Corporate Law Daily

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Silicon Valley Bank Crisis Explained in 10 Simple Points & Lessons Learnt therefrom

The sudden catastrophic collapse of the 16th largest bank in USA, the Silicon Valley Bank (SVB) and its seizure by the US Regulatory Authorities, in the last week, has caught the attention and interest of 'We - the Mango People' of India also, and has raised some nerves too.

But in view of the very limited and negligible exposure of our Indian Banking System and our Indian economy, to the economic and other repercussions of the fall out of this US based bank's failure, this collapse hopefully, will not have any direct financial impact on us. Though a few of the Indian Tech-startups do have some exposure in SVB.

However, this SVB crisis does impart some critical learning lessons for us. But before delving into the same, it becomes essential to first know and understand what actually has happened, which has led to this massive banking failure in the US.

So, here is a simple Explainer in 10 easy to understand, chronological turn of events, decoding the otherwise complicated maze of financial and technical jargons.

1. It all started on a very promising and bright note, with majority of the US Silicon Valley's big Tech-Startups, raising huge funds in a funding spree from venture capitalists and big investors and depositing their surplus/unutilised fund raises with SVB.
2. SVB instead of keeping these deposits in liquid form (cash) with it, invested these deposits in US Treasury Bonds. It is pertinent to mention here that these US Treasury Bonds were adequately backed by the US Government, with minimalistic default risk, so to be fair to SVB, these investments were not bad or risky.
3. The time bomb started ticking when the US Federal Reserve (the US Central Bank like RBI in India) increased Federal Interest Rate (US Central Bank lending rate like Repo Rate in India) in a series of interest rate hikes, in order to curb inflation in the US.
4. There is an inverse corelation between the interest rate and the bond prices. The increase in interest rate is being compensated by a decrease/compression in the principal value of the bond or debenture. So, the increase in the US Federal Interest Rate, resulted in the decline in the US Treasury Bond prices, which constituted the major chunk of the investment portfolio of SVB.
5. The Market Value/ Net Realisable Value of these US Treasury Bonds, forming the investment portfolio of SVB, became less than the carrying value/ book value of these investments, in the Balance Sheet of SVB.
6. At the same time, Silicon Valley Start-ups started incurring cash losses and faced a funding freeze and stopped getting funds from investors.
7. This liquidity crunch forced these Startups to ask for their money/deposits back from SVB.
8. In order to honour such deposit withdrawal demands of the Silicon Valley Start-ups, SVB was forced to sell its investments in the US Treasury Bonds at a loss of around $1.8 billion, due to rising federal interest rate and declining bond prices. To compensate for this loss, SVB announced the capital raise of 2.25 billion USD along with its stock sale. This created panic among the Silicon Valley Startups, and further accelerated the process of withdrawal of their deposits from SVB.
9. Fresh Deposits also became more expensive for SVB, with Federal Interest Rate's hike.
10. All this led to a crash of share price of SVB by more than 60% in the US capital market, and ultimately the collapse of SVB, and the Federal Deposit Insurance Corp. (US Regulatory Body) assuming the regulatory control of the Bank.

Lessons Learnt

It is important to understand here that the SVB Crisis didn't happen due to its bad loans or its advances becoming non performing but it happened because SVB failed to realistically foresee and assess the timing of serviceability/repayment of the deposits taken by it from the Silicon Valley Start-ups and instead of keeping these deposits in liquid or short-term investment instruments, invested these deposits in the long-term US Treasury Bonds.

In India, there is a concept called 'Cash Reserve Ratio' (CRR). It is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank RBI, to ensure that banks do not run out of cash to meet the payment demands of their depositors. CRR is a crucial monetary policy tool in India and is used for controlling money supply in the economy. Currently CRR is at 4.50%.

Secondly, SVB was caught off-guarded and it ran out of cash as it failed to foresee the very basic corelation between the rising US federal interest rate and the declining US Treasury Bond prices, constituting its investment portfolio and consequently its mark-to-market loss (book loss), suddenly converted into actual loss, on forced selling of its investments in US Treasury Bonds, below their acquisition costs, in order to service the withdrawal demands of deposits by the Silicon Valley Startups.

