Thursday 08 Jun 2023

Silicon Valley Bank collapse: The Valley of Sorrow

Shivanand Pandit | MARCH 19, 2023, 08:58 PM IST
Silicon Valley Bank collapse: The Valley of Sorrow

Established in 1983, Silicon Valley Bank was, just before collapsing, America’s 16th largest commercial bank. It provided banking services to nearly half of all US venture-backed technology and life science companies

Like an episode of a rapid-stridden misdemeanour murder mystery, the narrative of the 16th 

biggest bank of America, Silicon Valley Bank (SVB), shifted from a fifth-year-in-a-row Forbes best bank honour to bank fiasco - all in around 30 days! It appeared as if the catastrophe of SVB would spread to other banks, trigger an international infection, and activate one more financial disaster. However, the US Treasury, Fed, and Federal Deposit Insurance Corporation (FDIC) acted quickly, and their instant action to safeguard SVB depositors tackled the present panic attack. The hope that the Fed will now have to lessen or stop its rate hike programme, may perhaps perversely give markets a rest.

SVB is a regional bank in the United States of America, headquartered in Santa Clara, California. The bank was incorporated in 1983 and considered pretty influential because it was among the early banks to set emphasis on start-ups and venture capitalists. In December 2022, 56% of its advances were to venture capitalists and private equity firms guaranteed by their limited partners. SVB is held by SVB Financial Group, which has businesses outside the USA throughout ten countries, including India. During the Covid years, when start-up valuations mounted, SVB saw its total deposits sprout from around 65 billion dollars in 2020 to more than 145 billion dollars in December 2022.

An American Tragedy

Risk is entrenched in the business of banking. Borrowers or mortgagors may not repay their advances punctually, and depositors or investors may remove their funds at any time. Banks prosper on the supposition that depositors will space out their removals and borrowers will pay their obligations. There could probably be no bank in the universe that can outlive a run - an occasion where most of their depositors withdraw their deposits in a matter of days.

SVB could not outlast as a going concern after its depositors removed approximately $42 billion over two days. The withdrawals were alarmed by the loss of securities possessed by the bank and a declaration, perhaps made at an inappropriate time, by the top management not to panic. Asking depositors not to panic after suffering the loss on the sale of securities and being powerless to nurture extra capital, is not convincing, to say the least.

Blush with cash from start-ups, SVB did the same thing that nearly all of its contenders do. The bank preserved a minor portion of its deposits in the form of cash, and it employed the remainder to procure long-term debt similar to Treasury bonds. Those investments assured stable, reasonable returns when interest rates stayed low. But they were, it turned out, imprudent. 

The bank had not looked into what was transpiring in the larger economy, which was scorched after more than a year of pandemic impetus. This indicated that Silicon Valley Bank was trapped in the totter when the Federal Reserve, looking to fight express inflation, began increasing interest rates. Those once-secure investments looked a lot less appealing as newer government bonds kicked off more interest. In what would eventually bring distress for the bank, start-up funding was also beginning to decline, and prominent SVB’s customers - a blend of technology start-ups and their executives - started withdrawing their money. To accomplish its customers’ demands, the bank had to dispose of some of its investments at a sheer discount or markdown.

Nevertheless, not all SVB’s troubles are associated with increasing interest rates. The bank was distinctive in ways that influenced its quick downfall. The FDIC only underwrites amounts up to $250,000, therefore, whatever is above that would not have a similar government guard. SVB had a substantial number of large and uninsured depositors - the type of investors who have the habit of withdrawing their funds during signals of commotion. Once SVB disclosed its enormous loss recently, the tech industry panicked, and start-ups hurried to pull out money.

The chapter has a great lesson

SVB is not the first bank to break down as it did, and it won’t be the last. But every time a bank like SVB flops, it uncovers dodges on many stages. However, the collapse of SVB does call for stringent supervisory watchfulness on other counts. SVB crisis outlines that in a situation of fast-growing rates, banks’ investment books need an identical scale of scrutiny and stress-testing.

The current method of permitting banks to sweep their bond losses under the carpet by preserving large held-to-maturity (HTM) portfolios, can lead to explosions. In India, the RBI may need to inspect bank books for depositor intensity. The SVB saga also provides a valuable lesson to global central banks that when they shift from lengthy ultra-loose monetary policies to uncalibrated, severe rate hikes to crush inflation, they can cause harm not just on growth, but also to financial system stability that they struggle so hard to protect.

One of the major issues at SVB was that the losses were recorded only when the investments were disposed of and were not marked to market at fair value in the books of accounts. It is because accounting standards yet permit few investments, such as instruments that are HTM to be accounted for at cost in the books of accounts. Meanwhile, accounting standard-compositors also respond to SVB-kind incidents, one can anticipate them to order disclosure of fair values even when investments are recorded at cost in the books of accounts.

The RBI has kept hold of implementing the Indian Accounting Standards (Ind AS) for banks – maybe because of the effect it could have on both provisioning for doubtful as well as treasury gains or losses. While Ind AS cannot avert banks from crumpling, if implemented accurately, the standards would present a more convincing portrait of the financial status of banks. Considering the SVB fiasco, the RBI should issue the Ind AS implementation notification earlier than scheduled.

In conclusion, the episode has a great lesson for banks and regulators of banking. Banks should preferably adhere to traditional banking and rigorously follow the stricter capital adequacy and solvency rubrics. The SVB story also displays the dangers of niche banking where the emphasis is on particular customers instead of diversifying the risk with a broader clientele base.

Can this happen in India?

What materialised the disaster of the SVB was a textbook case of faulty risk management steering to an asset-liability disparity. The worth of the assets dropped considerably, so it could not cover its liabilities. In a bank, this is guaranteed death. 

Now the question is - Can this happen in India? Undoubtedly, both the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) have been impelling banks and mutual funds to mark their portfolios or collections to market - which denotes that if there are unrealised losses because of variation in the bond price, these should be accounted for. It means that banks today will be resting on mark-to-market losses due to their bond portfolios as RBI has been increasing rates, but it also means that an unexpected happening will not catch them off guard and trigger rapid corrosion of their asset values.

The SEBI has increasingly crafted rules stronger and sturdier for debt funds. Most of the 16 debt fund groups have been generated, keeping the holding period of the investor in mind. For instance, a money market fund must retain the average maturity of bonds in the portfolio at one year. It means that investors in this class of funds will not be encountering a gigantic interest rate risk or the risk of interest rate hikes causing portfolio losses.

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