The sudden catastrophic collapse of US-based Silicon Valley Bank (SVB) and its seizure by the US regulatory authorities has caught the curiosity of ‘We—the Mango People’ of India additionally, and has frayedsome nerves, too.
But in view of the very restricted or negligible publicity of the Indian financial system and banking system to the repercussions of the fallout of a US banking system failure, this collapse hopefully is not going to have any direct monetary affect on us.
However, this SVB disaster imparts important classes. But earlier than studying these, it turns into important to first know and perceive what led to this large banking system failure within the US.
So, right here is an easy explainer on the flip of occasions:
1. It all began on a really promising and brilliant observe, with majority of the US Silicon Valley’s huge tech-startups, elevating enormous funds in a funding spree from enterprise capitalists and massive buyers and depositing their surplus/unutilized fund raises with SVB.
2. SVB, as a substitute of maintaining these deposits in liquid type (money), invested in US Treasury bonds. It is pertinent to say right here that these US Treasury bonds had been adequately backed by the US authorities, with minimalistic default danger.
3. The time bomb began ticking when the Fed elevated federal rate of interest (US Central Bank lending price like Repo Rate in India) in a steady sequence, with the intention to curb inflation within the US.
4. There is an inverse correlation between the rate of interest and the bond costs. So, the rise within the US Federal rate of interest, resulted within the decline within the US Treasury Bond costs, which constituted the most important chunk of the funding portfolio of SVB.
5. The market worth/web realizable worth of those US Treasury Bonds, forming the funding portfolio of SVB, turned lower than the carrying worth/ guide worth of those investments, within the stability sheet of SVB.
6. At the identical time, Silicon Valley start-ups began incurring money losses and confronted a funding freeze and stopped getting funds from buyers.
7. This liquidity crunch pressured these Startups to ask for his or her cash/deposits.
8. In order to honour such deposit withdrawal calls for of the Silicon Valley start-ups, SVB was pressured to promote its investments within the US Treasury Bonds at a lack of round $1.8 billion, as a consequence of rising federal rate of interest and declining bond costs. To compensate for this loss, SVB introduced the promoting of its fairness. This created panic among the many Silicon Valley startups, and additional accelerated the method of withdrawal of their deposits from SVB.
9. Fresh deposits additionally turned dearer for SVB, with a federal rate of interest’s hike.
10. All this led to a crash of share worth of SVB by 60% within the US capital market, and finally the collapse of SVB, and the Federal Deposit Insurance Corp. (US regulatory physique) assuming the regulatory management of the financial institution.
Lessons learnt: The SVB disaster didn’t occur as a consequence of its dangerous loans or its advances changing into non performing but it surely occurred as a result of SVB didn’t foresee and assess the timing of serviceability/reimbursement of the deposits taken by it from the Silicon Valley startups and as a substitute of maintaining these deposits in liquid or short-term funding devices, invested them in long-term US Treasury bonds.
In India, there the money reserve ratio (CRR). It is a specified fraction of the full deposits, which industrial banks have to carry as reserves both in money or as deposits with RBI to make sure banks don’t run out of money to satisfy cost calls for of depositors. CRR is an important financial coverage device and is used for controlling cash provide. Currently CRR is at 4.50%.
Secondly, SVB was caught off-guard and it ran out of money because it didn’t foresee the very fundamental correlation between rising US federal rates of interest and the declining US Treasury bond costs, constituting its funding portfolio and, consequently, its mark-to-market loss (guide loss), instantly transformed into precise loss, on pressured promoting of its investments in US Treasury bonds, under their acquisition prices, with the intention to service the withdrawal calls for of deposits by the Silicon Valley startups.
Mayank Mohanka is the founding father of TaxAaram India, and a accomplice at SM Mohanka and Associates.
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