Silicon Valley Bank Debacle And A Lesson For India's Banking Sector

The broader decline of Indian indices suggests that investors are uncomfortable because of the US banking crisis and are reducing positions

People wait outside the Silicon Valley Bank headquarters in Santa Clara, California, to withdraw funds after the government intervened upon the bank's collapse.

Source : Getty

The ripple effects of the failure of the Silicon Valley Bank (SVB), the 16^th largest bank in the US, followed by Signature Bank and a sharp decline in the share price of Credit Suisse, may be seen globally. SVB collapsed because of poor financial management. The shareholders of the bank have lost all value as SVB’s equity has been wiped out. The ongoing banking crisis has shaken the confidence of investors. Three main indices of the US stock market fell down by 1-2 per cent on Friday in response to the news of the SVB collapse. India has also lost Rs 4.04 lakh crore alone of investor wealth on Monday.

The market capitalisation of the National Stock Exchange nosedived to Rs 256.56 lakh crore from Rs 260.60 lakh crore on Friday. The Indian stock market opened marginally lower on Monday and is now trading lower. The benchmark indices, Sensex and Nifty, closed 1.52 per cent and 1.49 per cent lower on Monday. The price was lowest in seven months. The broader decline of indices suggests that investors are uncomfortable because of the US banking crisis and are reducing positions.

This has caused a panic effect on banking stocks. Banking indices are facing selling pressure. Foreign investors have been net sellers of Rs 5905.17 crores in the first three days of the week. Flight of money due to fear may lead to depreciation of the Indian rupee and the RBI can further tighten our monetary policy.

Is SVB the next Lehman?

The California-based lender Silicon Valley Bank has specialised in financing tech companies and start-ups. The bank was shut over large withdrawals from depositors. According to the Federal Deposit Insurance Corporation (FDIC), it was among the 20 largest banks in the US with $209 billion in total assets. The main cause of the failure was an asset-liability mismatch and slower credit growth than the deposit growth.

According to an article in the LiveMint, the SVB had three months average deposits of $55 billion at the end of December 2019 which increased by 169 percent and reached $147.9 billion at the end of December 2021 and $173.1 billion at the end of December 2022. On the other hand, three months average lending which was $29.9 billion at the end of December 2019 was increased by 82 percent and reached $54.5 billion at the end of December 2021 and $74.3 billion at the end of December 2022. The SVB failed to maintain a similar pace in credit growth in comparison to deposit growth.

The bank did not follow the basics of trade-off between liquidity and profitability. The lender used short-term deposits received from startups and venture capital firms to lock in money for long-term US government securities. They did not apply the fundamentals of portfolio management – do not put all your eggs into one basket. It held more than 75 per cent of its investment in held-to-maturity securities. The bank had invested aggressively during Covid-19 period when bond yield was quite low. The US Fed increased interest rates by a whopping 450 basis points to curb rising inflation, leading to a fall in the prices of securities. The drop in prices was the reason which drove the SVB to collapse.

The losses on its investment portfolio followed by withdrawal of deposits by investors compelled the bank to liquidate its investment portfolio at a loss of $1.8 billion to offset bond losses the bank announced a $2.3 billion share sale. The scenario worsened with depositors losing confidence. In this light the debacle appears to be a result of unsystematic-risk about a particular bank which triggered the sentiment of bank run.

The US is clearly in an uncertain time with the upheavals in the banking system. However, the problem of SVB is not the same as what happened in 2008 with Lehman Brothers. The challenges facing the US economy today are totally different from those it faced in 2008. Neither SVB is Lehman Brothers nor 2023 is 2008. SVB is the 2nd largest bank to close in the US since 2008, while Lehman was the 4^th largest bank at the time of its collapse in the US.

As per the New York Times, in 2008 the US economy was dealing with collapsing banks and plunging demand, while these days the big challenge has seemed to be inflation driven by higher demand relative to the available supply. The cause of failure of both the banks is different. Subprime mortgage was the main cause of the 2008 problem, however, the problem of the SVB is held-to-maturity securities that was mismanaged by the bank.

Lehman had $639 billion in total assets and $613 billion in liabilities. Looking at the size of the SVB and Signature bank, it does not seem that the failure of these banks will affect the US financial sector and financial world. The US authorities have already announced that they would resolve the SVB issue in a way to safeguard deposits of the entire nation and they are not bound to the FDIC limit of $0.25 million.

However, according to HDFC bank, it could be a Lehman moment for the tech startups as SVB was a major partner to the startups industry.

Lesson for India

SVB’s debacle has spread fears across the financial world. As for as it is possible that there will be a selling pressure of banking stocks across the globe till the US banking crisis sets off – the fall in the price of Credit Suisse is the current example of this. India is not an exception. The country will also have to face this problem. Start-ups of India have had direct relationships with SVB and any adverse event can impact the Indian equity market. Foreign institutional investors will take their money back from India. There could be a smaller impact in the short term due to global contagion.

However, there will be no major impact on the Indian banking sector from the debacle of SVB followed by Signature Bank collapse in the long term. India’s banking system is regulated and the economy of the country is sound as compared to the major developed economies of the world. Apart from this, Indian banks do not have any direct exposure to SVB and Signature Bank. According to WealthMills’s Kranthi Bathni, the Indian banking system is more insulated and regulated under the supervision of the RBI. However, India has taken the SVB failure seriously and did not brush it off as none of its concern.

Indian regulators, including the RBI, have successfully tackled similar kinds of problems that arose before India in the past. We have already seen how the regulator and the government together successfully handled the failure of the Global Trust Bank (GTB) in 2004,  Punjab & Maharashtra Cooperative (PMC) Bank in 2018, YES Bank (YB) in 2020, and Lakshmi Vilas Bank (LVB) in 2020. In the case of YES Bank, the regulator had suspended the board of YES Bank and roped in a former CFO of SBI as bank administrator. According to Mint, private and public sector banks were brought together to buy stakes and bail out the bank. The RBI managed to bring the local branch of foreign lender DBS Bank for a merger of Lakshmi Vilas Bank.

India is also facing the challenge of rising inflation and like the US government, the RBI has also hiked the repo rate by 250 basis points to 6.50 percent to curb the inflation which stood at 6.44 per cent, still stayed above the RBI target of 2-6 per cent, at the end of February 2023. Another hike of 25 basis points is expected in the April monetary policy review meeting. The rising yields on securities have a negative impact on trading income as the prices of existing securities declined in the market. However, as per the RBI, Indian banks interest income and non-interest income could partly neutralise treasury losses in a rising interest rate situation.

Thus the failure of the SVB could not adversely affect Indian banking due to its better asset-liability management and little exposure to the SVB. Apart from this, Indian banks mostly do not fund start ups that's why any impact on start ups can be managed to a large extent. The financial stability report of the RBI disbands the possibility of a SVB like situation in the Indian banking system.

Dr Vinay K Srivastava teaches at ITS Ghaziabad.

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