Hear no EVE, see no EVE

As with the most illustrious of history’s financial collapses, Silicon Valley Bank’s implosion has been depicted as a tale of hubris. Yet rather than wilful arrogance, it is a different banking vice that emerges from the Federal Reserve’s chronicle of SVB’s failings: insouciance.

The bank buckled under the weight of the Fed’s interest rate hikes over the past 12 months, which devalued the assets on its balance sheet as market yields surged. It was a failure to manage what the Basel Committee on Banking Supervision calls interest rate risk in the banking book (IRRBB), which banks should monitor by simulating the impact of rate shifts on two key indicators: net interest income (NII) and economic value of equity (EVE).

EVE is – in the Basel Committee’s own words – “the net present value of notional repricing cashflows for the whole banking book, excluding the bank’s own equity capital.” EVE-based simulations aren’t a substitute for NII-based testing, rather they complement it, taking a longer-term view of the impact of rate shocks on cashflow generation.

In its post-mortem, the Fed chastised SVB’s management for its tunnel vision, saying it “was focused on a short-term view of [interest rate risk] through the NII metric and ignored potential longer-term negative impacts to earnings highlighted by the EVE metric.” Though the bank had nominal EVE limits in place, persistent breaches of which were communicated to the risk committee, “there is no evidence the full board” was aware of these.

SVB’s handling of IRRBB was particularly cavalier. Among other things, it conspicuously omitted EVE sensitivity figures from its Q4 2022 10-K filing with the Securities and Exchange Commission, despite having hitherto disclosed them every quarter.

But in disclosures for most US banks, the EVE measure keeps playing second fiddle to the NII outlook. Outside the global systemically important banks (G-Sibs), only 11 banks with $50 billion or more in assets disclosed EVE test results as of end-March. Another 11 referenced EVE-based controls without disclosing actual figures, with three not mentioning EVE at all.

The US’s implementation of Basel’s IRRBB rules does leave much to the discretion of executives, only requiring banks to use and disclose either metric, rather than both. Supervisory guidelines from the Office of the Comptroller of the Currency restricts Basel-like EVE testing to categories I and II organisations – the G-Sibs, plus Northern Trust.

Behind closed doors, US supervisors can and will ask banks to up their IRRBB monitoring game if necessary. However, unsealed correspondence between the Fed and SVB shows that while the regulator ordered the bank to overhaul its IRRBB models last November, it did not explicitly direct its attention to EVE – despite the findings in last month’s report.

US supervisors are no doubt more alert to the need to monitor IRRBB through multiple indicators than two months ago. But considering one of the main impediments to taking proactive measures around SVB, in the Fed’s own admission, was a lack of resources at the regulator, one has to wonder if the easiest step is not to finally mandate standardised, wider-encompassing IRRBB disclosures.