ESG could have saved Silicon Valley Bank

Think about the most important decisions that you've made. Would you have wanted more or less information? How about in mundane circumstances, whether that's deciding on a set of golf clubs or home appliances — or more serious matters, such as deciding on a babysitter or a school for your child?

A desire for more information is sensible. It's rare to ask for less information when making important decisions. Environmental, social and governance factors refer to a concept developed in the early 2000s by then-United Nations Secretary General Kofi Annan. His premise was that considering ESG factors — more data — could lead corporations to become better stewards.

Silicon Valley Bank, one of the nation’s largest banks, experienced a series of governance lapses that resulted in the mismanagement of interest-rate risk. Ignoring governance factors precipitated what could have caused another global financial crisis.

In March, regulators rescued SVB by protecting depositors through a liquidity facility, staving off more panic that could have led to a much longer series of bank failures.

An often-cited belief among detractors is that ESG is merely “nonfinancial factors” that are prioritized ahead of profits. This view overlooks the value of “both/and” with a self-limiting “either/or” constraint.

Three items are lost in this rhetoric. First, ESG is a separate concept from socially responsible investing, a values-based investment approach that originated in the 1800s and tends to prioritize social or environmental benefits.

Second, ESG factors are often of fundamentally material financial concern.

Third, awareness and assessment of ESG factors aren't mutually exclusive to seeking profits. Both can coexist. For example, a double-sided printer setting is almost standard across corporate America. This practice reduces the amount of ink and paper consumed, resulting in a lower printing expense. Lower expenses generally equate to greater gross profits.

Finally, market participants should note that non-quantitative factors aren't necessarily equivalent to nonfinancial factors. The SVB bankruptcy reflects the lack of adequate governance safeguards expected of a modern bank.

In 2019, the Federal Reserve warned SVB about its risk management systems by issuing a “matters requiring attention” citation. Through most of 2022, SVB did not have a risk officer; while some may perceive this as a nonfinancial factor, the reality is the contrary, as a risk officer’s primary role is to mitigate the risk that led to the bank’s downfall.

The very public case of SVB undermines total confidence in the banking system and highlights the benefits of awareness of ESG.

Such awareness is tantamount to fastening a seat belt when driving. While wearing a seat belt does not ensure surviving a collision, it surely increases the odds.

The recent bank failures shine an oft-neglected light on the “G” in ESG and present a sobering warning of how ESG factors can be deeply consequential in assessing risks. Globally, it's not surprising that ESG awareness has increasingly been adopted as a standard tool in the assessment of risks and opportunities for both corporations and investors.

Andrew Siwo is an adjunct assistant professor of public service at the Robert F. Wagner Graduate School of Public Service at New York University. He teaches an ESG investing course there and a similar course at the Jeb E. Brooks School of Public Policy at Cornell University.