Collapse of Silicon Valley Bank

1. Explain the concept of risk concentration and its role in SVB's collapse. How did the high
level of concentration in both assets and liabilities contribute to the bank's failure?

Answer: First, SVB is a classic example of the danger of a high level of concentration, both
in terms of assets and liabilities, in one bank. It is a classic example of bad diversification of
risks. It is an illustration of ancient advice in financial science: Do not put all your eggs in one
basket. Just look at this data: most of the sources of funds (liabilities) (67 percent) were
concentrated on technology companies. On the asset side, around 58 percent was invested in
US government bonds and mortgage-backed securities (MBS).

The Fed’s funds rate will rise to 5.75-6 percent. Rising interest rates have caused the value of
bonds and MBS to fall. As a result, the value of SVB's assets suffered a significant decline.

On March 8, 2022 SVB sold its assets amounting to $21 billion, resulting in a loss of $1.8
billion. SVB incurred losses. Seeing this condition, the depositors were worried and started
withdrawing their money from SVB. As a result, SVB was unable to pay back the money of
its depositors.

Concentration in Assets

Lack of diversification: Concentration in assets indicates a lack of diversification in SVB's

investment portfolio. By having a significant exposure to a specific sector or type of asset, the
bank became highly susceptible to the risks associated with that particular sector. If the sector
experienced a downturn or faced significant challenges, SVB's asset value could have been
severely impacted.

Amplification of sector-specific risks: When a bank concentrates its assets in a specific sector,
it amplifies the potential risks associated with that sector.

Limited ability to withstand shocks: The lack of diversification in SVB's asset portfolio
reduced the bank's ability to absorb unexpected losses. If the concentrated assets experienced
a significant decline in value, SVB might have faced difficulties in covering its losses,
resulting in financial strain and potential insolvency.

Concentration in Liabilities:
Dependency on specific funding sources: If a bank heavily relies on a single or a few sources
of funding, it becomes vulnerable to disruptions in those sources. If the funding dries up or
becomes more expensive, the bank may struggle to meet its financial obligations and maintain
liquidity.

Counterparty risk: Concentration in liabilities also increases counterparty risk. If a significant

portion of SVB's liabilities is concentrated with a particular counterparty, such as a large
depositor or institutional investor, the bank becomes highly exposed to the creditworthiness
and potential default of that counterparty. If the counterparty fails or withdraws its funds,
SVB may face liquidity challenges or even insolvency.

the high level of concentration in both assets and liabilities made SVB more susceptible to
sector-specific risks, limited its ability to withstand shocks, and increased its dependency on
specific sources of funding.
2. Analyse the role of risk management, regulation, and supervision in preventing banking
crises. What measures could have been taken to mitigate the risks faced by SVB and ensure
financial stability?

Answer: Poor risk management, because both assets and liabilities were highly concentrated.
There was a mismatch in the duration of assets and liabilities; short-term funds were used for
long-term asset investments, in addition to weak regulation and supervision.

Risk Management
Effective risk management practices within banks are essential for identifying, assessing, and
mitigating potential risks. Including:

 Risk identification and assessment: Banks need to have robust risk management
frameworks in place to identify and evaluate various types of risks, such as credit
risk, market risk, liquidity risk, and operational risk.

This enables them to understand their risk exposures and take appropriate measures to
manage and mitigate those risks.

 Risk diversification and portfolio management: Banks should adopt strategies that
promote diversification in their asset portfolios, reducing concentration risk.

Diversification across sectors, geographic regions, and asset classes helps mitigate the
impact of adverse events in any specific area.

 Stress testing and scenario analysis: Banks should conduct regular stress tests and
scenario analyses to assess the potential impact of adverse events on their financial
health.

This helps identify vulnerabilities and evaluate the adequacy of capital buffers and
risk management practices.

