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SILICON VALLEY BANK CRISIS – LESSONS TO INDIA FOR MAINTAINNING FINANCIAL PEACE BY – KEERTI. M
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SILICON VALLEY BANK
CRISIS – LESSONS TO INDIA FOR
MAINTAINNING FINANCIAL PEACE
AUTHORED BY – KEERTI. M
SCHOOL OF EXCELLENCE IN LAW
– TNDALU
PHONE NO – 9677593250
E-MAIL ID – manoharankeerti@gmail.com
ABSTRACT:
Several financial crises have occurred in recent decades, including the
OPEC oil crises of the 1970s, the
United States Savings and Loan crisis of the 1980s, and Japan's extended
economic depression. The Asian
financial crisis in the late 1990s and the troubles that followed the crash of the dot-com boom in the early part of
the 2000’S. Each of these events was accompanied by economic shocks to one or more markets or regions, and it took
several years of coordinated economic and regulatory policy adjustments
for the impacted markets to return to stability.
The
worldwide Financial Crisis, which began in 2008, is the most recent in a series
of economic crises that have had a
detrimental impact on worldwide economies. Unlike prior concerns, the present one has not spared any countries or market sectors and has ravaged usually
strong economies. For the past few
days the world 16th largest bank collapse of silicon valley bank the crisis has been in was not because for the
crisis of similar type that has happened before this is something new for the world to learn from in regard to asset
liability management and reserve ratio.
This paper will discuss about the silicone valley crisis and lessons India
should learn to escape such crisis in
future and will put an emphasis on comparative analysis of insurance cover in India and USA.
While
it is common for financial crisis to occur on a regular basis and for affected
economies to recover, it should
nevertheless results in economic losses for the countries involved as well as
for the people, businesses, and institutions in those countries.
* Student LLM 2nd year, law of taxation, TNDALU
- Chennai
INTRODUCTION:
“Its fine to celebrate
success but it is more important to heed the lessons of failure”
- Bill Gates
Silicon
valley Bank was one of the booming and largest banks of the USA. During the
pandemic, when several nations'
economy were crumbling, many venture capitalists who were investing in various start-ups dropped loan rates to 3%
or 2%, and some even to zero. They were dealing in equity rather than interest. In the United
States, the situation
was the same. Instead of banks, these
investors provided significant funding to start-ups. Because banks were unable to obtain consumers for company loans due to higher interest
rates than venture capitalists, banks began investing
their deposits to gain money. According to media sources, SVB is one of the
banks that have established solid
relationships with Silicon Valley enterprises, as a result of which a large number of deposits from such companies,
start-ups, and investors have begun to flow into SVB. Where in lending and deposits was majorly given and received by
service tech sectors and failed to
lend to machinery.[1] Where in
Indian Banking hugely depends on retail deposits accounting to around 50% and wide number of deposits
from social capital which leads to a strong resilience in Indian
Banking.
Nevertheless, given our Indian banking system's
and economies very limited and minimal exposure to the economic and other ramifications of this US-based
bank's bankruptcy, this collapse should have no direct monetary effect on
us. Despite this, a few Indian tech start-ups have some exposure in SVB.
However,
the SVB crisis has taught us some important lessons. But, before digging into
it, it is crucial that we first know and comprehend what transpired in the
US that resulted in this catastrophic banking disaster.
CHRONOLOGICAL TURN OF EVENTS
It
all started on a very hopeful and positive note, with a significant number of
the US Silicon Valley's big
Tech-Start-ups raising huge sums in a funding boom from venture capitalists and significant investors and depositing their surplus/unused cash raises
with SVB.
Instead of holding these deposits
in cash, SVB invested them in US Treasury Bonds. To be just to SVB,
these investments were not terrible or dangerous because they were fully
supported by the US government and
had minimal default risk.
The
ticking time bomb began when the US Federal Reserve (the US Central Bank,
similar to the RBI in India) raised
the Federal Interest Rate (the US Central Bank lending rate, similar to the Repo Rate in India) in an ongoing
string of interest
rate hikes to combat
inflation in the US.
The
interest rate and bond prices have an inverse correlation. The rise in interest
rates is offset by a reduction/compression in the principle
value of the bond or debenture. As a result
of the increase in the US Federal
Interest Rate, the price of US
Treasury Bonds, which comprised the majority of SVB's investment portfolio, fell.[2]
In
SVB's Balance Sheet, the Market Value/Net Realisable Value of these US Treasury
Bonds, which comprise the investment portfolio, became less than the carrying value/book value of these investments.
Simultaneously,
Silicon Valley start-ups began to sustain cash losses, faced a fundraising
freeze, and stopped receiving funds from investors.
