The recent collapse of Silicon Valley Bank (SVB) – the failure of the biggest US lender since the 2008 global financial crisis – has created waves across the global banking system. The subsequent collapse of another US institution, Signature Bank, the US$30 billion (£24.5 billion) lifeline given to First Republic Bank and the latest turmoil affecting Credit Suisse has dragged down European bank stocks.
While the Swiss bank was rescued by its competitor and markets are starting to recover, it too early to say whether when or how recent nerves about the global banking sector might end. But no matter when the US bank failures and European bank panic end up, some lessons must be learned in the UK. In particular, increasing corporate governance and corporate social responsibility (CSR) requirements could help ease future banking failures.
The first version of the UK Corporate Governance Code (the code) was published in 1992 by the Cadbury Committee. It defined corporate governance as “the system by which companies are directed and controlled,” with boards of directors holding responsibility for this.
A large body of academic studies have shown a positive relationship between corporate governance and company performance. Even then, many companies still do not pay enough attention to this issue.
SVB is a good example. Only one member of its board had previously made a career in investment banking, according to reports, with other members coming from sectors such as healthcare and consultancy.
This goes against principles issued by the Basel Committee on Banking Supervision – a global banking standard setter – that board members should have a range of knowledge and experience in relevant areas. This includes financial analysis and reporting, financial stability, information technology, risk management, regulation and corporate governance.
Similarly, the reason the collapse of SVB hit Swiss bank Credit Suisse much harder than others was almost certainly due to recent material weaknesses that had been revealed in its internal controls and risk management procedures. These important governance measures help banks prevent and manage issues that might affect company stability.
Credit Suisse has already endured many scandals in recent years, including high profile departures, money laundering charges and spying allegations. All of this indicates a failure in its corporate governance. So, recently rescued banks such as Credit Suisse and First Republic, as well as other banks that remain safe so far, need to reassess and strengthen this area of their businesses. This includes looking at internal controls, risk management and protections for investors.
What is corporate social responsibility?
CSR and corporate governance are two sides of the same coin. They encourage companies to integrate social and environmental concerns in their business operations and interactions with their stakeholders such as customers, employees, suppliers and shareholders.
CSR can also help banks maintain financial stability, especially in times of crisis. Research shows that during the COVID-19 pandemic, banks with higher levels of environmental and social activities were more financially stable. Similarly, right now banks also need to prioritise financial stability. They could do this, for example, by lowering their exposure to credit and liquidity risk to protect their customers, investors and employees – and by extension, the wider economy.
Other research also shows that investors become more tolerant and more lenient towards banks with stronger CSR after an economic recession. This can reduce the likelihood of extreme devaluations of banking stocks – such as that experienced by Credit Suisse before its rescue by UBS. This also helps banks manage unexpected and long-term risks after times of crisis.
Lessons for government and financial regulators
Following the SVB and Signature Bank collapses, the US government stepped in and took decisive action to protect depositors and the banking system. The UK government and the Bank of England also swiftly facilitated the sale of SVB UK to HSBC. Then the European Central Bank (ECB) provided emergency support to Credit Suisse and helped broker a deal for the bank’s rival to buy it for £2.6 billion. All of these quick actions will have helped to shore up confidence in the banking sector to some extent – even if the immediate reaction was negative.
But regulators have a responsibility to protect markets from a crisis, not just rescue their participants. Last December, the UK government announced plans to overhaul financial sector regulation under the Edinburgh Reforms. This is an attempt to spur growth following Brexit and the COVID-19 lock downs. But the most recent turmoil in the global banking sector should cause all governments to rethink any reforms or changes to financial sector rules very carefully.
Banking reforms could make the UK a sustainable finance hub, but also threaten financial stability
In particular, given the importance of corporate governance, especially in times of crises, regulators need to update corporate governance codes and policies. The UK’s current Corporate Governance Code requires a board and its committees to have a combination of relevant skills, experience and knowledge. Although the code calls for at least one member with recent and relevant financial experience, that threshold should perhaps be lifted for banks – especially since their fortunes are so closely tied to the businesses and households that they lend to.
Research shows that the regulatory environment, as well as an industry’s level of self-regulation and an organisation’s commitment to maintaining an open dialogue with relevant stakeholders, were crucial factors in whether banks reported on CSR. Those that did so largely survived the 2008 global financial crisis.
Regulators need to work with professional bodies, bank investors and the banks themselves to strengthen CSR reporting and ensure it fulfils its potential in maintaining banks’ financial stability during the current crisis.
Erwei (David) Xiang received funding from Accounting and Finance Association of Australia and New Zealand (AFAANZ) on a relevant research project.
He is a member of European Accounting Association (EAA), British Accounting and Finance Association (BAFA), and AFAANZ.