It will take more time to get a full explanation behind the recent collapse SiliconValley Bank (SVB). But there is still a lesson to be learned for everyone, not just for banks: it is critical to have an effective risk management program.
SVB’s risk management was allegedly not properly calibrated for its business model, among other problems.
In a recent interview, Russ Porter, chief financial officer of the Institute of Management Accountants (IMA), in particular said that it is a good time for CFOs to apply lessons learned from the bank failures to their company operations. While people are talking about the need to diversity their banking relationships, a bigger lesson is diversification and risk management for CFOs in all industries and all types of businesses.
“What we are seeing is it’s not a startup issue. It’s not a single industry with the high tech. It is something that could affect any organization anywhere. That underlying theme really is making sure that CFOs are thinking about all of their business relationships and ensuring that they’re applying good risk management techniques in terms of assessing, implementing preventative controls and being prepared for mitigating actions should risks actually come to fruition,” said Porter, a former 30-year member of IBM’s finance team.
It is somewhat akin to the popular adage of not putting all your eggs in one basket.
However, Porter emphasized that this does not mean businesses can never use just one bank or one supplier, for example.
“Rather it’s much more about just being aware of the risks that you face…and that you are assessing, ‘hey, what are the risks of that? what do I do if there are changes in the environment? And what do I need to think about in terms of signals that would lead me as a CFO to make some changes to the underlying business, the business model,’” he explained. “But very often companies and CFOs as the risk managers, they look at that, they say ‘look, you know, all my eggs are in one basket.’ And if a company is doing so with eyes wide open, recognizing the risks that it creates for their company, and having balancing or mitigating actions so that they’re prepared to act if risks get realized. Then that’s an acceptable way of doing it.”
What executives do not want is to find out after the fact that there were risks that management has not thought of or that management was aware of it but did not do anything to protect against it.
“So, when you know about a risk out there that could significantly affect your ability to operate, and you don’t do anything about it, and you don’t communicate it to the rest of the business, that can lead to real difficulties for organizations,” he said.
Advice to CFOs: Be Creative
To better illustrate his point, Porter said that risk management is an area that CFOs get to use their right brain and be creative about thinking through the different risks that could affect their organizations while getting input from the left-brain side of the organization. Thus, it is getting information from operation’s view of their key risks, input from sales and marketing as well as feedback from human resources.
For example, if talent is absolutely a driver of the value of the business, then HR should be able to weigh in about the risks it sees.
“So, it gives the opportunity to be creative in identifying risks, and then also to be creative and saying, what would we do if our top talent left? What would we do if our biggest client decided to take their business elsewhere? Or supplier X suddenly was going out of business,” Porter said. “That’s where the creativity comes in. And then once you’ve got the creative issues, then it comes down to the nuts and bolts of planning.”
COSO Framework on Risk Management
One tool that has been helpful to companies is the Committee of Sponsoring Organizations of the Treadway Commission’s (COSO) Enterprise Risk Management—Integrated Framework. This is widely used at least by big companies as it represents best practices in risk management.
COSO is a joint initiative of five private sector organizations that develop frameworks and guidance on enterprise risk management, internal control and fraud deterrence. The five organizations are the American Accounting Association (AAA), the AICPA, Financial Executives International (FEI), the Institute of Internal Auditors (IIA) and IMA.
The framework discusses the significance of a risk to a company and the probability of that risk happening. And in Porter’s view, it is a great framework for an organization to assess what it really needs to be concerned about, a risk that could put the entire existence of the organization in danger as opposed to things that are not likely to happen. If they do happen, they may not wipe out the business.
“But you still think about all of those and some of the mitigating factors. And that may be as simple as ‘hey, here’s a playbook. Hey, here’s the top 20 risks that we think we’re exposed to. And here’s what we are going to do if these risks actually come to pass,” Porter said. “So at least you’ve got the framework there.”
