Fears lurk for a wider 2008-Type instability in Global Financial System
By Anjan Roy
Aprominent private bank in the United States — the country's sixteenth largest— has failed and this can have significant impact on the Indian technology industry.
Silicon Valley Bank —better known by its acronym SVB— has gone into liquidation. This was one of the 20 largest banks in the USA and its sudden demise is sending shivers down the spine of many in the financial sector. Albeit, few outside of Silicon Valley really knew of the bank's existence.
But far away from SVB headquarters and main operating bases in America, the failure of the SVB is creating uncertainty for many Indian start ups. It is learnt that many of the startups had banking relations with the SVB and a good part of their funds were lodged with the SVB.
Now that the bank has gone into liquidation, these start ups are wondering whether they will get their money back. PayTM, Bluestone are among the many Indian start ups which have their money in SVB accounts.
The good news however is that the America's Federal Deposit Insurance Corporation has taken over the failing bank's assets and it promises to pay the depositors and others.
Once beaten twice shy. So everyone in the financial sector is wondering if the fall of SVB is a pointer to a wider instability in the financial system and like in 2008 global melt down, this incidence presages a general risk of the entire financial system.
The financial sector operators are reliving the days after the global financial melt-down in 2008-09 when a whole host of the largest American banks are faced with the prospects of closure and liquidation. It may be remembered one of the storied US investment bank, 200-year-old Lehman Brothers, had been liquidated as a fall out of the 2008 crisis.
Experts point out that the failure of the SVB is very, very specific. The bank was over-exposed towards the technology sector and recent troubles in the technology companies and such start ups was the primary cause of its liquidation.
With the major world central banks raising their policy interest rates to fight inflation, the IPO market as well as funds market in general were feeling the squeeze. As result many of the startups were failing to raise funds from IPOs and facing problems of liquidity. There are instances when these firms were seeking to withdraw their deposits from the SVB and too many were demanding too much cash all the same time.
That was the classic case of a bank run. If all the depositors and others who have money in a bank try to withdraw their deposits at the same time, no bank, however solvent, can meet it. Because, typically, banks do not hold cash they place all their funds in various loans which cannot be realised all at a time.
In fact, faced with too much demand for funds, SVB tried to liquidate some of their investments. What they tried to do was to sell off their treasuries —that is, holding of US government bonds— in the bonds market. However, the price of long dated bonds have suffered because the US central bank had raised their interest rates.
Now, bond prices go down when interest rates go up. Because, in anticipation of future higher interest rates, existing bond try to sell off their current bonds and thus their prices drop.
The news was out that SVB had sold a good part of their bond holding at a loss. That sent the initial tremors through the SVB depositors and customers. They sought to withdraw their monies as fast as they could do. That triggered a fear of a bank failure.
In fact, the SVB drama unfolded too fast in course of just a couple of days. The initial rumours were that SVB was in trouble as the week opened. Then there were instances of bond sales around Thursday. By Friday mid-day things had turned so acute that the FDIC had to step in and close the banks transactions. It was so fast paced that even veteran financial sector players wondered what could have upset the bank's credibility so quickly.
It is a classic case of a number of adverse factors happening all at once. The process of a macro-economic rewind was on for a while now in the face of rising prices, its wider impact on the IPO markets and the financial markets had serious implications.
At the same time, the technology sector was at the cusp of a secular restructuring a recast. Even some of the largest technology companies were going through a process of corporate and strategic restructuring. Their incomes, top line profits and employment all have been hit. They have started facing a liquidity crisis of sorts after years of indulgence and excesses.
In such a wider situation, the bank was concentrated in its operations to the technology sector. No wonder that the banker to the technology sector should allow face a crunch when most of its customers were going through a crisis and readjustment.
