Regulatory failure behind SVB collapse : The Tribune India

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Regulatory failure behind SVB collapse

The cumulative lesson is that the authorities have to keep a close watch not only on tech startups burning venture capital cash merrily but also their bankers that host funds which are in one day and out the next. This implies close regulatory oversight and intervention, direct or indirect.

Regulatory failure behind SVB collapse

Risky: Silicon Valley Bank chose to rely only on walk-in businesses. PTI

Subir Roy

Senior economic analyst

THE collapse of Silicon Valley Bank (SVB), one of the 20 largest banks in the US, has sent ripples around the world, with the financial sector and stock markets in major economies getting jittery. More than the event itself, it’s the recall of the global financial crisis of 2008 during which Lehman Brothers collapsed that has made financial players spend restless nights.

By all accounts, the crisis seems to have been contained, preventing a contagion, and the jitters should be dying down. While that is a matter of enormous relief, what is needed now is to determine who did what wrong in taking things to the brink and who did what right in pulling things back from the brink. The right lessons learnt are likely to prevent a recurrence.

Fingers are being pointed at SVB for doing little other than only one kind of specialised lending — focusing on tech entrepreneurs and their startups. This is as risky a corner of the financial world as you can find and large banks typically have a very small portion of their portfolio assigned to such businesses so as to spread the risk. As to why the SVB chose to step in nevertheless, this is what likely happened. It chose to rely only on walk-in businesses. Tech entrepreneurs with billions of dollars in venture capital funding parked these with the likes of SVB which in turn put them in bonds. Is there a risk in this? Who could tell you? The chief risk officer of the bank. A startling fact has now come to light: The SVB failed to replace its retired chief risk officer for eight months.

But then came the tech slowdown, drying up of venture capital (VC) funding and rising inflation as the Ukraine war took hold. In response, the US Federal Reserve raised interest rates, bond prices fell and SVB had to suffer huge notional losses in marking them to market. When word of the losses got around, its depositors rushed to withdraw their cash and the bank had to sell the bonds, make huge losses in the process and eventually go under.

Another question that needs answering and intrinsically points to the list of don’ts for the future is why so many entrepreneurs put so much of their money in one bank and why the venture capitalists who gave the funding in the first place did not advise the borrowers to spread out their deposits. A startup sector considered arguably the most dynamic in the world in its field appears to have been very careless with its money.

If we can agree that high risk-taking is a part of the overall Silicon Valley culture, what explains the trouble that the giant Credit Suisse, larger-than-life banking name in intrinsically conservative Switzerland, got into and which has now led to its takeover. Surely its work style should have been marked by a conventional ethos and solidity. As it happens, Credit Suisse has been in trouble for quite some time predating the present crisis with management changes, having to book huge losses and lack of a proper turnaround strategy. The last few months have been marked by withdrawal of funds, huge losses and a fruitless search for investors. Then when the SVB headwinds came, the giant with the feet of clay toppled over.

All this brings us to the question as to what kind of a role regulators have played in the run-up to the current crisis. It would be known to any regulator which has its ears close to the ground (that is its job) that the likes of the SVB were heading for trouble. It would also be known that the trouble began with the steady upping of interest rates by the Fed. It is a no-brainer that when there is a pronounced inflationary trend in place, the central bank has to step in and start hiking interest rates, which the Fed did.

The big question is: could it have done otherwise? In the present instance, the inflationary bout set in not because of too much money chasing a given basket of goods and creating additional demand, but a fall in the basket of goods available because of global disruption in the supply of commodities, particularly energy, as a result of the Ukraine war. There is an alternative course of action which the Fed could have taken. It could have let inflation ride and wait for the rising prices to dampen demand. If it had done that, then bond prices would not have played havoc with the portfolios of bondholders and created the crisis in financial institutions that led to the collapse of the SVB and the selling of Credit Suisse.

In contrast to the US, several large economies like India, China and Japan appeared to have been able to step aside from the global headwinds which emanated from the SVB collapse. Importantly, all have fairly highly-regulated financial sectors in which the kind of financial freewheeling that the SVB went in for would not be allowed. This is because of two reasons. Both India and China have been through trouble in recent years — China through its shadow-banking bubble and India through the travails of cooperative banks (Punjab and Maharashtra Cooperative Bank) and even the odd private bank (Yes Bank). This made them go in for regulatory reform which has now stood them in good stead.

As for Japan, its Finance Ministry has historically kept its financial sector on a short lease in a way which other developed free market economies would not. All this has helped the three economies avoid the headwinds coming from across the oceans.

In India’s case, there is an additional reason for the absence of any kind of depositor panic. Over half the deposits are with public sector banks which by definition cannot fail. Besides, there is an implicit guarantee in the way in which private banks in trouble have been dealt with, as in the case of Yes Bank, which was rescued by a group of banks led by the State Bank of India, obviously at the behest of the Reserve Bank of India.

The cumulative lesson from all this is that the authorities have to keep a close watch not only on tech startups burning venture capital cash merrily but also their bankers which host funds that are in one day and out the next. This implies close regulatory oversight and intervention, direct or indirect, in case of need. This is in contrast to the space the US allows for innovative new businesses to come up and take the US and global economy forward. The dilemma is that systems cannot afford depositor panic even as they need creativity to evolve new businesses.

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