One More Bank in the US Fell down

Life’s wisdom consists in the eliminating of non-essentials
March 14, 2023
The Art and Science of Selecting Right Mutual Funds
The Art and Science of Selecting Right Mutual Funds
March 17, 2023
One More Bank in the US Fell down

One More Bank in the US Fell down

Shut down of Silicon Valley Bank (SVB in short) in America sent a shockwave across the world and brought back memories of the collapse of Lehman Brothers in 2008.

Let us see the reason of its collapse and what the implications are for the economies and the investors like you and me.

Why this bank caved in- SVB was a specialised bank giving the banking services to start-up companies mainly in tech sector. It was a niche player which specialised in understanding the needs of the start-ups who didn’t have lot of collaterals for taking loans from conventional banks and institutions. Also just like any other banks, SVB was taking deposits also and most of these deposits come from the same companies to whom it had given loans. All the operations were going on quite smoothly till 2020. In fact the period between 2012-2019 was the golden period for the bank because of the start-up boom in the USA.

Trouble begins when at the outbreak of Covid, US federal reserve in order to float the economy decided to cut the interest rates aggressively. It was thought all around the world that the heavy impact of covid and lockdowns can be controlled only by massive (and somewhat artificial) interest rate cuts. Due to such monumental cuts, cheap money flooded the financial system.

What SVB did was to park this excess liquidity in the US treasury bills.

By 2022 onwards, there has been a lull in the start-up ecosystem. Companies have been facing downturn in business, and the start-up party music halted abruptly. But more than that, due to inflation spiralling to a record level in 40 years, US fed has started increasing the interest immensely. Rates jumped up from less than 2% to 5% in a very short span of time. Due to this, the value of old US bonds crashed remarkably and there was a huge mark to market loss to the bank.

 Around this time, couple of things also happened. One, start-ups were facing funding winter along with challenge to float their fledging business, they needed to break their deposits from the SVB. Secondly many savvy venture capital funds started advising their funded companies to withdraw cash from the bank. All this resulted in massive sell off of US bonds by the bank at a heavy discount. But the pressure of deposits withdrawal was so high that SVB could not withstand and collapsed on Friday the 10th March.

Is this a repeat of 2008- This collapse is getting equated with 2008 collapse of Lehman Brothers. But in my opinion the impact of SVB is limited to Start-up companies and not the wider economic landscape. Some companies would definitely face the brunt especially if US Govt won’t bail out their deposits. Some may even shut down. So, its lot to do with US authorities as how will they handle this situation. They have given some indications that deposit amount ( even beyond the insured deposit amount of $ 2,50,000 per person) may be bailed out. Also, besides focusing on the affected parties of this fiasco, they may also be looking into the health of other banks because the massive rate hike might pose a big challenge to these bigger banks as well.

In there any impact on Indian Banking system- Indian banking system is quite robust with number of safety net and check and balance by the RBI. Also, these banks are not as aggressive as the US banks which is good for our system. Moreover RBI is continuously ensuring that banks are properly funded and adhering proper capital adequacy norms.

Lessons for the investors- There are very important lessons for the common investors. SVB in their greed to earn higher return have deployed bulk of its deposits in long terms papers and taken a huge amount of interest risk. It should have parked the amount in the securities of different time horizons. In other words it must have weighed in the worst possible risk factors and should have prepared for that. Alas, the greed had blinded its managers’ senses or so it seems.

As the investors, it’s important to remind ourselves the time tested principles of proper asset allocation, diversification and define your fears and not just your goals. You may have to forgo some short term gain in the bargain but these hard choices will eventually make your life easier in the long run.

PS- Franklin Templeton Mutual Fund had faced a similar situation in April 2020. They had the choice to let their troubled 6 funds carry on and let the investor incur a huge loss. But they made the hard choice of shutting down these funds. They faced heavy backlash and criticism but they stuck to their decision. Finally it paid off and investors got their money back along with reasonably good return. What could have been a staggering blow to Indian investment space was averted by the hard choice made by Franklin Templeton. Kudos to them.

Manoj Pandey