Regulation and Supervision

regulatory and supervisory frameworks are critical for maintaining stability in the banking
sector. Key measures include:

 Capital and liquidity requirements: Regulators should set prudential standards that
mandate banks to maintain adequate capital and liquidity buffers to withstand
potential losses and liquidity shocks.

Capital adequacy ratios, such as the Basel III framework, ensure banks have
sufficient financial resources to absorb losses and maintain solvency.

 Risk-based supervision: Supervisory authorities should conduct regular assessments

of banks' risk management practices, internal controls, and overall financial health.

Risk-based supervision focuses on identifying and addressing systemic risks,

monitoring compliance with regulations, and taking corrective actions when
necessary.

 Macroprudential policies: Authorities should employ macroprudential policies to

mitigate systemic risks and prevent excessive credit growth and asset price bubbles.
 Mitigating Risks Faced by Silicon Valley Bank:

 Enhanced risk management practices: SVB could have implemented more robust risk
management frameworks to identify and assess risks associated with concentrated
assets and liabilities.

This would involve diversifying its asset portfolio and reducing reliance on specific
funding sources.

 Stricter regulation and supervision: Regulators and supervisory authorities should

have closely monitored SVB's risk concentrations and taken appropriate actions, such
as imposing higher capital requirements or liquidity buffers to mitigate potential
vulnerabilities.

 Improved transparency and disclosure: SVB should have provided clearer and more
comprehensive information to stakeholders regarding its risk exposures, financial
health, and risk management practices.

3. Discuss the concept of a bank run and its implications for the stability of the financial sector.
How did the fear of SVB's collapse lead to a self-fulfilling prophecy, triggering a chain effect
with other banks?

Answer: A bank run refers to a situation where a large number of depositors simultaneously
withdraw their funds from a bank due to concerns about the bank's solvency or liquidity.

Implications for Financial Stability

 Liquidity crunch: A bank run can quickly deplete a bank's available liquid assets,
causing a liquidity crunch. As depositors rush to withdraw their funds, the bank may
struggle to meet the demand for cash, potentially leading to insolvency.

 Contagion risk: A bank run at one institution can create a contagion effect, spreading
to other banks in the system. Fear and panic can lead depositors to withdraw funds
from other banks, even if those banks are financially sound. This contagion effect can
erode trust in the entire banking system and undermine financial stability.

After SVB collapsed, Signature Bank followed. Then Credit Suisse, which had been in
trouble for some time, was taken over by UBS.

The world's Central Banks, especially The Fed, are currently in a dilemma. On one hand, they
should do monetary tightening by raising interest rates. On the other hand, there is concern
that interest rate increases will cause a stability problem in the financial sector.

The European Central Bank, for example, last week kept raising interest rates and gave
forward guidance to guide the market rather than maintaining the stability of the financial
sector. However, the problem is, there is a risk of asymmetric information that may be
sensitive to monetary policy.
 In the case of SVB's collapse, the fear surrounding the bank's viability and potential
insolvency led to a self-fulfilling prophecy, triggering a chain effect with other banks. The
following process unfolded:

 Fear and loss of confidence: News or rumors about SVB's financial difficulties
created fear and loss of confidence among depositors.

 Liquidity pressures: As depositors rushed to withdraw funds, SVB faced liquidity

pressures, making it increasingly difficult for the bank to meet the demand for cash.

 Negative spiral: The withdrawal of funds from multiple banks led to a negative spiral,
putting strain on the liquidity and solvency of those institutions.

The chain effect resulting from the fear of SVB's collapse demonstrated how widespread
panic and loss of confidence can lead to a self-fulfilling prophecy. As depositors reacted to
the perceived risk, their actions put pressure on the banks, exacerbating the actual risk and
contributing to the instability of the financial sector.

4. Evaluate the potential consequences of the collapse of SVB, Signature Bank, and Credit
Suisse on the global financial system. How do these interconnected failures increase the risk
of a banking crisis and a potential repeat of the 2008 global financial crisis?

