Context
- Startup-focused lender SVB Financial Group on March 10 became the largest bank to fail since the 2008 financial crisis, in a collapse that roiled global markets. Regulators had abruptly shut down Signature Bank to prevent a crisis in the broader banking system.
- In this context, this edition of the burning issue will talk about this crisis, scenarios which could emerge, how India will be impacted by it and how the government is responding to the situation.
About Silicon Valley Bank
- It is a financial institution that provides banking services to the technology industry and venture capital firms.
- Founded in 1983, it has since become the go-to bank for startups and entrepreneurs in Silicon Valley and beyond.
- It is unique in that it understands the specific needs and challenges of the tech industry, and provides a range of services that cater to startups, including loans, deposits, and investment management.
- It has become a critical player in the startup ecosystem, providing funding and financial services to many of the world’s most successful startups, including Tesla, Uber, and LinkedIn.
Why did it collapse?
- Heavy investment in government bonds: During the period of near-zero interest rates, SVB invested billions of dollars in US government bonds. What appeared to be a safe investment quickly unravelled as the Federal Reserve aggressively raised interest rates to combat inflation.
- A decline in bond prices: Bond prices decline when interest rates rise, hence the rate increase undermined the value of SVB’s bond holdings. According to Reuters, the portfolio was yielding an average of 1.79% last week, well below the 10-year Treasury yield of roughly 3.9%.
- Customers panicking: SVB disclosed that it had sold a slew of securities at a loss and would sell $2.25 billion in new shares to plug a hole in its finances. Customers panicked, and they withdrew enormous sums of money.
- Bank’s Stock prices plummeted: The bank’s stock fell 60% dragging down rival bank shares as investors began to fear a replay of the global financial catastrophe a decade and a half ago.
- Regulators stepped in: Trading in SVB shares had ceased and the company had abandoned efforts to raise funds or find a buyer. California regulators stepped in, closing the bank and placing it in receivership under the Federal Deposit Insurance Corporation, which normally entails liquidating the bank’s assets to repay depositors and creditors.
- A case of liquidity risk: The case represents a classic case of an economic crisis situation called liquidity risk. Liquidity risk is the risk that a bank won’t be able to meet its obligations when they come due without incurring losses.
Reasons for SVB’s downfall
- A downturn of tech stocks: The bank was hit hard by the downturn in technology stocks over the past year as well as the Federal Reserve’s aggressive plan to increase interest rates to combat inflation.
- Lower bond yield due to lower interest rates: SVB bought billions of dollars’ worth of bonds over the past couple of years, using customers’ deposits as a typical bank would normally operate.
- Mostly startup account holders: SVB’s customers were largely startups and other tech-centric companies that started becoming needier for cash over the past year.
- Drying VC funding: Venture capital funding was drying up, and companies were not able to get additional rounds of funding for unprofitable businesses.
- Fear over deposit insurance: Since its customers were large businesses and the wealthy, they likely were more fearful of a bank failure since their deposits were over $250,000, which is the government-imposed limit on deposit insurance.
Is this a start of a banking crisis?
- The demise of both Silicon Valley Bank and Signature Bank put a spotlight on the challenges surrounding small and midsize banks, which tend to focus on niche businesses and can be more vulnerable to bank runs than larger peers.
- The most immediate concern is that the failure of one would scare off customers of other banks. Both Silicon Valley Bank and Signature are small compared with the nation’s largest banks — Silicon Valley Bank’s $209 billion and Signature’s $110 billion in assets pale next to the more than $3 trillion at JPMorgan Chase. But bank runs can happen when customers or investors panic and start pulling their deposits.
- Shares of bigger banks were not affected as much. All banks face interest rate risk today on some of their holdings because of the Fed’s rate-hiking campaign. This has resulted in $620 billion in unrealized losses on bank balance sheets as of December 2022.
- But most banks are unlikely to have significant liquidity risk.
Implications
- The collapse of Silicon Valley Bank and Signature Bank made a huge impact on global finances as stocks have lost $465 billion in market value so far.
- Startups scramble: Many startups and other companies that relied on the bank’s services were suddenly left without access to their funds, which caused financial strain and uncertainty for these businesses.
- Ripple effect: They now fear that they might have to pause projects or lay off or furlough employees until they could access their funds.
- Huge uninsured deposits: The vast majority of these were uninsured due to its largely startup and wealthy customer base.
- No scope for asset reconstruction: There is no potential buyer of Silicon Valley Bank.
How India could be impacted?
- SVB has invested in around 21 Indian start-ups including Paytm, Paytm Mall, Shaadi.com, CarWale, Naaptol, and One97 Communications – though the amount remains unclear. But according to the data, SVB has no ‘significant investments in Indian start-ups post-2011.
- For Indian mutual fund investors who have exposure to international mutual funds and international hybrid mutual funds, this news is not a good news.
Impact on Indian startups
- Uncertainty over deposits: The failure of SVB is likely to have a ripple effect on Indian startups, many of which have significant amounts of funds deposited with the bank.
- Hamper the funding: SVB has been a major player in the Indian startup ecosystem, providing banking services and funding to many of the country’s most successful startups, including Flipkart, Ola, and Zomato.
- Ripple effect: This could lead to a cash crunch for many companies, which may be forced to cut costs, delay projects, or lay off employees.
- Reduce global footprints: SVB has also been instrumental in helping Indian startups expand into the US market, by providing them with the necessary infrastructure and support to set up operations in Silicon Valley.
India’s resilience
- The risk remains quite low: as Indian banks are well-capitalised. RBI’s Financial Stability Report noted that even under a severe stress scenario, the capital adequacy ratio of banks is likely to remain within the mandated range.
- Improve with time: Some Indian startups with exposure to SVB may face difficulty in funding day-to-day operations as their funds remain locked. FDIC will facilitate withdrawals, but it may take time.
- Government lending support: Indian Government has indicated that it will meet Indian startups this week to understand the impact of SVB Financial’s collapse on them and how the government can help during the crisis.
Learnings from this bank’s failure
- Question the Trump-era deregulation of banks: The crisis brings into question the Trump-era deregulation of banks such as the decision to roll back Dodd-Frank’s ‘too big to fail’ rules, reducing both oversight and capital requirements. Both seem to have contributed to SVB’s collapse. It appears that the deregulation has allowed banks such as Silicon Valley Bank to take reckless risks. Now there needs to be a serious conversation about reversing the law to shore up confidence and avoid further collapses.
- Pause on its rate hike programme: It is now doubtful that the Fed will continue with its plan for aggressive interest rate hikes. The next hike was widely expected on 22 March following robust jobs data in January and February. The stress in the banking sector, and the wider impact on confidence, will now give the central bank cause for pause on its rate hike programme.
- Praise for RBI: The Reserve Bank of India (RBI) deserves credit for how it handles the Indian banking system. Time and again and in each global crisis, it gets proven that Indian banks are tightly regulated, which ensures that there are no major shocks.
- To be fair, most Indian banks are safe, at most times. And the reason is that the RBI monitors them very closely and forces them to take corrective actions proactively if there is something amiss. But still, all banks are not the same.
Conclusion
- When an ecosystem collapses, like the crypto, start-ups and PEs, some casualties are bound to happen. The meltdown could be in its final leg and collateral damage has hit market sentiments.
- But this will not last long and may be closer to a panic bottom in the markets.
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