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Are Guardians of Investors Letting Them Down?

The banking crisis over the past week brings to the fore once again the prominent question, why are those tasked with raising any red flags of impending risks not doing so?

Photo by Oyemike Princewill / Unsplash 

Post the 2008 financial crisis, ratings agencies received a lot of flak for not having assessed the risks from mortgage-backed securities, which were rated as top investment grade.

Well, not until it was a full-blown crisis at least.

The guardians of investors remain behind the curve and react to an event, rather than pre-empt any risks and warn investors appropriately.

After the demise of Silicon Valley Bank (SVB), the largest US bank collapse since the 2008 financial crisis, and Signature Bank, international financial markets have been choppy.

The closure of those three US banks last week resulted in a market meltdown, with global financial stocks losing over US$250 billion in under two sessions between Monday and Tuesday.

Regulators stepped in and tried to comfort investors by announcing that deposits were secure, and offered lifelines, which helped markets recover somewhat.

Are Ratings Agencies Behind the Curve?

On Tuesday, global ratings agency Moody's cut its ratings for the US banking sector to "negative" from neutral, citing the deteriorating outlook for American banks.

The collapse of SVB and two other major US banks had credit agencies scrambling to re-evaluate their ratings.

Moody's ratings agency cited contagion fears and deteriorating scenarios for its outlook cut.

On March 4, Moody's downgraded Silvergate Capital Corp's deposit rating. But that was after the crypto-focused bank raised concerns and its survival.

So was Moody's too late and behind the curve in rating banks?

Should it not have raised the red flags in the banking system well ahead of the collapse?

Just days ahead of SVB's collapse, it was among the best-rated banks by Moody's.

The now-defunct bank had an 'A' rating which is among the top ratings, suggesting a low credit default risk

But on March 10, 2023, SVB's collapse raised questions about the prestigious agency's credibility, again.

The ratings agency failed to assess the intrinsic value of SVB and its ability to repay its lenders, drawing flak from investors and experts alike.

The periodic system failures include the 2008 financial crisis when global rating agencies, including Moody's, failed to spot problems in the financial system.

While investors and depositors could not have seen the collapse coming, ratings agencies, which are expected to flag financial risks should have.

Auditors in Focus Amid Banking Crisis

Just 14 days before SVB's failure, KPMG, one of the "big four" accounting firms in the world, gave the bank a clean bill of health.

Eleven days after the accounting company gave its stamp of approval on the bank's audit, Signature Bank collapsed.

So the questions on what KPMG knew and didn't know about the two banks' finances are inevitable.

The parent company of Silicon Valley Bank, SVB Financial Group, had an audit report signed on February 24 by KPMG.

But on the heels of that audit report, on March 10, regulators took over the bank because of a withdrawal rush that may have left it without enough funds.

Even while Signature Bank didn't have the same balance-sheet problems as Silicon Valley Bank, it too suffered a run last week and was seized by authorities on Sunday. The audit was officially completed by KPMG on March 1.

Signature's increased deposits were wiped out as the cryptocurrency market began to crash.

Clients were more inclined to bail out at the first hint of problems since a big portion of their deposits were not protected by insurance.

On the other hand, it had a better ability to reimburse depositors because it hadn't declared the same losses on its investments as Silicon Valley Bank.

Lynn Turner, who was chief accountant of the Securities and Exchange Commission (SEC) from 1998 to 2001, said "common sense tells you that an auditor issuing a clean report, a clean bill of health, on the 16th-largest bank in the United States that within two weeks fails without any warning, is trouble for the auditor."

Increased Scrutiny?

The auditing company may be subject to additional scrutiny.

Shares of First Republic Bank, which KPMG also audited, plunged 76% despite the firm receiving a liquidity infusion from JPMorgan Chase and the Federal Reserve.

But the audits of those banks were for the year 2022, so the troubled period, being this year, was not in KPMG's purview.

Still, auditors have a responsibility to draw attention to potential threats facing the businesses they examine.

In addition, they should bring up crucial concerns that arise after a company closes their records but before the audit is finished.

Broadly, the so-called guardians of investors have failed them.

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