The SVB Bank’s Fall & its Impact on Indian Banks

Silicon Valley Bank Collapse

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.

U.S. authorities launched emergency measures on Sunday to shore up confidence in the banking system after the failure of Silicon Valley Bank threatened to trigger a broader financial crisis.

WHY DID SILICON VALLEY BANK FAIL?

The collapse happened for multiple reasons, including a lack of diversification and a classic bank run, where many customers withdrew their deposits simultaneously due to fears of the bank’s solvency. Many of SVB’s depositors were startup companies.

Silicon Valley Bank had already been hit hard by a rough patch for technology companies in recent months and the Federal Reserve’s aggressive plan to increase interest rates to combat inflation compounded its problems.

The bank held billions of dollars Worth of Treasuries and other bonds, which is typical for most banks as they are considered safe investments. However, the value of previously issued bonds has begun to fall because they pay lower interest rates than comparable bonds issued in today’s higher interest rate environment.

SVBs customers were largely startups and other tech-centric companies that needed more cash over the past year, so they began withdrawing their deposits. That forced the bank to sell a chunk of its bonds at a steep loss, and the pace of those withdrawals accelerated as word spread, effectively rendering Silicon Valley Bank insolvent.

Action taken by US Government

The Federal Reserve, the U.S. Treasury Department, and Federal Deposit Insurance Corporation decided to guarantee all deposits at Silicon Valley Bank, as well as at New York’s Signature Bank, which was seized on Sunday. Critically, they agreed to guarantee all deposits, above and beyond the limit on insured deposits of $250,000.

Many of Silicon Valley’s startup tech customers and venture capitalists had far more than $250,000 at the bank. As a result, as much as 90% of Silicon Valley’s deposits were uninsured. Without the government’s decision to backstop them all, many companies would have lost funds needed to meet payroll, pay bills, and keep the lights on.

The goal of the expanded guarantees is to avert bank runs where customers rush to remove their money by establishing the Fed’s commitment to protecting the deposits of businesses and individuals and calming nerves after a harrowing few days.

Banks will be allowed to borrow money straight from the Fed in order to cover any potential rush of customer withdrawals without being forced into the type of money-losing bond sales that would threaten their financial stability

Bank Term Funding Program

Bank Term Funding Program will provide loans to banks, credit unions, and other financial institutions for up to a year. The banks are being asked to post Treasuries and other government-backed bonds as collateral.

Fed will charge a relatively low interest rate just 0.1 percentage points higher than market rates and it will lend against the face value of the bonds, rather than the market value. Lending against the face value of bonds is a key provision that will allow banks to borrow more money because the value of those bonds, at least on paper, has fallen as interest rates have moved higher.

As of the end of last year U.S. banks held Treasuries and other securities with about $620 billion of unrealized losses, according to the FDIC. That means they would take huge losses if forced to sell those securities to cover a rush of withdrawals.

HOW DID THE BANKS END UP WITH SUCH BIG LOSSES?

In its fight to cool the economy and bring down inflation, the Fed has rapidly pushed up its benchmark interest rate from nearly zero to about 4.6%. That has indirectly lifted the yield, or interest paid, on a range of government bonds, particularly two-year Treasuries, which topped 5% until the end of last week.

Fed has rapidly pushed up its benchmark interest rate from nearly zero to about 4.6%.

Banks are not forced to recognize such losses on their books until they sell those assets, which Silicon Valley was forced to do.

Going beyond the $250,000 cap required a decision that the failure of the two banks posed a “systemic risk.” The Fed’s six-member board unanimously reached that conclusion. The FDIC and the Treasury Secretary went along with the decision as well.

Impact on India

The Indian banking system has its inherent strengths and won’t be impacted much as Silicon Valley Bank goes through its troubles.

Indian financial system could get impacted if the exporters who are dependent on US market start seeing slowdown in their businesses and that would impact job growth and ability to repay debt to their banks.

SVB through its parent entity holds investments in Bluestone, Carwale, InMobi, and Loyalty Rewardz. Therefore, a direct impact on the Indian start-up and/or new economy cannot be ruled out. Further, YCombinator one of the key clients of SVB has in turn invested in over 19 start-ups in India. Therefore, we cannot rule out a second-order impact. The funding winter, which was already catching up in the start-up space, may intensify.