As I write this, the dust from the collapse of Silicon Valley Bank (SVB) has yet to settle. Investors around the world are reexamining financial institutions for weakness. Banks like Credit Suisse and First Republic have been propped up while Signature followed SVB into failure. The situation is ongoing and developing; no one knows what the news will be tomorrow or next week, but for now, we must ask ourselves: what can we learn from SVB’s collapse?
What Happened?
The meltdown at SVB is a cautionary tale for organizations, highlighting the importance (and challenge!) of pursuing both short-term gains and long-term stability.
Despite the complexities that often accompany banking failures, SVB’s downfall can be traced back to some standard risks that were not effectively managed: interest rates, duration risk, and “tight coupling.”
Interest rate and duration risk are both well-known and clearly defined in finance. As Matt Levine has noted, these risks were not particularly complex; they were standard risks for a bank.
Tight coupling, however, is less understood. A concept introduced by Charles Perrow in his book “Normal Accidents,” tight coupling refers to systems where one event directly and quickly impacts another, leaving little room for error or intervention.
For example, you could think of a morning rush-hour freeway as a tightly coupled system: onramps and offramps, small windows of opportunity for lane changes, and thousands of cars filled with people trying to make it to work on time. Any accident affects all the cars behind it for miles, and leaves little room for all the people caught in the ensuing traffic to maneuver; they must either come to a screeching halt or end up part of the collision.
In the case of Silicon Valley Bank’s collapse, the herd behavior of venture capitalists exemplified a form of tight coupling. Venture capitalists are notorious for following each other’s lead. As existing clients spent their funds, and deposits from new venture capitalist money slowed to a trickle, questions about SVB’s health arose. Investors got spooked. The crisis gained press coverage, and many venture capitalists advised their portfolio companies to withdraw their funds from SVB. This triggered a domino effect, encouraging others in the ecosystem to do the same.
This tightly coupled environment left little buffer for adaptation or correction, amplifying the risk for SVB.
While these herd dynamics added a layer of complexity, the SVB collapse is a far cry from the many interactions at work in the bankruptcy of Lehman Brothers or the collapse of Bear Stearns. Those collapses were caused by obscure derivatives and an over-reliance on complex mathematical formulae. SVB’s collapse, on the other hand, involved basic bonds whose value could be modeled in a few cells on a spreadsheet.
If an organization is reaching for returns, it must equip itself to manage the risks it is taking on. Organizations must attend not only to the work they do, but to how they work.
Bold Action
Risk is the twin of return — the safest business is to not do anything, but when an organization decides to take action, it must effectively manage the risks associated with its ventures. This involves thinking both short-term and long-term.
Here are a few strategies you can employ to mitigate some of the unforeseen risks that might arise and avoid a complex, tightly-coupled disaster:
- Opportunistically pursue short-term gains while maintaining a long-term view. Move opportunistically when the chance presents itself, but support those movements with a longer-term, robust approach to risk and resilience. Much of business is about finding undervalued options. Amazon’s retail business barely broke even for years, but it allowed the corporation to start Amazon Web Service (AWS), which now generates outsized profits. Success begets growth, and Amazon has invested in the robustness of AWS. What began as a short-term move is now a huge contributor to the organization’s resilience and viability.
- Invest in people. This includes not only helping employees master the content of their work but also helping them improve their ability to effectively communicate, trust, and collaborate with their colleagues. Building strong relationships, leadership skills, and open communication channels can have a profound impact on an organization’s ability to manage risk.
- Drive strategy. Strategy is the path between chaos and complacency, a series of choices that help organizations choose what to do, and more importantly, what to say “no” to. By focusing on strategy, organizations can give executives the attention they need to prevent things from slipping through the cracks.
- Think inside the box. While some disasters are unexpected, others are known by all, but ignored. One antidote to this is to conduct a premortem. As described by Gary Klein, a premortem involves imagining that a project or initiative has failed and then working backward to identify the factors that contributed to the imagined failure. This exercise can help teams proactively address potential risks and increase the chances of success.
- Pay attention to warning signs. In SVB’s case, the risk committee and the Federal Reserve warned of potential problems. Ignoring these warnings proved disastrous for the bank.
Strengthening these approaches can not only improve short-term returns but can also contribute to the long-term health of an organization.
As we reflect on SVB’s downfall, it is essential to remember that no organization is immune to risk. However, by implementing the strategies and practices outlined above, businesses can increase their chances of navigating challenges and emerging stronger on the other side. The ability to adapt, innovate, and respond to the changing environment is a critical determinant of an organization’s long-term success.
In a world where short-term gains and long-term stability often seem to be at odds, the story of Silicon Valley Bank’s collapse serves as a poignant reminder of the importance of striking the right balance. By focusing on the people, teams, and organizational culture that underpin success, businesses can ensure they are well-positioned to face the challenges and opportunities that lie ahead.
The collapse of SVB demonstrates that even the most seemingly stable organizations can falter if they fail to manage risk effectively. Let this cautionary tale serve as a call to action for businesses everywhere to invest in their people, consider the long-term, conduct premortems and pay attention to warning signs as we move forward. By doing so, we can avoid many of the dangers created by complexity and tight coupling, and create a resilient and thriving corporate landscape capable of weathering the storms of an ever-changing global economy.
Want to learn more about managing risk in a world of increasing complexity? Download this free sample of Meltdown, by Chris Clearfield and András Tilsik.