Issue link: https://digital.shearman.com/i/1512772
Shearman & Sterling LLP SVB Fallout: Banks Face Heightened Corporate Governance and Risk Management Scrutiny | 46 Corporate Governance Under the Microscope • Corporate governance and board oversight failed to keep up with the failed banks' accelerated growth, increasing complexity and changing risk profiles. Following the recent bank failures, boards and management should expect more granular reviews on a range of corporate governance and board practices and procedures. • According to the Federal Reserve's report, SVB's failure can be "tied directly" to the failure of SVB's board and senior management to oversee or manage effectively the risks inherent in SVB's business model and balance sheet strategies. Specifically, SVB's full board failed to obtain adequate information from management about key risks (for example, management did not send the board updates on critical liquidity issues until late 2022 despite already deteriorating conditions), "did not hold management accountable," and often treated resolution of supervisory issues as merely a task for the compliance function rather than a critical risk management issue to be properly overseen by the board and senior management. Management was also faulted for "reacting to supervisors identifying the issues," instead of proactively identifying them on their own. In light of these findings, boards of banking organizations should assess reporting protocols, including relating to the substance and cadence of reports on critical topics, and explore ways in which director education can be enhanced. • Signature's corporate governance failings and lack of management responsiveness were cited by the FDIC and NYDFS in their respective reports. Examiners found certain decisions were "without regard for having proper governance standards." Key decisions were "often made by individuals or small informal groups of executive officers, without always following prescribed processes" and various committee charters did not provide for appropriate accountability or safeguards against concentrated authority. Signature's executives also "were sometimes disengaged from the examination process and were generally dismissive of examination findings." Actions to address exam findings "were more 'check-the-box' or done to assuage the examiners, versus management understanding and appreciating the importance of underlying findings or control weaknesses." Banking organizations should consider the issues highlighted by these reports when assessing how their own governance practices can be improved. Risk Management in Focus • Risk management practices and controls, particularly liquidity risk management, were at the heart of the recent bank failures. In addition, the adequacy of stress testing assumptions and contingency funding plans have come into focus. "Foundational weaknesses" in SVB's liquidity risk management, including its liquidity position, internal liquidity stress tests, and contingency funding plans were cited by the Federal Reserve, while the FDIC's report on Signature found that the bank's failure to adequately address examiners' liquidity risk management concerns "figured prominently into [its] failure." Similarly, the FDIC identified First Republic Bank's failure to sufficiently mitigate interest rate risk as a cause of the bank's collapse. Banking organizations should anticipate the need to respond to more supervisory inquiries on risk management, including with regard to interest rate risk and liquidity issues. • A major cause of the liquidity crisis that afflicted all three failed banks was overreliance on uninsured deposits. Deposit funding sources and concentrations (e.g., uninsured vs. insured, brokered vs. retail) are being scrutinized by regulators in the post-SVB environment. Banking organizations should ensure they have adequately responded to regulators' concerns on these topics, including whether internal limits have been established and/ or revisited, as appropriate, based on changes in market conditions, interest rates and depositor behavior patterns.