When the pandemic led to a sudden drop in international enrolments, the inherent vulnerability of our universities was laid bare. Worryingly, a half are now undergoing a full-blown corporate-style reorganisation
Opinion: In March, the banking world was shocked by the abrupt failure of Silicon Valley Bank in the United States. Not long after, news emerged here about the financial troubles of several universities. When I delved into the current difficulties confronting our universities, I was struck by some uncanny parallels to the factors behind the bank’s collapse.
Our universities are heavily regulated, drawing parallels to the scrutiny seen in the banking sector. Yet, despite this intense regulatory oversight, our universities exhibit vulnerabilities reminiscent of Silicon Valley Bank and other US banks. In times of prosperity, they thrive. However, when hardships hit, their vulnerabilities surface, risking jobs, livelihoods, and taxpayer dollars.
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The similarities don’t end there: both serve the public in many ways, they are important for the economy, their fees and rates are regulated, and they are subject to debt restrictions. There is, however, a key distinction: legally, universities are not corporations. And rightly so, they should never be run as such. But here we are: alarmingly, half of New Zealand universities are currently undergoing a full-blown corporate-style reorganisation.
Silicon Valley Bank’s downfall originated from an unsustainable business model reliant on perpetually low interest rates and disproportionate investments in government bonds. The bank was caught out when rates started increasing, leading to large losses on its main investments.
Universities need to step up their game when it comes to reporting on risk and the effects of risk on viability
This scenario bears a resemblance to the business models adopted by our universities, which have long relied on an almost endless increase in student numbers. But when the Covid-19 pandemic caused a sudden plunge in international enrolments, their inherent vulnerability was laid bare.
Further examination of Silicon Valley Bank’s failure uncovered an underlying theme of weak regulation and governance, inadequate risk management, and a lack of proper supervision.
The challenges experienced by Silicon Valley Bank, along with other small and mid-sized US banks, were because it relied on banking rules that were basically left unchanged after the 2008 global financial crisis. These banks continued to operate almost as if the GFC never happened. This oversight made SVB’s collapse predictable, almost inevitable.
In stark contrast, European Union banks exhibited resilience in the face of the March mini-crisis. This is largely because of the comprehensive regulatory reforms the EU implemented after 2008. (I exclude Swiss bank Credit Suisse, as it is a non-EU bank, and not supervised by the European Central Bank.)
The primacy of governance
Why were the EU reforms so effective? Before 2008, banking regulators concentrated on banks’ activities, using a complex system of risk weights.
This system rewarded banks for investments in secure assets such as residential mortgages while penalising those venturing into riskier assets.
However, this approach proved to be convoluted, prone to gaming, and sometimes rigid and wrong: Greek sovereign debt was deemed to be risk-free, until it wasn’t.
The post-2008 bank rules are the result of a radical change in focus. Instead of getting tangled up in the intricate details of bank activities, they concentrate on a broader, more critical area: governance. The reformed rules are wide-ranging and cover risk management, stress testing, financial disclosures, living wills, and a prescriptive fit and proper person regime for bank executives. Regarding the governance of finances, the rules mainly focus on two areas: capital and liquidity.
This change in focus ensured banks were properly managed and proved to be more effective in maintaining financial stability.
This takes us to our first important lesson for New Zealand universities. They would benefit from a similar shift in focus, moving away from a top-down approach to managing the courses they offer to an approach that predominantly encompasses governance, specifically capital and liquidity management, risk management, and risk disclosures.
Stress testing should be on the cards as well. The focus should be first and foremost on resilience: the ability to withstand unexpected headwinds. Viability and profitability, or the lack thereof, should be treated as risk factors. These metrics are forward-looking, and for that reason ambiguous, which makes them difficult to manage, potentially easier to game.
Virtues of centralised supervision
The second lesson draws inspiration from the European Central Bank’s assertive regulatory role. Since 2014, it has become the single supervisor of Europe’s largest banks. A significant factor driving the need for centralised banking supervision in Europe was the inability of national supervisors to … supervise. They were preoccupied with maintaining a ‘level playing field’ between countries. In practice, this encouraged banks to expand their businesses. Some European banks opened subsidiaries abroad, to later discover they did so at their peril.
Another destabilising factor was national politicians’ influence on banking. The result was a banking system that wasn’t uniformly regulated or adequately controlled and allowed banks to run a de facto boom-and-bust business model at taxpayers’ expense.
Right now, the risk information that universities provide in their annual reports is inadequate—it doesn’t give employees, who are exposed to the university’s losses, or the public a clear picture of the challenges these institutions face
New Zealand’s university overseers, the Tertiary Education Commission and the Ministry of Education, should change their approach and become more assertive. A common pitfall apparently lies in managing overly optimistic enrolment forecasts. For instance, the University of Otago significantly miscalculated its enrolment predictions for 2022-23. Instead of the projected growth of 4.9 percent, enrolments fell by 0.9 percent.
When I worked in bank supervision, it was regular practice for us to ask banks for their revenue forecasts. Often, they were overly optimistic. In response, we’d send them back to the drawing board to come up with more realistic estimates. This is something the commission and the ministry should consider. With access to aggregate forecasted enrolment data, they should use this to better steer our universities’ budgeting processes.
Less is more here: currently, the Tertiary Education Commission relies on a complex framework with many metrics to assess university sustainability and viability. This is not helpful, because some institutions may use this complexity to play the commission against others. Instead, I suggest it focus on core metrics of financial health: capital and liquidity buffers. It’s these metrics that reveal the most about an institution’s viability and resilience, with their erosion often signalling impending financial distress, possibly culminating in a taxpayer-funded bailout.
The Tertiary Education Commission and the ministry could also consider implementing a gradually escalating sanctioning system for universities that taps into these two key buffers. This method, already integral to global banking regulations, could serve our universities by precluding a university financial crisis before it escalates beyond control.
Let’s talk about risks
The third lesson shines a spotlight on the importance of risk management as universities have become more complex. Governance structures should reflect this reality, comprehensively addressing a wider array of risks, such as strategic, regulatory, reputational, geopolitical, technological, and environmental, social and governance risks.
Right now, the risk information that universities provide in their annual reports is inadequate – it doesn’t give employees, who are exposed to the university’s losses, or the public a clear picture of the challenges these institutions face. Universities need to step up their game when it comes to reporting on risk and the effects of risk on viability.
Though these recommendations may appear to infringe on universities’ autonomy, they are intended to bolster resilience, viability, and adaptability. By learning from the recent banking crises and adapting proactively, New Zealand universities can break free from an inherently fragile business model that strongly focuses on ‘bums on seats’.
The changes suggested do not call for a radical overhaul, but smart changes in governance and supervision. The ensuing realignment of incentives among all parties involved in the tertiary education system is a crucial step towards ensuring the stability and continuity of our universities. As with the banking system, a stable university system is the result of efforts from both the universities and their overseers to govern well.