Due to rising federal interest rates and falling bond values, SVB was
compelled to liquidate its investments
in US Treasury Bonds at a loss of about $1.8 billion in order to meet such
deposit withdrawal demands from
Silicon Valley start-ups. To compensate for this loss, SVB announced a 2.25 billion
USD capital increase
as well as a stock sale. This caused alarm
among Silicon Valley
start-ups, hastening the process
of withdrawing their deposits
from SVB.
With the increase in the federal interest
rate, new deposits
became more expensive
for SVB.
All of this resulted
in a 60% drop in the share price of SVB in the US capital
market, and ultimately the bank's failure, with the Federal Deposit Insurance Corp.
(US Regulatory Body) taking over regulatory authority.
IS SVB THE
NEXT LEHMAN[4]
With $209 billion in total assets, it was one among the 20 largest banks
in the United States, pursuant to the Federal
Deposit Insurance Corporation (FDIC). The fundamental reason for failing
was asset liability
mismatch, as well as slower loan growth than deposit growth.[5] The SVB had
$55
billion in three-month average deposits at the end of December 2019, which
climbed by 169 percent to $147.9
billion at the ending of December 2021 and $173.1 billion at the ending of December
2022. On the other hand,
three-month average lending
climbed by 82 percent from
$29.9 billion at the end of December
2019 to $54.5 billion at the ending of December
2021 and
$74.3 billion at the ending
of December 2022.
The bank did not adhere to the fundamentals of balancing liquidity and
profitability. Short-term deposits from start-ups and venture capital
firms were used by the lender to secure funds for long-
term US government assets. They failed to apply the fundamentals of portfolio management, such as not putting
all of your eggs in one basket. More than 75% of its investment was in held-to- maturity securities. During the Covid-19
period, when bond yields were low, the bank invested heavily.
With
the changes in the banking sector, the United States is definitely in an
unstable period. However, SVB's
predicament is not the same as what happened with Lehman Brothers in 2008. The issues that the US economy is facing today are vastly
different from those that it faced in 2008. SVB is not Lehman Brothers, nor is 2023 2008. SVB is the second largest bank to fail in the United States since 2008, whereas Lehman
was the fourth largest at the time of its demise.
The cause of failure of both
the banks is distinct.
The fundamental cause of the 2008 problem was subprime mortgages; however,
the SVB's concern
is held-to-maturity securities that were mismanaged by the bank.
Given the scale of SVB and Signature Bank, it is not appear
that their failure
will have a significant impact on the US financial system or
financial world. The US authorities have already stated that they
will settle the SVB issue
in such a way that all deposits
in the country are protected, and they will not be restricted by the FDIC limit of $0.25 million.
REGULATORY FAILURE
As the Ukraine war took root, the tech sector
slowed, venture capital
(VC) financing dried
up, and inflation rose. In response, the US Federal
Reserve hiked interest
rates, causing bond values to fall and forcing SVB to incur significant speculative losses in marking them to market.
When word of the
losses spread, depositors hurried to withdraw their funds, forcing the bank to
sell the bonds, incur huge losses,
and eventually fail.
All
of this begs the question of what role regulators had in the lead-up to the
current crisis. Any regulator with
its ears close to the ground (which is its duty) would have seen that the SVB
was headed for problems. It would
also be understood that the problem originated with the Fed's consistent raising of interest rates. When
there is a clear inflationary trend, the central bank must intervene
and begin raising interest rates,
which the Fed did.
In
this case, the inflationary bout occurred not as a result of too much money
chasing a given basket of goods and
creating additional demand, but as a result of a fall in the basket of goods available as a result of global disruption
in commodity supply, particularly energy, as a result of the Ukraine war. The Fed could have taken a different path. It might have let inflation run its course and waited for rising prices
to decrease demand.
If it had done so, bond prices would not have
destabilised bondholder portfolios and caused the financial institution crisis
that ultimately to the SVB's
demise.[7]
There
is an additional explanation for the absence of any form of depositor panic in
India. Over half of the deposits are
with public sector banks, which cannot fail by definition. Furthermore, there is an implicit guarantee in how private
banks in crisis
have been handled,
like in the instance of Yes Bank, which
was rescued by a group of banks led by the State Bank of India, apparently at the request
of the Reserve Bank of
India.
There
is an additional explanation for the absence of any form of depositor panic in
India. Over half of the deposits are
with public sector banks, which cannot fail by definition. Furthermore, there is an implicit guarantee in how private
banks in crisis have been handled, like in the instance of Yes
Bank, which was rescued
by a group of banks led by the State
Bank of India, apparently at the request
of the Reserve Bank of India.
