Peter Hughes
When the CEO of Silicon Valley Bank (SVB) issued a letter to investors on March 8 explaining the need for an emergency injection of liquidity due to elevated levels of cash burn, catastrophe struck with shocking speed. The letter had been prompted by the bank’s loss of US$1.8 billion on a forced sale of US$21 billion worth of US Treasury bonds, and just two days later, following the withdrawal of US$42 billion by panic-stricken depositors, SVB failed.
A bank that had generally been considered financially sound just days before was now insolvent. Fear of contagion and systemic risk subsequently swept through the market, raising many questions about how such a failure could have been prevented or detected before it was too late.
Risk concentration
A bank that is overly concentrated in any type of asset or liability is invariably vulnerable to unexpected movements in market rates and prices. As the chart below illustrates, SVB’s assets had unusually heavy concentrations in fixed-rate, long-dated US Treasury securities on top of liabilities that were made up mostly of deposits from tech start-ups.
It goes without saying that any significant unexpected loss must have previously existed as a material exposure to non-financial risk. In other words, there is a positive correlation between increasing exposure to non-financial risks and resultant unexpected financial losses.
It follows the adage all accountancy professionals can attest to: if an organisation accepts a risk, it also accepts a probability of loss. The question is, how do we define accepted best practice when it comes to identifying and accounting for accumulating non-financial risks in the form of expected losses?
Accepted risks
Is accepted risk about disclosure or accounting? SVB’s 2022 annual report lists 38 risk factors accompanied by a health warning: "If any of the events or circumstances described in the following factors occurs, our business, financial condition and/or results of operations could be materially and adversely affected."
Backward-looking financial statements that require only the disclosure of accepted risks without accounting for them are obviously of little use or relevance. The consequent "risk and profit taking now, losses later" is of particular concern from the audit perspective, as it invites less principled businesses and staff to play irresponsibly with investors, clients, the environment and even public health and safety.
Some would claim that a non-financial risk is intrinsically impossible to observe and you cannot account for the unobservable; only financial outcomes are observable. However, as the recent banking sector turmoil continues to prove, this simply does not make sense. Accounting standards for accepted non-financial risks must be established.
Under the direction of the Risk Accounting Standards Board (RASB) and the Durham University Business School, a research partnership between ACCA and the Professional Risk Managers’ International Association (PRMIA) has codified a next-gener
