The Collapse of Silicon Valley Bank: Factors, Theoretical Insights, and

Regulatory Implications!

The collapse of Silicon Valley Bank (SVB) provides a compelling case study on the
multifaceted risks and regulatory shortcomings that can lead to a financial institution's
downfall.

According to Diamond (1984), SVB’s failure can be attributed to insufficient monitoring of

its borrowers, which increased its exposure to credit risk. The bank’s portfolio, heavily
invested in high-risk tech startups, suffered as these companies struggled to repay loans.
Monitoring and credit risks were not in check. Diversification within the financial
intermediary is the key to understanding why there is a benefit from delegated monitoring.
Diversification increases the probability that the intermediary has sufficient loan proceeds to
repay a fixed debt claim to depositors. The other factor is SVB faced significant interest rate
risk due to its maturity mismatch. The rise in interest rates reduced the market value of its
long-term securities, leading to substantial unrealized losses. Due to its inability to swiftly
turn long-term investments into cash without suffering large losses, the Bank was unable to
satisfy withdrawal requests, which resulted in a liquidity crisis as well. Due to its significant
holdings of marketable securities, SVB was exposed to market risk. The value of these
investments was negatively impacted by changes in the market, which added to the instability
of the financial system. This impacted the regional banks as well, like the New York
Bank Corp, where the stock prices took a major hit! Along with all the risks, the
operational risk at SVB was exacerbated by inadequate risk management practices and
internal controls, which failed to mitigate other risk factors effectively. This all led to
negative news and market perceptions which made a swift decline in depositor confidence,
triggering a run. SVB had a quick bank run. Seru notes that a significant portion of SVB's
depositors were uninsured, and they quickly withdrew their money after the bank disclosed
large losses. This behaviour closely resembles the panic-driven withdrawals that is under
Dybvig's model. Bank runs precipitated by fear rather than actual insolvency was there. The
model's predictions were exemplified by SVB's high percentage of uninsured deposits,
which, once anxious about the bank's health, resulted in a quick withdrawal of funds. Next,
the risks associated with a mismatch between asset liquidity and liability liquidity
requirements are highlighted in both talks. The ratio of SVB's long-term assets to its
liabilities for instant withdrawals reflects the theoretical weaknesses that has been examined.
Also, the efficacy of government-backed insurance or guarantees such as FDIC insurance is
discussed. These safeguards are intended to stop the kind of runs that happened at SVB.
According to Seru's analysis, there was a systemic problem rather than just bad
management at SVB; the types of risks that caused the bank to fail were common to many
banks. He points out that many other banks would have failed in a similar situation if SVB's
situation had only involved losses. This contrasts with the other paper, which is more focused
on the individual bank's structure and depositor behaviour. Next, Dybvig argues that
government tools like deposit insurance can avert bank runs. However, Seru notes that such
measures may not suffice in severe economic conditions indicating that external economic
factors like interest rates play a significant role, that affect many banks, emphasizing the
need for stronger safeguards against widespread financial shifts. Seru's analysis indicates that
updated theoretical models are needed to better predict and manage bank failures,
highlighting a theory-practice gap. The examination of the papers explain the research which
indicates that increased bank transparency heightens uninsured depositors' responsiveness to
the bank's financial health. More informed depositors react more sharply to signs of trouble.
Applied to SVB, better transparency about its risks could have prompted earlier actions
by depositors or regulators, potentially reducing the impact of the bank run. The 2022
study indicates that transparent banks often increase deposit rates more sharply after poor
performance to keep depositors. This suggests that if SVB had been more transparent, it
might have faced higher costs to maintain deposit levels by raising rates, which could have
impacted its profitability. The document highlights how major regulatory changes, such as
the Sarbanes-Oxley Act, affect bank behaviours by enforcing stricter disclosure rules. The
2020 study highlights the impact of liquidity management and transparency on bank
stability, especially under stress. For SVB, clearer communication of its liquidity strategies
could have been crucial. Inadequate transparency, combined with weak liquidity
management, likely intensified its collapse by leaving depositors and stakeholders unprepared
for the bank's real risk and liquidity conditions. The failure of SVB brought to light the
impact that external economic shocks (such as sharp increases in interest rates on bond
prices) can have on banks' stability. This is a risk discussed in relation to the relationship
between banks' liquidity and asset values along with the view of how depositor perceptions
can trigger bank runs. Rapid dissemination of concerns via social media accelerated
withdrawals, demonstrating the "PANIC-BASED" run theory. The regulatory tools like
deposit insurance can reduce panic. However, many uninsured deposits limited this
effectiveness, highlighting a noted theoretical limitation.
The collapse of Silicon Valley Bank underscores the critical need for robust risk management
practices and regulatory oversight in the banking sector. The analysis reveals that SVB's
failure was not merely a consequence of poor management but also highlighted systemic
issues prevalent across the banking industry. Enhanced transparency and better
communication of liquidity strategies could have mitigated the impact of the bank run. The
case emphasizes the importance of diversifying risks, monitoring borrowers effectively, and
maintaining adequate liquidity to safeguard against market volatility and economic shocks.

Ultimately, SVB's downfall serves as a stark reminder of the interconnectedness of financial

stability, depositor confidence, and the regulatory environment, stressing the need for
continuous improvement in theoretical models and regulatory frameworks to prevent similar
failures in the future.

References:

1. Diamond, D.W. & Dybvig, P.H. (1983), "Bank Runs, Deposit Insurance, and Liquidity.”

2. Seru, Amit (2023), "Many US banks face the same risks that brought down Silicon Valley
Bank," Stanford Institute for Economic Policy Research.

3. Chen, Q., Goldstein, I., Huang, Z., & Vashishtha, R. (2022). Bank transparency and
deposit flows.

4. Chen, Q., Goldstein, I., Huang, Z., & Vashishtha, R. (2020). Liquidity transformation and
fragility in the US banking sector.