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As of now, muted SVB impact anticipated on Indian economy

US–based Silicon Valley Bank (SVB) shut down over the weekend triggering a decline and stoking volatility in the financial markets worldwide.

This explainer goes behind the reasons that led to the failure of SVB, and its implications for global and Indian financial markets.

What is the business of SVB?
SVB is a bank based in California that started operations in 1983. As the name suggests, its business is mostly with technology companies. The bank lends to tech firms and most of its depositors are also from the tech sector: venture capitalists (VC), high net-worth individuals (HNI), and tech firms. SVB calls itself the ‘financial partner of the innovation economy.’

Why do banks fail?
Before discussing the failure of SVB, let us discuss why banks fail. Banks fail as they lend long term whereas their deposits are short term. This means that banks cannot call back their long-term loans easily, whereas their short-term deposits have to be paid on demand. As long as depositors do not rush to the bank for their deposits, things are fine.

However, in case of an economic/financial crisis or concerns over the asset profile of a bank, depositors may rush to withdraw their funds. When that happens, any bank, healthy or otherwise, is bound to fail. Even rumours can trigger bank runs and cause them to fail, as we saw in the case of SVB Bank. Such is the nature of banking.

Bank failures are common and have similar underlying causes. The economics Nobel Prize for 2022 was given to scholars who studied banks and bank runs. For more details on bank runs, one can read this explainer on the 2022 economics Nobel.

Why did SVB fail?
In case of SVB, it was a mix of factors that led to the crisis.

Since the global financial crisis (GFC) of 2008, the US Federal Reserve (the Fed) and other developed economy central banks have followed an easy monetary policy. This was also a period where we started transitioning to an increasingly digitised economy. The pandemic catalysed further digitisation of the economy. This, along with an easy monetary policy, led to a significant boom in technology companies. Tech companies of all sizes found it easy to raise and deploy funds.

SVB was a beneficiary of this boom as well as the bank’s business revolved around Silicon Valley and technology companies. The bank opened offices across the world in this period: Israel, China, Ireland, Germany, Canada, Denmark, and so on. It also opened an office in Bengaluru. It featured on Forbes’ list of best US banks for the last five years, including the last such list released just three days before the bank tanked.

Economists did warn that the end of the easy monetary policy will have a large impact on the world economy and financial markets as governments, corporates, and banks were all now highly dependent on easy money.

The easy monetary policy finally ended with the Russia-Ukraine war. The war led to a surge of inflation across the world, particularly in developed countries. The rise in inflation led central banks to tighten monetary policy aggressively. The Fed has increased policy rates by 450 basis points (bps) in the last one year, and other rich country central banks have also tightened policy rates significantly.

The higher interest rates set off fears of a slowdown of the US economy, and the high valuation enjoyed by the tech firms started to decline. The easy money available to technology companies in the form of venture capital, etc., also started to dry up. This started to weigh particularly heavily on smaller technology firms, which found it more difficult to raise funds.

What was the timeline of SVB’s failure?
The reversal of monetary policy and decline of tech stocks started to weigh on the banking system and SVB was no different. The bank released its annual report for 2022 on 23 Feb 2022, and reported a capital ratio of 16 percent, higher than the required ratio of 10 percent. It highlighted the growing risks in the banking system due to the change in policy, but there were no immediate concerns.

But suddenly, on Wednesday, March 8, 2023, the bank started to unravel. There was news that one of the funds run by leading VC Peter Thiel had asked to withdraw funds from SVB. This spread like wildfire and depositors started to withdraw their funds. On the same day, the bank issued a statement and a presentation highlighting that it had sold government bonds to shore up its capital base and was also raising funds from a large global investor. The bank said it had ample liquidity to manage the balance sheet and there were no concerns.

However, these assurances did not assuage the depositors. By Friday, 10th March, the bank was declared bankrupt. In just two days, a US bank had failed.

What is the policy response?
The Federal Deposit Insurance Corporation, which deals with failed banks in the US, placed SVB under receivership. The FDIC insures deposits worth $250,00 per depositor, which means that those with deposits up to $250,000 have nothing to worry about as they will get the full amount. Unfortunately, as SVB’s clientele comprised HNIs, VCs, and tech firms with deposits much larger than $250,000, it seems a high percentage of the deposits are uninsured.

Per FDIC, the bank had $209 billion in assets and about $175.4 billion in deposits at the end of December 2022. The FDIC is determining the amount of uninsured deposits and we will soon have the details. Uninsured depositors will receive funds only after the FDIC sells the assets of the bank.

What will be the impact of SVB’s failure on US and global financial markets?
Each time a bank fails, one suspects that other banks will fail too. Thus, we saw SVB’s failure translating into a slide in bank stocks. Indeed, as banks are pretty much the lifeline of the financial system, it also led to a decline across stock markets, not just in the US but in other economies as well.

The commentary has drawn comparisons with the failure of Lehman brothers, which led to the GFC. There are both similarities and differences with the Lehman crisis. The similarity is that both the Lehman and the SVB crises happened after many years of easy liquidity. The difference is that Lehman was a much bigger global investment bank whose failure naturally had greater international repercussions.

Post Lehman and the GFC, regulators have strengthened the banking system. But nothing is foolproof. If the rout in the markets continues, it will raise further concerns about a global recession.

What will be the impact on Indian financial markets?
India is part of the global economy, not an isolated island. We have seen this in each global crisis yet somehow believe that the Indian economy can decouple from global shocks.

As India is a more consumption-oriented economy, the impact may be muted, but there will be some impact. If the financial markets in the West continue to decline and there is a recession, it will impact Indian financial markets as well and result in lower growth rates in India. Moneycontrol

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