RESILIENT MECHANISM IN INDIA
The Deposit Insurance and Credit Guarantee Corporation, a wholly owned
subsidiary of the Reserve Bank of India, insures bank deposits in the following ways:
In
accordance with the stipulations of the DICGC Act of 1961, the DICGC covers all
deposits, including savings,
fixed, current, and recurring deposits,
as well as accrued interest. As defined in Section 2 (g)[8] of the Act, a "deposit" is the sum of all unpaid sums due
to a depositor in respect
of all his accounts,
regardless of name, and includes,
among other things,
fixed deposits and
accumulated
interest. Section 16 (1) of the Act also allows for deposit insurance by DICGC
for a depositor equal to the amount
payable to him in respect of his deposit in the bank, subject to the ceiling
prescribed and provisions of the Act.
To
provide additional security to bank depositors, the DICGC increased the ceiling
of insurance coverage for depositors in insured banks from 1 lakh to 5 lakh per deposit
holder with effect from 04.02.2020.
As
a result, at the end of March 2022, the number of fully secured accounts
constituted 97.9% of the total
number of accounts.
Total insured deposits was at 81,10,431 crore as of end-March 2022, accounting for 49.0% of assessable deposits
(1,65,49,630 crore). This is greater
than the International Association for Deposit
Insurance (IADI) recommendation of 80% coverage for number of accounts and 20-30% coverage for value.[9]
In such situations, the DICGC is required to make interim
payments to depositors up to the deposit insurance cover of 5 lakh within 90 days
after the enforcement of such orders. The time-bound payout to depositors of banks placed under AID has
prepared the way for increased public trust in the banking industry
while also contributing to financial stability.
LESSONS FOR INDIA AND INDIAN RESILIENCE
“Further, our ratio of foreign claims to
domestic claims is also least among countries signifying that our banking and financial system is very disciplined and no
international balance sheet contagion
can start from India. Maturity wise also, International claims on India are the
least among major countries,” [10]
- Soumya Kanthi Ghosh
We are living in a global entity now and anything that happens in one
part of the globe will have repercussions, going by business
model SVB is a 40 year old bank and where lending majorly to
start-ups
and their deposits were mostly parked there.[11]
In India the system is maintained by DICGC
where insurance is 3.1% of per capita income. In India account base are wide
majorly by Jan Dhan Account scheme
and the lending should be in such a way that the loans are parked proportionately. And, it provides
for maintaining CRR and SLR which prevents
major risk and for proper
management of Assets and Liabilities.[12]
It is critical to understand that the SVB Crisis did not occur as a result of its bad loans or advances becoming non-performing; rather, it occurred
as a result of SVB's failure to realistically predict and assess the timing of serviceability/repayment of deposits
taken from Silicon Valley start-ups and in lieu of keeping these
deposits in liquid
or short-term investment instruments, invested these
deposits in long-term US Treasury Bonds.
In
India, there is a term known as the "Cash Reserve Ratio." (CRR).[13]
It is a predetermined minimum fraction
of total customer
deposits that commercial banks must retain
as reserves, either
in cash or as deposits with the central bank RBI, to ensure that banks
do not run out of cash to meet their depositors' payment
obligations. In India,
the CRR is an important monetary policy tool for managing
the economy's money supply.
CRR is now at 4.50%.
Second, SVB was caught
off guard and ran out of cash because it failed to anticipate the very basic
correlation between rising
US federal interest
rates and declining
US Treasury Bond prices, which
comprised its investment portfolio, and thus its mark-to-market loss
(book loss) was suddenly changed to actual loss, on necessitate selling of its investments in US Treasury
Bonds, below the cost of their acquisition costs,
in order to service deposit
withdrawal demands by the silicon
Valley start-ups.
Finally, the SVB crisis can be attributable to an asset-liability mismatch. A healthy
bank is usually distinguished
by a solid and sturdy advance base. However, in the instance of SVB, its deposits from consumers on the liability side
greatly outweighed its loans to customers on the assets side. So, at all times, the interest it was
compelled to pay on client deposits outweighed the interest revenue
it earned on advances
made to customers.
These measures by USA would lead to a relief now:
Allowing all depositors to have full access to their entire
deposit base, rather than only the insured
value of $250,000, in stages. More crucially, the cost of this bailout
package would not be borne by US taxpayers,
but rather by stakeholders in the bankrupt
SVB.
