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What's the article about?
- It talks about the recent Silicon Valley bank crisis and the lessons that can be learned from it.
Relevance:
- GS3: Indian Economy and related issues; Effects of Liberalization on the Economy;
- Essay
- Prelims
Context:
- The recent failure of a Silicon Valley bank in the United States sparked worldwide concern about a repeat of the 2008 global financial crisis.
- The writer of this article analyzes the measures taken by the US government to address the situation and the lessons RBI should take away from it.
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The Global Financial crisis of 2007–2008:
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What is the Silicon Valley Bank crisis?
- The Silicon Valley Bank, which was founded in 1983, dealt with high-growth, high-risk businesses such as technology startups.
- SVB 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 phenomenon of bank run caused the SVB to collapse suddenly.
- A bank run is when a large number of customers of a bank or other financial institution withdraw their deposits at the same time over fears about the bank's solvency. As more people withdraw their funds, the probability of default increases, which, in turn, can cause more people to withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the withdrawals.
- The SVB became the second-biggest collapse in the history of the US.
Significance for India:
- 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.
| SaaS applications are also known as Web-based software, on-demand software, or hosted software. It is a cloud-based software delivery model that allows SaaS applications to run on SaaS providers' servers instead of installing and maintaining software on-premises. |
Analysis:
- Steps are taken to bolster public confidence in the banking system.
- The Federal Deposit Insurance Corporation (FDIC) first took over the Silicon Valley Bank.
- The Federal Reserve and the Treasury Department announced that depositors in both the banks would be repaid in full.
- U.S. President Joe Biden sought to reassure the nation and global markets that the U.S. was committed to maintaining a resilient banking system, and would move to simultaneously tighten regulations for banks to make it less likely for such failures to occur again.
- Silicon Valley Bank’s case is fairly unique.
- With the depositor base comprising start-ups and venture capitalists, mostly from the tech hub of Silicon Valley, the customers were geographically and sectorally concentrated.
- The bank had also invested extensively in a portfolio of U.S. Treasuries and mortgage bonds, which had as a result of the recent sharp interest rate increases by an inflation-battling central bank accumulated unrealised losses that became too costly to liquidate in a distress situation.
- Blaming the Fed’s monetary tightening as the proximate cause for the bank failures is a case of being unable to see the wood for the trees.
- Interest rates move in cycles and all banking is fundamentally predicated on managing the risks associated with interest rate moves as well as ensuring that the deposits banks accept to fund lending are always reasonably matched with income or holdings that could be used to meet withdrawals.
Way Forward:
- The Reserve Bank of India’s guidelines of 2018 advising banks to create an Investment Fluctuation Reserve is just the kind of countercyclical tool that has relatively insulated Indian lenders from interest rate risks.
- Still, the RBI must remain on guard to ensure neither global contagion nor management missteps threaten any local lender.
