real time insights

Why real-time transparency could have avoided the SVB bank run

The lack of transparency in the traditional financial system has long caused concern among economists. “A bank’s financial statements provide a depiction of reality, not reality itself,” wrote Robert Bushman in his paper on transparency and bank stability

Every quarter, the industry is provided with a snapshot of financial institutions’ health, isolated within the confines of a three-month historical period. That which is good is highlighted, while other areas are swept conveniently to one side, on view but only to those who have an inkling of what to look for. 

Robert M Bushman, Professor of Accounting
Robert M Bushman, Professor of Accounting

“The properties of transparency derive from how closely a bank’s true underlying fundamentals map into reported accounting numbers,” continued Bushman. “The application of accounting rules to specific economic situations often allows substantial scope for privately informed bank managers to exercise their own judgment.”

“Accounting discretion is a double-edged sword. On the one hand, discretion creates scope for informational benefits by facilitating the incorporation of private information into banks’ accounting reports. On the other hand, it increases the potential for opportunistic accounting behavior by managers that can degrade bank transparency.”

Six months ago, the banking system was reminded of transparency’s value. 

SVB: A case study in banking transparency

Economic conditions had not been kind to banking, particularly for those focused on the tech ecosystem. Rising rates and a slowdown in start-up funding had left Silicon Valley Bank vulnerable, and a series of long-term investments weighed heavier as deposits continued to slide. 

The bank, in an attempt to improve liquidity, announced in early March its intention to undergo a balance sheet restructuring involving the sale of assets. To a customer base of tech entrepreneurs already within an uncertain environment, the risk to their uninsured deposits was too high. It was enough to spark a catastrophic bank run.  

“While the proximate cause of SVB’s failure was a liquidity run, the underlying issue was concern about its solvency,” stated Michael Barr, Vice President of Supervision in The Federal Reserve’s supervision report of SVB. 

The report, published in late April, marked “the first step” in adjusting the financial system to learn from their mistakes. In summary, Barr equated its failure to four things: 

  1. A failure to manage risks from SVB’s board of directors.
  2. An underestimation by supervisors of the bank’s vulnerabilities as it grew.
  3. A lack of sufficient action when the vulnerabilities were eventually identified.
  4. A shift in supervisory policy, adjusting the approach of regulators. 

With at least two of the causes rooted in a lack of transparency between the management, the board, and the supervisory eye of regulators, it poses a question of whether the traditional approach to quarterly financial reporting is sufficient.

Some say that with real-time insights, issues would have been clear all along. 

Tokenized Financial Contracts could provide Real-Time insights. 

“Today, information moves in real-time, but financial information is stuck,” said Peter Lyons, Head of Partnerships at Nucleus Finance. He explained that tokenizing financial contracts could move financial reporting away from the quarterly insights into an institution’s cash flows. 

“It allows accountants and CFOs to have a direct view of the live cash flows associated with that particular contract,” he said.  

RELATED: Open finance and financial contract tokenization – A crossover to supercharge markets

Building on top of the ACTUS standards, which mathematically define the algorithm of financial contracts, a digitally native financial contract can be created and brought on a blockchain in the form of a smart contract. The financial contract is then tokenized. Unlike the tokenization of real-world assets, it includes a view into the cashflows associated with the product. 

“There’s a lag between the time that cash flow information is generated and the time it actually gets reported…If you bring assets on-chain with a standardized definition of their cashflows, it doesn’t require quarterly audits and estimations…the financial results that you get are deterministic, meaning they’re actually the cash that moves, not an estimation of what cash moved, shown on a daily basis.”

He explained that, in the case of SVB, this could have made a difference to their outcome. Insight into the cashflows surrounding their assets would have shown clear proof of the issues.  “People would have seen from day one that there was a problem,” he said, explaining that it could also have impacted how the problems were handled.  

 “Regulators are looking at backward-facing information,” said Lyons. “They can’t really get a view of where they are, much less where they’re going. The same with investors….For investors and regulators, it is imperative to have as much real-time clarity as possible.”

Bushman discusses the benefits of the quarterly buffer time, stating it could allow for longer-term investment strategies without the risk of investors’ negative response, thus improving bank stability. However, he also writes that increased transparency could improve market confidence in institutions.

“Transparency can mitigate indiscriminate panic and rollover risk by reducing the uncertainty of depositors and other short-term lenders about the solvency of individual banks.”

In the case of SVB’s failure, a situation caused by an underlying issue of solvency concerns, according to Barr, this confidence could have made all the difference.

  • Isabelle Castro Margaroli

    Isabelle is a journalist for Fintech Nexus News and leads the Fintech Coffee Break podcast.

    Isabelle's interest in fintech comes from a yearning to understand society's rapid digitalization and its potential, a topic she has often addressed during her academic pursuits and journalistic career.