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The big bank collapse

Long-term solution needed to deal with systemic issues

The big bank collapse

Ironic: Silicon Valley Bank recently featured on Forbes’ Best Banks list. Reuters

Sushma Ramachandran

Senior Financial Journalist

Failure is not a word one associates with Silicon Valley. The holy grail for new tech start-ups, it has been the incubator for some of the world’s biggest success stories. It remains the headquarters for Big Tech with familiar names like Apple, Google, Intel, HP, Facebook, Adobe and eBay. It was thus startling to hear that a leading bank in this area had failed and been taken over by the US Federal Deposit Insurance Corporation (FDIC). Silicon Valley Bank (SVB), which featured recently on the Best Banks list of Forbes, collapsed as it was unable to find funds to cope with a run on the institution. The magnitude of the crisis can be gauged from the fact that it is the 16th largest bank in the US with assets roughly estimated at $200 billion.

Such events are unlikely to take place in India as the regulator would not allow any bank to park such a major chunk of funds in bonds alone.

The repercussions of the bank’s collapse are not limited to the US and have crossed the globe to India’s shores. Panic hit the Indian startup ecosystem as soon as the news broke since a host of Indian startups and tech companies as well as venture capitalist funders are depositors with this institution. It offers easier terms and conditions for new ventures and had become the go-to bank for startups in the past few decades. According to one estimate, 50 per cent of venture capital-based startups in the US bank had deposits with SVB. As for India, at least 60 ventures backed by accelerator YCombinator had accounts with the bank.

The ramifications of this development are still unfolding, but the facts are that the bank has been closed down and the FDIC has taken it over. The initial fear was that only the amount covered by insurance — $2,50,000 — would be returned to the account holders. This set off alarm bells as most accounts were of startups that held much larger deposits. Many had been anticipating payroll issues from this week. The situation changed, however, when President Joe Biden announced that the customers of SVB and also Signature Bank would have access to all their funds. Clearly, this has been a political call for the present administration that wants all doubts removed over the credibility of the American banking system.

Even before this news came in, most analysts had ruled out any contagion effect from the bank’s collapse. It would not spark off a domino effect of bank failures, like in 2008. The big worry is over a repeat of the financial crash that demolished big banks in western economies. But the fact is, there can be no assurances on this score, given the fact that SVB is not the only bank failure in recent days. The past week has seen the closure of two more US banks. The first was a relatively smaller entity, Silvergate, that provided services largely for the crypto-currency sector. It was in failing health after the decline in crypto prices and the bankruptcy of FTX. The second was more serious. Signature Bank, which collapsed over the weekend, had assets of about $100 billion. Its meltdown has sent worrying signs that the US financial system is in trouble.

Other western countries have also been galvanised into action; witness the rapid action taken in the UK with HSBC taking over the British subsidiary of SVB. What is needed, however, is more stringent oversight by regulators in these countries. In the US, for instance, despite regulations having been tightened tremendously since the 2008 financial crisis, banks seem to be failing regularly, though SVB is the biggest and the most high-profile case.

The reasons for its collapse seem to hinge on a few major issues. First, the rapid increase in US interest rates that reduced the value of the bank’s large portfolio of long-term bonds. This, at a time when funds for tech startups were drying up and the ventures needed to rely on funds parked in the bank. The drawdown of funds was much higher than anticipated by SVB. The other problem has been the concentration of venture capitalists as customers instead of having a more diversified portfolio. And finally, reports indicate that the bulk of the bank’s funds were accounted for by about 50 CEOs of venture capital firms, many of whom were shaken by SVB’s decision to sell $21 billion worth of securities last week while seeking to raise $2.25 billion in a share sale. Many of them urged their start-ups to pull out money suddenly, which brought about the unprecedented, and ultimately, ruinous run on the bank.

There are lessons here for Indian tech startups that have had a scare over the weekend. They may get their funds back, but first, it would be wiser to diversify accounts across several banks. And second, shifting domicile to countries like the US may not be such an advantage in the long run, given the possibility of a recurrence of such events in the financial sector. The Indian banking regulator may be tougher, but there is far more comfort in terms of safety and protection of funds.

In comparison to western countries, the Indian banking system seems to be smelling of roses. Such events are unlikely to take place here as the regulator would not allow any bank to park such a major chunk of funds in bonds alone. Global financial services agencies like Macquarie have already commented that there is little risk of contagion to the banking system here, given its large reliance on domestic deposits and investments in government securities. Moving forward, it is clear that the concern raised in recent times by western commentators over regulatory issues in financial sectors of emerging economies like India has been overblown. In fact, it is time for developed economies to scrutinise their own regulatory issues and take remedial measures to prevent bank failures that ultimately hurt both individuals and corporates. The swift resolution of the current crisis must be commended, but salvage operations are not a long-term solution. A resolution to prevent future crises is essential since a contagion effect could affect financial systems around the world.

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