After Silicon Valley Bank and Signature Bank collapsed, bank stocks all over the world fell even as President Joe Biden promised to guarantee the security of the American banking system. After Silicon Valley Bank’s failure threatened to spark a wider financial catastrophe, U.S. authorities took immediate action to restore trust in the banking system.
Silicon Valley Bank
Silicon Valley Bank, a financial organization best known for its connections to high-flying international technology startups and venture capital, failed as a result of one of the oldest issues in banking, a bank run. It is one of the most notable banks in the US, proudly tweeted on March 7, 2023, that Forbes has awarded/recognized them as “one of the best banks in America”.
What caused the Silicon Valley Bank to fail?
The decline in technology stock prices over the past year and the Federal Reserve’s bold plan to raise interest rates to fight inflation both had a significant negative impact on Silicon Valley Bank. Over the last couple of years, the bank purchased bonds worth billions of dollars using customer deposits, as a conventional bank would. Although these investments were generally secure, their value decreased because they carried lower interest rates than a similar bond would have if it had been issued in the current climate of higher interest rates.
In most cases, this is not a problem because institutions keep those for a very long time, unless they are forced to sell them in an emergency. But most of Silicon Valley’s clients were start-ups and other tech-focused businesses, which over the past year began to become more in need of funding. Due to a lack of venture capital financing, businesses were forced to use their existing cash reserves, which were frequently deposited with Silicon Valley Bank, which was located in the heart of the tech startup universe.
Customers in Silicon Valley then began taking their deposits out. That wasn’t a big deal at first, but as withdrawal demands increased, the bank had to start selling its own assets to cover them. Since the majority of the customers in Silicon Valley were businesses and affluent individuals, they were probably more concerned about a bank failure because their deposits exceeded the $250,000 cap on deposit insurance set by the government. This necessitated selling generally safe bonds at a loss, and as a result of those losses, Silicon Valley Bank effectively went bankrupt. The bank looked for outside investors to help generate more money, but it was unsuccessful. The earliest problem in banking—a good ol’ run on the bank—destroyed the fancy tech-focused bank. Bank authorities were forced to seize Silicon Valley Bank’s assets in order to safeguard the assets and deposits that were still held by the bank.
According to several start-up founders, the pressure from investors to have accounts with US banks while collecting capital is what led many start-ups—even those without a sizable customer or vendor presence in the US—to open accounts with SVB. In order to accomplish this, a company had to be established in the US, of which the Indian entity would become a fully owned subsidiary. The Asian PE/VC and start-up market is forced to look for a viable alternative as a direct result of the aforementioned, in addition to a worldwide liquidity crunch and rising interest rates. One such option is to look for assistance from top international financial centers (“IFC”) around the world.
The Asia-Pacific area is home to numerous eminent IFCs, such as IFSC and GIFT City, in well-known economies like Singapore, the UAE, Hong Kong, and also India. The best option to assist SVB’s affected depositors, particularly Indian startup and venture capitalists, is emerging as India’s IFSC at GIFT City, with its light touch regulatory regime. This is due to the delay in opening accounts in Singapore, the changing taxation regime in the UAE, and the aversion of the China connection with Hong Kong.
What comes after that?
There are still two significant issues with Silicon Valley Bank, but both of them could cause other problems if not addressed right away. The sizeable assets at Silicon Valley Bank are the most pressing issue. Deposits up to $250,000 are guaranteed by the federal government, but deposits above that amount are not. As of Monday morning, insured accounts would be accessible, according to the Federal Deposit Insurance Corporation. However, due to the fact that Silicon Valley Bank’s clients were primarily startups and well-off tech employees, a distinctive feature of the bank was the vast majority of its deposits not being insured.
All of that money is currently unavailable, and it will probably need to be distributed in a systematic manner. However, many businesses are unable to wait weeks to obtain the money they need to pay employees and cover office costs. It might result in cutbacks or furloughs.
Furthermore, Silicon Valley Bank has not found a suitor. The assets of a failing bank are typically acquired by a stronger bank, but in this instance, no stronger bank has expressed interest. A bank buying Silicon Valley Bank could go a long way to resolving some of the problems linked with the money that startups can’t get to right now.
Is this a sign that what occurred in 2008 might happen again?
Presently, no, and specialists don’t anticipate any problems spreading to the larger banking industry. Despite being big, Silicon Valley Bank stood out because it catered almost entirely to the tech sector and venture-backed businesses. It made significant progress with the area of the business that suffered the most last year. Other banks are far more diversified across numerous sectors, customer bases and geographies.
The biggest banks and financial institutions’ most recent round of “stress tests” by the Federal Reserve revealed that all of them would survive a severe recession and a sharp increase in unemployment. However, if the remaining funds can’t be swiftly released, there might be negative economic repercussions in the Bay Area and the world of technology start-ups.
Is IFSC, GIFT City – a ready answer?
Many commercial and public sector banks can be found in IFSC, GIFT City, along with a number of well-established international MNC banks. The main goal was for the IFSC in India to be more than just a tax haven and to be a location of substance. As a result, the IFSC Banking Units (“IBUs”) are required to staff the essential positions with qualified individuals by the regulator, the IFSC Authority (“IFSCA”). The IBUs have the required teams on the ground as a consequence, and over the past few years, they have also gained pertinent experience for working in offshore markets and providing related financial services to the worldwide diaspora.
It should therefore come as no wonder that many IBUs took advantage of this circumstance by establishing a taskforce to assist the industry in moving its funds from US banks to IBUs at IFSC, GIFT City, where they experienced an unprecedented increase in their deposit growth.
Additionally, on March 10, 2023, the Indian banks borrowed a 14-day Variable Rate Repo (“VRR”) at a weighted average rate of 6.53% from India’s central bank, the Reserve Bank of India (RBI), injecting liquidity worth INR 82,650 crore into the financial system. The infusion by the RBI comes at a good time for India, even though Indian bankers and authorities have ruled out any second order effects on the Indian economy as a result of SVB’s collapse.
The SVB saga might not even be the beginning and only be the top of the iceberg. Whatever the case may be, from an IFSC standpoint, one wonders if the failure of SVB and Signature Bank in the USA and the global liquidity crunch will ultimately bring the fintech, start-up, private equity, and venture capital players (both global and Indian) to the IFSC jurisdiction. This may likely give IFSC, GIFT City the boost it needs to draw international and Indian fintech and financial service companies, realizing the Indian ideal of a fully functional global financial hub on Indian soil.
What is Silicon Valley bank? Why is it failing? Are 2008 crisis back? What will be the repercussions on India? Pondering- check out this blog!