarding cash flow impact 

9% Benchmarking existing bank services and associated fees  

8% Scenario modelling the impact on the cost of credit 

4% Other 

Source: Gartner Bank Failures 

AAT Comment offers news and opinion on the world of business and finance from the Association of Accounting Technicians.

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