Answer: The collapse of SVB, Signature Bank, and Credit Suisse, if they were to occur, could
have significant consequences for the global financial system. The interconnected failures of
these banks increase the risk of a banking crisis and raise concerns about a potential repeat of
the 2008 global financial crisis.

 Contagion and systemic risk: The interconnectedness of the global financial system
means that the failure of one bank can have ripple effects on other financial
institutions. If SVB, Signature Bank, and Credit Suisse were to collapse, it could
trigger a contagion effect, leading to a loss of confidence in the broader banking
sector.

 Liquidity and funding strains: The collapse of these banks would create liquidity and
funding strains in the financial system. Banks rely on interbank lending and funding
markets for liquidity and short-term financing. If these banks fail, it could lead to
disruptions in these markets, making it harder for other banks to access necessary
funding.

 Loss of trust and confidence: Bank failures erode trust and confidence in the financial
system. The collapse of prominent banks like SVB, Signature Bank, and Credit
Suisse would shake investor and depositor confidence, leading to increased caution
and potential capital flight.

 Regulatory and policy responses: The collapse of these banks could prompt regulators
and policymakers to implement stricter regulations and oversight measures. The 2008
financial crisis led to a wave of regulatory reforms aimed at enhancing financial
stability and risk management. If similar failures occur, it could trigger further
regulatory interventions, potentially impacting the operations and profitability of
banks globally.
5. Assess the potential impact of the collapse on Indonesia's economy through both the financial
and trade channels. How can common creditors and the actions of international investors
influence capital flows and economic stability in Indonesia?

Answer: The collapse of banks, such as SVB, Signature Bank, and Credit Suisse, can have
potential impacts on Indonesia's economy through both the financial and trade channels.
Additionally, the actions of common creditors and international investors can influence
capital flows and economic stability in Indonesia.

If investors in SVB have investments in the Indonesian financial market, they will study their
portfolio. If they suffer losses, it is not impossible for them to reduce their portfolio in
Indonesia, even though Indonesia has nothing to do with the origin of the shock.

If the indicators they use show worrisome signs, they will pull the portfolio. In this context,
Indonesia's risk is relatively small because the portion of foreign ownership in government
obligations is relatively small (less than 15 percent).

Financial Channel:
Capital flight: The collapse of major banks can trigger capital flight from emerging markets,
including Indonesia. Investors may become risk-averse and withdraw their investments,
seeking safer assets or jurisdictions. This can lead to a significant outflow of capital from
Indonesia, putting pressure on its financial system and currency.

Market disruptions: Bank failures can lead to market disruptions, volatility, and declines in
asset prices. This can affect the valuation of Indonesian financial assets, including stocks and
bonds, which may impact the wealth of investors and financial institutions.

Credit availability: If global lenders and creditors are exposed to the collapsed banks, their
ability to extend credit to Indonesian entities could be impaired. This can reduce the
availability of credit for businesses and households in Indonesia, potentially impacting
investment and consumption.

Trade Channel:
Reduced trade financing: The collapse of major banks can disrupt trade financing
mechanisms, such as letters of credit and trade finance facilities. This can make it more
difficult for Indonesian exporters and importers to conduct trade transactions, leading to a
decline in trade volumes.

Weakened investor sentiment: A banking crisis can negatively impact investor sentiment and
confidence in the Indonesian economy. This could reduce foreign direct investment (FDI) and
discourage international investors from engaging in trade and investment activities in
Indonesia.

various measures that Indonesian authorities can take to mitigate these

potential impacts and enhance economic stability:

 Strengthening financial sector oversight and regulation to prevent bank failures and
enhance resilience.

 Implementing policies to attract and retain foreign investors, such as ensuring a stable
and predictable investment climate, and promoting transparency and investor
protection.
 Maintaining adequate foreign exchange reserves to manage potential capital outflows
and currency volatility.

 Diversifying trade partners and expanding trade relationships to mitigate dependence

on specific regions or countries.