Determining the validity of the going concern assumption is an important consideration across all sectors. However, it holds particular significance within the banking industry in the context of the relatively recent failure of Silicon Valley Bank (SVB). 

With that in mind, the Financial Reporting Council’s (FRC) ongoing consultation on revisions to its “Guidance on the Going Concern Basis of Accounting and Related Reporting” is particularly topical.

The draft guidance is intended to help companies in performing going concern assessments and in preparing company-specific disclosures about their going concern conclusions and how they were reached. Its objective is to allow investors to understand a company’s exposure to, and plans to navigate, solvency and liquidity risks.

The collapse of SVB in March 2023 sparked a global discussion about risk management, transparency and the resilience of financial institutions. Just weeks out from the bank’s eventual demise, audited financial results were released to market that did not indicate in any substantive way the critical risks faced by the firm’s going concern assumption. 

Identifying material uncertainties

According to the FRC’s draft guide, directors are expected to evaluate not only the likelihood and impact of potential adverse events but also the effectiveness of any mitigating actions available. SVB’s failure is a case in point: it was caused by unforeseen liquidity pressures following concerns over the value of the bank’s long-dated securities and its ability to manage in a higher interest rate environment. 

Admittedly, it is always easier in hindsight to assess whether these factors constituted material uncertainties sufficient to cast significant doubt on the company’s going concern status. Nonetheless, the guide highlights the importance of accurately sizing and scaling uncertain events. It also emphasises the need for directors to assess how effectively management can address and mitigate such risks through timely intervention.

More detailed disclosure?

Reflecting on SVB’s experience begs the question whether more detailed disclosures about its reliance on long-term securities and exposure to interest rate fluctuations might have altered the course of events. 

Could a more proactive approach in communicating these risks have enabled stakeholders to better manage the crisis? The difficulty there is that modern banking relies heavily on public confidence in its business model, requiring a delicate balance between appropriate levels of transparency and the need to avoid unnecessary market panic.

Company-specific judgements and assumptions

The SVB case also highlights the potential dangers of relying on generic assumptions in financial reporting. The guide emphasises the importance of disclosing company-specific judgements and assumptions, especially those that significantly impact the going concern assessment. 

SVB’s reliance on a concentration of large corporate depositors from the venture capital and tech start-up scene exacerbated the run on the bank, with well-connected depositors creating an environment ripe for panic and herd mentality. The guide reinforces the need for banks to carefully consider how their specific judgements and assumptions might expose them to vulnerabilities, ensuring that such risks are clearly communicated and managed.

Linking solvency and liquidity

The interconnectedness of solvency and liquidity risks was evident in the SVB crisis, which subsequently raises questions about how these risks should be disclosed and managed.

In the final days of the firm’s demise, the demands by depositors for cash withdrawals meant the only option was to dispose of long-dated bonds at prices well below book value. These disposals would have negatively impacted upon the capital position of the firm. It soon became apparent that the firm’s liquidity problem would also become an issue of solvency (or lack thereof). The guide encourages companies to consider solvency and liquidity as principal risks that could affect their going concern status.

Forward-looking risk assessments 

A key factor in SVB’s collapse was its apparent failure to anticipate and plan for adverse economic conditions. The guide emphasises the importance of forward-looking risk assessments and scenario analysis in financial reporting.

It’s fair to say that the banking sector is already more advanced in developing robust stress testing and exploring adverse scenarios. However, the SVB example illustrates that there is always more that can be done in that regard. 

An area that perhaps requires further challenge is the veracity of any management actions assumed to be available during stress scenarios. How does management get comfortable with the effectiveness of such actions and their ability to implement them over short timeframes, often while under duress? 

Strengthening governance 

SVB’s downfall highlighted governance weaknesses, particularly in risk oversight. The guide reiterates the responsibility of directors to ensure that financial statements present a true and fair view, with adequate disclosures on going concern and material uncertainties.

In this context, banks might reflect on how to strengthen their governance frameworks to ensure comprehensive risk assessments and transparent reporting. What role should boards play in reviewing and challenging management’s assumptions and judgements? How can alignment between the board’s understanding of risks and what is disclosed in financial statements be achieved?

The collapse of Silicon Valley Bank serves as an important reminder of the importance of transparency, rigorous risk management, and strong governance in the financial sector. While this recent exposure draft provides a useful framework, the challenge lies in applying these principles effectively to build greater resilience against future shocks. 

The consultation on the FRC’s exposure draft is open until 28 October 2024.

Reuben Wales, Head of Financial Services at ICAEW