Genesis

On March 10, USA’s sixteenth largest bank, the Silicon Valley Bank (SVB), with assets worth around US$209 billion, collapsed. SVB was established in 1983, providing business banking services for companies at every stage, but it was particularly serving startups and venture-backed firms. In due course, the bank however, ignored the basic principles of risk management, which led to its eventual downfall.

Over the last few years, the bank grew on an era of cheap money due to ultra-low interest rates in the developed world. SVBs fortunes reversed with the reversal of interest rate cycle. As a result of record high inflation in Advanced Economies (AEs), the US Federal Reserve raised interest rates by 4.5 percent within last 12 months. As a result, startup funding dried up and founders started digging into their bank deposits to keep the businesses running. This is where cracks at SVBs start emerging.

It turned out, that while an era of easy money had led to deposit growth at SVB, its loan portfolio has failed to grow at a similar pace. As a result, SVB had to park its excess funds into long term government bonds and illiquid mortgage backed securities (MBS). What seemed like safe investments became problematic for SVB as interest rates hiked. Rise in interest rates led to erosion of value of SVBs bonds portfolio, due to inverse relationship between interest rates and bond prices. Further, it was revealed that portfolio was yielding an average 1.79 percent return, which was far below the 10-year US Treasury yield of around 3.9 percent. To meet the demand on deposits, the bank had to sell its bonds at a huge loss of USD 1.8 billion as announced on March 8, along with plans to sell both common and preferred stock to raise $2.25 billion. In the aftermath of this announcement, Moody's downgraded Silicon Valley Bank’s ratings. As the news of loss spread, withdrawal of deposits (attempted withdrawals of $42 billion on March 9) accelerated, leading to bank run at SVB.

At the core of the crisis, lies a classic case of asset liability mismatch and underwriting risk conservatism by management of bank. A large chunk of liabilities at the banks were short term, while its assets were of long term maturity that has to be liquidated prematurely. What prompted such long term investments was the need for higher returns and lack of foresight to realize that cheap money may not be available forever.

At the same time, the collapse also bring the fault lines in US’s banking regulatory ecosystem. For instance, out of its assets amounting to nearly USD 209 billion, investments worth USD 98 billion were classified as ‘held-to-maturity’ (HTM). HTM securities, unlike ‘available for sale’ securities, are not marked to market in bank’s balance sheets. This masked the quantum of risk to bank. Unlike, the RBI of India, the US Federal Reserve does not apply any limits to HTM securities in a bank’s assets.

Lapse in Regulatory/Supervisory Role

As a part of Dodd-Frank, banks with more than $50 billion in assets would be subject to additional oversight and rules. But the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act, significantly changed that requirement. Instead of setting the threshold at $50 billion, the 2018 law increased it to $250 billion. If the threshold was never changed, SVB would have been more closely watched by regulators.

Actions of Top Management

Former SVB President and CEO Greg Becker sold over $3.5 million of his company stock holdings on Feb. 27, according to a disclosure made to the U.S. Securities and Exchange Commission filed on March 1. The same day, the bank’s CFO Daniel Beck sold more than $575,000 worth of shares. In both cases, Beck and Becker had filed paperwork 30 days in advance of the sales, a practice required by regulators to avoid allegations of trading on non-public information. Other executives at SVB, including Chief Marketing Officer Michelle Draper, Chief Financial Officer Daniel Beck and Chief Operating Officer Philip Cox, also sold millions of dollars worth of shares since 2021. Altogether, SVB executives and directors cashed out of $84 million worth of stock over the past two years, according to Smart Insider.

Resolution of Crisis

UK SVB resolution: UK SVB was acquired by HSBC for 1 pound, in a deal facilitated by government.

USA resolution to SVB: Immediately after the crisis, FIDC took over the management of the bank. It was decided that taxpayers money will it be used to bail the bank out. Rather, FIDC will dig into the shares of bond holders and shareholders of SVB. The residual will be taken over by a deposit insurance corpus of FIDC. The Biden administration assured full return to SVB depositors. USA also tried selling the bank immediately after the crisis, but the planned sale failed.

Lessons for India

Immediate Risks

The crisis holds several lessons for Indian banking system

1. Are Indian Banks under risk: In general No. Even in the USA, standard commercial banks, pursuing commercial banking have not collapsed but an “outlier” bank with different model has failed. The other Banks which have failed are due to cryptocurrency (Signature Bank), and lack of confidence (Credit Suisse). In India, indirectly, Yes, the risk does exist though we all have a ALCO committee managing the asset liabilities but lot depends on securities held under HTM and those for sale. HTM cases are used to avoid recognizing the loss in investments and carried at their face value and not market price.
2. NBFCs, which are closely regulated and supervised are under more risk with steeply rising interest rates. Defaults from NBFCs could hurt the balance sheet of commercial banks and cause stress.
3. The empirical evidence shows that crisis don’t go away easily and come in waves. While the US and the UK as also Europe have attempted to contain the crisis it can travel through spillovers of capital flows as well as confidence channel to emerging countries (EMEs) like India. Therefore India should be ready with different plan for different scenarios. Most importantly RBI may have to persistently state that Indian banks, appropriately regulated, are safe. The government may have to recapitalize some banks after annual results are finalized on March 31, 2023. This recapitalization may be required after mark to market is firmed up.

General Concerns

1. Role of Rating Agencies and Auditors need to be examined. In the US these rating agencies created false sense of robust banking in case of SVB.
2. India has generally followed a responsible and conservative approach. In normal times, conservative approach may appear to be a drag on growth on a normal day, but it’s true value is realized at the time of crisis. However, conservatism, should not be taken for granted in case of turn in interest rate cycles as the financial sector is very vast and some vulnerable segment may become a cause of concern. Therefore the RBI and the government need to be watchful.
3. In general, selling the Bank is better than attempting to revive it. Global Trust Bank sale in 2004 in India was a good initiative. Similarly, UBS has bought Credit Suisse on March 19. The UK Government successfully did it in the current situation while US could not, needs to be noted.