Accounting Treatments and Issues
In the meantime, there has been a discussion about the Financial Accounting Standards Board’s (FASB) accounting rule in connection with the bank collapse. While the accounting rule per se did not cause a run on a bank deposit, some experts pointed to the need for the U.S. standard-setter to change held-to-maturity (HTM) accounting rule for certain financial instruments.
In the aftermath of the global financial crisis over a decade ago, there was a debate about whether some financial instruments should be carried at amortized cost or at fair value—available-for-sale.
The FASB had a proposal in 2010 would have required many financial instruments to be accounted for at fair value. Investor advocacy group like the CFA Institute supported the fair value option because it is the most relevant measure when making a capital allocation decision. Management intent does not alter the value of a financial instrument. But a mixed measurement model creates inconsistency, making it confusing and difficult to compare between companies. Moreover, the mixed model hides economic mismatches because assets are reported at fair value but liabilities are at amortized cost. Fair value, on the other hand, highlights those mismatches by reporting the changing value of assets and liabilities. The standard-setter retreated from the proposal under political pressure, the CFA Institute noted.
“What that means is that the financial statement carrying value of those financial instruments held-to-maturity is reflected at amortized cost, or what management paid for the asset sometime in the past plus amortization of the discount or premium from the face value. The fair value is only disclosed on the face of the financial statement and in the footnotes. Any unrealized loss is ‘hidden in plain sight,’” wrote CFA Institute’s Sandra Peters in a blog. “But management intent and business model do not change the value of financial instruments. The HTM classification only makes it harder for investors and depositors to see.”
However, not everyone thinks held-to-maturity accounting should be eliminated.
Denny Beresford, who served as chairman of the FASB from 1987 to 1997, said that the original accounting for marketable securities standard was issued in 1993 in SFAS 115, Accounting for Certain Investments in Debt and Equity Securities.
“As Peters’s post points out, it was rebated at great length again when Bob Herz was chairman, and the board decided not to change the held-to-maturity classification,” Beresford said.
“I can certainly see excellent arguments both pro and con for the current accounting standards as well as the changes suggested by Peters,” he added. “But I don’t think long-standing accounting should be changed as a result of one bank failure that could have easily been foreseen had investors, regulators and others read the financial statements with some reasonable care. As Peters’s post said, the matter was ‘hidden in plain sight.’”
Meanwhile, IMA’s Porter pointed out that the FASB’s accounting rules are mainly for external consumption.
“I love them because as an investor, it makes sure that all of our communications are on a level playing field, and that we’re being consistent in analyzing different investment opportunities,” Porter said. “But I really have to differentiate between the information that’s done for GAAP purposes and external reporting purposes versus the information that’s used for the internal decision making of a company. Now, should the two reflect each other? Yes. But GAAP financial statements are produced on a quarterly basis; they’re not real time. They’re done for consistency, not necessarily decision making inside the company.”
IMA recognizes that there is a difference in the information that is needed for real-time decision making versus what is put into a financial statements for use by investors and other stakeholders.
“I am confident that organizations like SVB, they’re not necessarily using cost-base hold to maturity when they are doing the internal discussions of their valuation and their liquidity and their solvency,” Porter said. “They are using the mark-to-market information. What’s the value of our asset portfolio today when they’re doing their analysis.”
He speculated that as part of its process, the bank might have been using statistical expectations of withdrawals.
“And it’s something deviating in that statistical analysis of what their expected growth might have been. And that’s what kind of started the ball rolling to throw them off. But as a general rule, I’m a big believer that there’s a lot more data, a lot more analysis, a lot more real-time information being looked at from multiple directions inside a company that isn’t necessarily presented on the face of our financial statements.”
He emphasized that he is not saying that the FASB or anybody else made a mistake by saying, “hey, you should have been marked-to-marketing these things.”
“Inside the company, I am sure they were looking at, you know, what’s our mark-to-market value? What’s our historical value, what’s our hold-to-maturity value? So they then get that multi-dimensional perspective on their business,” he explained.
This article originally appeared in the April 11, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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