Banking » Should CFOs make bank diversification a priority?

Should CFOs make bank diversification a priority?

The failure of Silicon Valley Bank this year has been a cautionary lesson for treasury teams about putting all their eggs in one basket when depositing funds. SMEs have learnt their lessons and are now diversifying their pool of banks

Should CFOs make bank diversification a priority?

On March 14, 2023, the largest US bank failure since the 2008 global financial crisis occurred as regulators closed Silicon Valley Bank (SVB) and the US government-backed fund that protects depositors was stretched to its lowest since 2015.

After record levels of investment between 2020 and 2021, SVB was a favourite among tech start-ups that deposited huge amounts of money in the bank.

As rumours started swirling about the bank, customers started pulling their money out but as those funds were tied up in long-term instruments, the bank couldn’t meet the scale of withdrawals. In the end, depositors pulled a staggering $41bn out of the bank, leading to its ultimate demise.

This whole affair has called into question the ways in which CFOs and treasurers manage their deposits and mitigate risks associated with a single point of failure.

Even though the Federal Deposit Insurance Corporation (FDIC) has protected all deposits with SVB, and other failures such as New York’s Signature Bank, to strengthen the banking system, treasury teams still had to deal with huge amount of uncertainty and risk.

A bank failure can cause serious short-term liquidity issues which can affect vital expenditures such as payroll and supplier invoices, even if it is only for a few days.

While in this instance bank deposits have been protected, this won’t always be the case and the crisis illustrated to businesses that banks can fail. Thankfully businesses are increasingly aware of the need to spread their deposits among several banks and financial institutions.

Who to diversify to?

Our research found that CFOs and treasurers at SMEs with cross-border operations are taking action to protect their businesses. Three-quarters of respondents are now considering diversifying their banking partners in the coming months, while 6% already have done so.

Treasury teams that are not already looking to diversify with several banks should be looking to spread deposits with a minimum of three banks. This means that should a bank go into difficulty, they have cash at hand to make vital payments, while not having to manage too many banking partners.

Unsurprisingly, the banking crisis has also massively impacted treasurers’ trust in the banking sector and as a result, an increasing number of businesses are looking into other solutions with 92% having conversations about virtual account solutions.  When choosing a new provider, treasurers also need to do their due diligence to make sure their deposits will be protected.

What should SMEs ask their banks?

To make sure that each of these banking partners has strong balance sheets and is also risk averse, it is important that treasury teams regularly question their banks and fintech partners, particularly regarding their investment policies.

This was a critical error in the SVB case. A bank which is serving start-up tech firms shouldn’t be investing in longer-term US government bonds which take a decade to yield results. If businesses had investigated this more closely, they likely would have seen the risk and moved deposits elsewhere before the trouble started.

Only half of SMEs always enquire about the name and or credit rating of their provider’s safeguarding partner. While 47% sometimes enquire but not always, only 3% said they don’t do it at all.  It is vital that treasurers always ask to enable a better understanding of their bank or fintech’s investment policies.

CFOs and treasurers should also be more suspicious of banks offering above-the-market yields. Silicon Valley Bank was offering positive yields on euro accounts when interest rates were negative. This should have raised suspicion as there is no such thing as a free lunch. When offered yield above risk-free assets then you are most likely taking on additional risk.

Follow the markets

As we are in an uncertain economic period, CFOs should keep a closer eye on the performance of their banks and regularly question investment policies.

It is vitally important that CFOs continue to follow the markets. If a situation were to arise where a bank’s share price drops by 50% on a Wednesday, treasurers should act as if that bank would be closing on Saturday and withdraw their money.

If you’re in the minority which isn’t looking to diversify banking partners, you should reconsider this position.

Andrew Bailey, governor of the Bank of England, said SVB’s crisis was, “the fastest collapse from health to death” since the UK’s Barings Bank failed in 1995 after suffering heavy losses resulting from fraudulent investments.

While many got away with it this time, without action they might not be as lucky next time.

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