SILICON
VALLEY BANK (SVB) COLLAPSE - ECONOMY
News: Explained
| Will the SVB collapse impact Indian start-ups?
What's in the news?
● On
March 10, banking regulators in the U.S. took control of the Silicon Valley Bank (SVB), which typically
catered to start-ups, venture capitalists and tech firms, after it suffered a
sudden collapse.
Key takeaways:
● Over
48 hours last week, after California-based Silicon Valley Bank (SVB) failed,
hundreds of Indian startups with millions of dollars stuck in accounts at the
bank went to the brink and back.
● Without
the intervention of the United States government, these businesses were staring
at mass layoffs and, in some cases, extinction.
Silicon Valley Bank:
● SVB,
which was founded in 1983, dealt with high-growth,
high-risk businesses such as technology startups.
● Silicon
Valley Bank provided banking services to nearly half of venture capital-backed
technology and life-science companies, according to its website, and over 2,500 venture capital firms.
● The
bank offered an easy way for startups in India, especially those in the Software as a Service (SaaS) sector who
have a number of US clients, to park their cash - as they could set up accounts
without a US Social Security Number or Income Tax Identification Number.
● SVB
became the second-biggest collapse in
the history of the US.
SVB Crisis:
● Silicon
Valley Bank was hit hard by the downturn
in technology stocks over the past year as well as the Federal Reserve’s aggressive
plan to increase interest rates to combat inflation.
● The
bank bought billions of dollars worth of
bonds over the past couple of years, using customers' deposits as a typical
bank would normally operate.
● These
investments are typically safe, but the value of those investments fell because
they paid lower interest rates than
what a comparable bond would pay if issued in today’s higher interest rate
environment.
● But
Silicon Valley’s customers were largely start-ups and other tech-centric
companies that started becoming more needy
for cash over the past year.
Causes for SVB Collapse:
1. Downturn of tech stocks:
● The
bank was hit hard by the downturn in technology stocks over the past year as
well as the Federal Reserve’s aggressive
plan to increase interest rates to combat inflation.
2. Aggressive raising interest rates:
● Global
borrowing costs have risen at the fastest pace in decades over the last year as
the Federal Reserve lifted U.S. rates by
450 basis points from near zero, while the European Central Bank hiked the
eurozone by 300 bps.
● Due
to this, the value of existing bonds that were issued at lower interest rates
has fallen. Banks, which bought these bonds are sitting on steep unrealised
losses.
● Another
facet of the rising interest rates was the decline in funding for startups as
the venture capital ecosystem doesn't
want to take risks.
3. Mostly startups account holders:
● SVB’s
customers were largely startups and other tech-centric companies that started
becoming needier for cash over the past year.
4. Heavy investment in long-term government bonds:
● SVB’s
invest heavily in US government bonds.
● A
spike in interest rates has led to a sell-off in bonds, leaving banks exposed
to potential losses on the securities they hold.
5. “Run on the bank”:
● The
bank failed after depositors - mostly technology workers and venture
capital-backed companies began withdrawing their money in panic, creating a
“run on the bank”.
6. Soft Regulations:
● In
2018, regulations were loosened for regional banks like SVB - among other
things, it reduced the amount of potential loss reserves mandated for these
banks.
7. Liquidity crunch:
● SVB’s credit rating was
downgraded by multiple agencies, and a number of
fund companies called on their portfolio companies to withdraw their funds from
the bank, leading to an inability for SVB to fulfill such a high demand for
withdrawal.
Impacts of SVB Collapse:
1. Startups scramble:
● Many
startups and other companies that relied on the bank’s services were suddenly left without access to their funds,
which caused financial strain and uncertainty for these businesses.
2. Impacts on small businesses:
● According
to a petition to the US government, around 10,000 small businesses with
accounts in Silicon Valley Bank may be unable
to pay their employees in the next 30 days, and approximately 1 lakh jobs
are anticipated to be affected as a result of the collapse.
3. Impact the technology industry:
● It
will immediately impact the US technology industry and US competitiveness
worldwide and ultimately set back US competitiveness by a decade or more.
4. Can trigger a run on the bank:
● Its
collapse has already instilled fear among founders and management teams to look
for safer havens for their remaining cash, which can trigger a bank run on
every other smaller bank.
5. Vulnerability to the rising cost of money:
● The
SVB crisis spread concern about hidden risks in the banking sector and its
vulnerability to the rising cost of money.
6. Damage of confidence:
● The
impairment or failure of a bank with large size is also more likely to damage confidence in the banking system as a
whole.
Impact on Indian startups:
1. Uncertainty over deposits:
● The
failure of SVB is likely to have a ripple effect on Indian startups, many of
which have significant amounts of funds deposited with the bank.
2. Hamper the funding:
● SVB
has been a major player in the Indian startup ecosystem, providing banking
services and funding to many of the country’s most successful startups,
including Flipkart, Ola, and Zomato.
3. Ripple effect:
● This
could lead to a cash crunch for many companies, which may be forced to cut
costs, delay projects, or lay off employees.
4. Reduce global footprints:
● SVB
has also been instrumental in helping Indian startups expand into the US
market, by providing them with the necessary infrastructure and support to set
up operations in Silicon Valley.
5. Affecting stock markets:
● The
SVB issue, however, created nervousness
in the stock markets with bank shares taking a hit and investors losing money
in the process.
The
reasons for SVB’s failure are unlikely to play out in India as domestic banks
have a different kind of balance sheet structure, according to bankers.