With the events of the last few weeks shaking the banking industry, there will inevitably be some regulatory reaction. History has shown that in the wake of a financial crisis, one common reaction has been increased disclosure in financial statements. Most notably, in the wake of the 2008 credit crisis, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2010-20 in July 2010, and 2016-13 in June of 2016 (CECL). These updates require enhanced disclosures around credit quality in the loan portfolio and the allowance for loan losses.
The liquidity issues Silicon Valley Bank (SVB) and Signature Bank faced were a culmination of several factors, including rising interest rates and significant amounts of uninsured deposits. Accordingly, I believe that liquidity risk and interest rate risk will be the next areas of focus. Sources of revised rules include FASB and the Securities and Exchange Commission (SEC).
What I find interesting is that the concept of enhanced liquidity disclosure is not new. All FASB must do to get started is dust off its 2012 proposal which intended to require disclosures regarding liquidity risk and interest rate risk. This proposal never came to fruition due to concerns raised by key stakeholders that much of the information for public companies was already disclosed in SEC filings and that some of the disclosures contained forward-looking information, which would present auditing challenges. Also of interest is that FASB acknowledged this in the proposal and attempted to explain why they decided to propose this standard. Per FASB:
As further discussed in the basis for conclusions of this proposed Update, the Board acknowledges that the Securities and Exchange Commission’s (SEC) rules for management’s discussion and analysis (MD&A), among other requirements, also currently require certain disclosures about an entity’s liquidity risk and interest rate risk. However, the Board decided to propose the disclosures in this proposed Update primarily because of the strong demand by users for audited, standardized, and consistent disclosures that are complementary to those found today in MD&A of public entities. For nonpublic entities, these disclosures would provide incremental new information about these important risks.
For liquidity risk, the proposal would have required that the carrying amounts of classes of financial assets and financial liabilities be disclosed in a table, segregated by their expected maturities, including off-balance-sheet financial commitments and obligations.
As part of this disclosure requirement, the proposal stated, “for deposits, consideration should be given to expected run-off rates if a depositor has the contractual right to withdraw funds before a specified date.”
In addition, the proposal would have required the following interest rate risk disclosures:
- An interest rate sensitivity table that presents the effects on net income and shareholders’ equity of hypothetical, instantaneous shifts of interest rate curves
- Quantitative or narrative disclosures of the organization’s exposure to interest rate risk, including discussion about significant changes in the amounts and timing in the quantitative tables, and how the reporting organization managed those changes during the current period
If this proposal had become reality, might the fact that these disclosures were subject to public and audit scrutiny possibly have surfaced some of the issues that caused the liquidity crisis?
As noted above, I think we can all agree that one of the causes of the liquidity crisis was the large amount of uninsured deposits held at these institutions. But was deposit concentration also another cause of the liquidity issue? Did the SEC intend to acknowledge this in their 2020 rewrite of Guide 3, which provides additional disclosures for public banks to make in their 10-k? Let’s take a look.
The 2020 revisions to Guide 3 included the requirement to disclose uninsured deposits. But the wording the SEC used when discussing the proposal in the Background of the Deposits section contained another potential disclosure item.
Disclosures about significant amounts of deposits from a small number of depositors or certain types of deposits, such as uninsured deposits, could provide investors with insight as to the registrant’s reliance on particular sources of funding and risks related to those sources of funding.
Why is this so interesting? The only mention of providing disclosure regarding significant amounts of deposits from a small number of depositors is in the above paragraph. It was never proposed as a disclosure, never mentioned elsewhere in the proposal. With news outlets reporting that SVB had depositors with significant deposits, would a disclosure intended to address this issue have put more focus on the risk and possibly led to mitigation prior to SVB’s collapse? I certainly think a disclosure like this will be contemplated.
We may never know the answers to the questions raised above, but I am confident that renewed discussions regarding enhanced disclosures around liquidity and interest rate risk will take place. And if I were a betting man, my money would be on the FASB already having the Pledge and dust rag ready.