Thirdly, SVB crisis can also be attributed to its Asset-Liability Mismatch. Usually a healthy bank is characterised by its sound and robust advance base. However in case of SVB, its deposits from customers appearing at liability side, far exceeded its advances given to customers appearing in assets side. So, at all times, the interest which it was required to pay on its deposits from customers outweighed its interest income which it was earning on advances given by it to customers.

Thus, this serious impending disaster, now being unravelled into a massive US banking system failure, could have been averted, had the SVB stuck to the basics of financial proprietary norms i.e., not assuming somebody else's money (deposits from Silicon Valley startups) as its own money and secondly it had not ignored the very basic fundamentals of the financial market, i.e., the correlation between the interest rate and the bond prices, and thirdly SVB had rectified its asset-liability mismatch in a timely manner.

Corrective Measures by US Government & Federal Reserve

It's really commendable how quickly the President Biden led US Government has acted and bailed out the helpless depositors of the shut-down SVB, by taking two excellent measures:

1. Allowing all the depositors to have full access to their entire deposit base and not limited to insured value of $2,50,000, in a phased manner. More importantly the US taxpayers will not bear the cost of this bail-out package, and stakeholders in the failed SVB will bear this cost.
2. Setting up a new lending facility to enable Banks to pledge their investments in US Treasury Bonds, Mortgage-Backed Securities (MBSs) and other qualifying assets as collaterals, with US Federal Reserve (US Central Bank), wherein banks will receive loans equivalent to the face value of such Treasury Bonds/ MBSs), even if their respective market values have fallen in the wake of rising Fed interest rate, at prevailing market interest rate plus an additional fees of 0.1% only.

SEBI prescribes time limits for FPIs to disclose information to Board and DPs under FPI Regulations

Notification No. SEBI/LAD-NRO/GN/2023/128., Dated 14.03.2023

The SEBI has notified the SEBI (Foreign Portfolio Investors) (Amendment) Regulations, 2023. An amendment has been made to regulations 22 & 31 of the SEBI (Foreign Portfolio Investors) Regulations, 2019.

Regulation 22 of SEBI (Foreign Portfolio Investors) Regulations, 2019 outlines the general obligations & responsibilities of foreign portfolio investors (FPIs).

As per the amended norms, FPIs are required to inform the Board and designated depository participants (DPs) within 7 working days, if there is any material change in the information previously furnished by them. This includes any direct or indirect change in FPIs structure or ownership or control.

Additionally, FPIs must maintain accurate details of their investor group with DPs at all times. Various other amendments were prescribed.

Regulation 31 of SEBI (Foreign Portfolio Investors) Regulations, 2019 outlines the obligations & responsibilities of designated depository participants (DPs).

As per the amended norms, all designated depository participants who have been granted approval by the Board must inform the Board within 2 working days if any information or particulars previously submitted to the Board are found to be materially false or misleading.

As per the amended norms, all designated depository participants who have been granted approval by the Board must inform the Board within 2 working days if any information or particulars previously submitted to the Board are found to be materially false or misleading.

Further, in case any penalty, pending litigation or proceedings, findings of inspections or investigations have been taken or is in the process of being taken against a designated depository participant, then DPs are obligated to bring such information to the attention of the Board, depositories and stock exchanges within 2 working days.

SEBI grants renewal of recognition to ‘AMC Repo Clearing Limited’ for a period of 1 year

Notification no. No. SEBI/LAD-NRO/GN/2023/127, Dated: 14.03.2023

The market regulator SEBI, on being satisfied that it would be in the interest of the trade, and also in the public interest, has granted renewal of recognition to the ‘AMC Repo Clearing Limited’ for a period of 1 year commencing on the 17th of January 2023 and ending on the 16th day of January 2024. The recognition is subject to a condition that the Clearing Corporation shall comply with the conditions specified by SEBI.

Further, the Clearing Corporation is restricted from undertaking any activity other than that of clearing and settling of transactions in the repo and reverse repo in the debt securities that are traded on a recognised stock exchange.

That’s it from us for today! Stay Tuned for more updates from?Taxmann.com.

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