Setting
up a new lending facility with the US Federal Reserve (US Central Bank) to
allow banks to pledge their investments in US Treasury Bonds, Mortgage-Backed Securities (MBSs), and other
qualifying assets as collateral, wherein banks will receive loans
equivalent to the face value of such
Treasury Bonds/MBSs), even if their respective market values have fallen in the
wake of rising Fed interest rates,
at the prevailing market interest
rate plus an additional fee of 0.1% on top of the prevailing market interest rate.
CONCLUSION
Recent economic history has taught us that financial crises that
simultaneously affect several economies
occur frequently, and that prudent policies and appropriate responses by
monetary authorities help in managing
the crises. However, the task of containing the adverse effects becomes more challenging when all the economies
of the world are affected
by the crisis. However the recent crisis has not affected
the world inversely.
This study
discussed the effects
of the global financial crisis
on the Indian economy, as well as the Indian
government's response to the
crisis.
The
RBI's proactive measures have ensured that adequate liquidity is available in
the markets. Interest rates
and inflation rates
have stabilised in the loan and consumer
markets. The Indian Rupee has recovered in the foreign
currency market against
the currencies of its key trading partners.
The government's fiscal stimulus will help cushioning the decline.
[1] Lessons from Silicon Valley Bank crisis – Hinh.T.Dinh
[2] Ghosh, Jayati (2009), “Global Crisis
and the Indian
Economy”, in ‘Global
Financial Crisis: Impact
on India’s Poor’,
United Nations Development Programme (India).
[3] Why India
need not worry about Silicon Valley Bank’s collapse, but must learn from it –
Radhika Pandey Available at - https://nipfp.org.in/
[4] Mohan, Rakesh (2009), “Global Financial Crisis: Causes, Impact, Policy Responses
and Lessons”, Working Paper 407, Stanford University, Stanford, CA, USA
[5] Silicon Valley
Bank Crisis – Vinay K
[7] Mayank
Mohanka (2023) - Silicon Valley Bank Crisis Explained in 10 Simple Points &
Lessons Learnt therefrom Available at
- https://www.taxmann.com/research/fema-banking-insurance/top-story/105010000000022750/silicon- valley-bank-crisis-explained-in-10-simple-points-lessons-learnt-therefrom-experts-opinion
[8] “deposit”
means the aggregate of the unpaid balances due to a depositor (other than a
foreign Government, the Central
Government, a State Government, a corresponding new bank, Regional Rural Bank
or a banking company or a
co-operative bank) in respect of all his accounts, by whatever name called,
with a corresponding new bank or with a
Regional Rural Bank or with a banking company or a co-operative bank and
includes credit balances in any cash credit account but does not include,
(i)
where a banking company or a corresponding new bank at
the commencement of this Act or where an eligible cooperative bank at the commencement of the Deposit Insurance
Corporation (Amendment) Act,1968 is working under
a scheme of compromise or arrangement or of reconstruction sanctioned by any
competent authority providing for
the acceptance of fresh deposits, any amount due to the depositor in respect of
his deposit before the date of the coming into force of the scheme to the extent it is not credited after the said date under the
provisions of that scheme; or
(ia) any amount
due on account of any deposit with any insured
bank which has been specially
exempted in this behalf by the Corporation with the previous approval of the Reserve Bank
or,
(ii)
any amount due on account
of any deposit received
outside India;
[9] The Moral Hazard Implications of
Deposit Insurance: Theory and Evidence – (2006) Patricia A. McCoy Available at – seminar on current
developments in Financial law, Washington D.C
[10] SBI Report
– Indian Banks are Epitome of resilience
Available at - https://www.businessworld.in/article/Indian-Banks-Are-Epitome-Of-Resilience-SBI-Report-/20-03- 2023-469680/
[11] Measures taken by the Government to protect the interest of investors/account holders
in the bank Available at: https://pib.gov.in/PressReleasePage.aspx?PRID=1849973
[12] ALM in banking refers to the management of the cash flows of assets and liabilities in order to increase profitability, manage risk, and
ensure safety and soundness.
Simply described, it is the process through
which a bank's overall assets and liabilities are simultaneously controlled and
managed in an integrated manner.
ALM is concerned
with three major risks:
Liquidity
Risk Interest Rate Risk
Foreign exchange risk.
It
also includes managing, for banks with FX operations. Currency volatility.
[13] Maintenance
of Cash Reserve Ratio – circular DOR.No.Ret.BC.35/12.01.001/2020-21 dated
05/02/2021 Available at - https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12020&Mode=0
Article Information
SILICON VALLEY BANK CRISIS – LESSONS TO INDIA FOR MAINTAINNING FINANCIAL PEACE BY – KEERTI. M
Authors: KEERTI. M
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/04/15
- Volume 2
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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