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The SVB Collapse Explained and Its Impact On The Indian Equity Market

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SVB Collapse
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SVB Collapse in the News

March 13th saw headlines such as “SVB Collapsed“, Why Silicon Valley Bank collapsed and what it could mean, SVB, and Signature Bank collapse. The world woke up to panic withdrawals and shuttering of well-known banks in the US that had far-reaching effects.

The world’s financial gatekeepers have once again found themselves in the midst of chaos and uncertainty following the failure of Silicon Valley Bank (SVB), the 16th largest bank by assets in the US. The SVB collapse comes when the world faces multiple macroeconomic challenges, raising investor concerns about a possible rerun of the Lehman Brothers moment.

Let’s take a closer look at what happened with the start-up-friendly Silicon Valley Bank and how it will affect the Indian equity market.

The SVB Collapse: A Timeline of Events

March 8th, 2023: SVB Financial Group announced a $1.8 billion realized loss from investments in long-term debt papers, and to plug the hole in the balance sheet, it planned to raise more than $2 billion.

March 9th: The distressed financial position of the bank resulted in investors dumping SVB’s shares in the market, and by the end of the day, the bank’s share fell by 60%.

March 10th: Rapid withdrawal of funds gained momentum across all depositor classes as the credit rating agency Moody’s downgraded SVB Financial Group and its subsidiary SVB. Their long-term currency bank deposits and issuer ratings were downgraded from A1 to Caa2 and Baa1 to C, respectively.

It raised concerns that the bank would fail to generate enough cash to honor withdrawals, putting it on the verge of collapse. California Banking Regulator closed the bank, and the Federal Deposit Insurance Company (FDIC) took control of the bank to protect depositors’ interests.

FDIC guarantees protection of up to $250,000 in funds to account holders, but as the bank’s primary client base is institutions, the deposit sum far exceeded the $250,000 threshold.

The shock from the SVB collapse spread across the market, from global equity to the crypto market, witnessing the worst fall in recent times. Another New York-based Signature Bank, which lends mostly to real estate and law firms, witnessed large-scale withdrawals of funds and a sharp fall in stock price.

March 12th: Fearing banking contagion, regulators shuttered the Signature Bank and announced an emergency $25 billion liquidity backstop for depositors to cover their needs and avoid more bank runs.

March 13th: Moody’s downgrades the debt rating of shuttered Signature Bank to junk and places six more banks under review. Despite President Biden’s assurance that the country’s banking system is strong and safe, the rout in banking stocks continued.

March 14th: Moody’s Investors Service downgrades outlook on US banking system from stable to negative, citing deteriorating operating environment.

The Silicon Valley Bank Collapse Explained

Like any big failure, Silicon Valley Bank’s failure did not happen in a day, and it exposed the systemic risks in the US banking system. It is the second-largest bank failure in the US after the 2008 collapse of Washington Mutual.

But why did SVB collapse? Here are a few reasons

Ultra-loose Monetary Policy

When the Covid-19 pandemic hit the world in 2020, central banks worldwide, including the Federal Reserve, chose an ultra-loose monetary policy to shore up global liquidity and push growth in response to the disruption.

Between March 3 and March 15, 2020, Fed cut its federal funds rate by 1.5%, lowering the funds rate from 0 to 0.25%. Additionally, the Fed resumed Quantitative Easing (QE), purchasing treasury securities amounting to $500 billion and $200 billion in government-guaranteed mortgage-backed securities.

High Inflation Hits the US

The prolonged near-zero interest rate and billions of dollars worth buying of debt securities every month to stimulate the economy stoked inflation in the country. The annual inflation rose to 7% in 2021 from 1.4% in 2020, raising fears of a slowdown in the economy. In November 2021, Fed began tapering off QE, and by December, it doubled its speed of reducing monthly bond purchases.

Fed Starts Tightening Monetary Policy

Sustained high inflation continued into 2022, compelling the Fed to begin the rate hike process. The Fed raised interest rates by 25 basis points on March 17, 2022.

With the Russia-Ukraine war raging on, the global supply chain has been severely disrupted, resulting in US inflation reaching a 40-year high of 9.1% in June 2022. The Fed used aggressive rate hikes to control inflation, raising interest rates by 425 basis points by January 2023, with the Federal funds rate ranging from 4.5% to 4.75%. This is where things began to deteriorate for US banks.

Inverted Yield Curve

Before delving into the specifics of SVB’s fallout, it’s important to understand the concept of an inverted yield curve, sometimes referred to as a negative yield curve.

What is a Negative Yield Curve

An Inverted Yield Curve is a situation where the yield on long-term bonds is lower than that on short-term bonds. It is unusual for any economy as the indicator indicates an impending recession.

Simplifying Jargon

With the Federal Reserve’s aggressive rate hike journey in 2022, the US yield curve has reached the deepest inversion since 1981, stoking recession fears. As a result, continuing with the investment would be a loss for any long-term bondholders, as debt papers with shorter maturities will provide more yield. Also, the market value of long-term bonds with lower yield declines.

SVB Collapse: The Final Days

SVB was a startup-friendly bank with many leading venture capitalists and unicorns as clients. During the 2021 funding boom in new-age startups, the bank amassed large deposits, which peaked at $198 billion.

Later, SVB invested those deposits in long-term bonds in a low-interest rate scenario. During 2022, as clients started withdrawing their money to meet the liquidity requirements amid the funding crunch and challenging macroeconomic conditions, SVB had to start selling their investments to honor the withdrawals.

Due to the high withdrawal pressures, SVB sold securities worth $21 billion from its portfolio at a lower market value and suffered a net tax loss of $1.8 billion. The investment portfolio yielded an average of 1.79%, lower than the current rate of 3.9% in 10-year Treasury Securities.

From this point, the world started to know about the developments in the Silicon Valley Bank. The SVB fallout is not the result of a scam or a failure to follow regulatory rules but rather due to a sharp rise in interest rates that the bank did not anticipate.

Uday Kotak on SVB collapse on Twitter

Impact on the Indian Equity Market of SVB Collapse

A bank failure is always a troubling development for any economy, and when it occurs in the United States, it has ripples around the world.

Indian banks have no major direct exposure to the two collapsed banks in the US. Therefore, the impact will be the least. The current sell-off in the Indian equity market reflects global sentiments and foreign investors pulling out their money from risk-on assets due to fear. Post the Lehman Brothers crisis, or during the global financial crisis, there was a sudden stop in capital inflows in the country. Thus, returns were muted.

Lower global demand for goods and services in the short term can impact export revenues; however, with preventive regulatory measures, the impact of the SVB fallout is expected to be minimal on export-oriented stocks.

Also, with stronger and well-capitalized banks in India and RBI’s strong supervisory rules, India can manage external shocks well and safeguard its economy. Therefore, the impact of SVB fallout in the Indian equity market is most likely to be short-lived.

FAQs

What is SVB collapse?

SVB was the 16th largest bank in the US and was the go-to bank for US tech startups. Huge investment losses and a capital crisis led to California Banking Regulator closing the bank on March 10th, 2023.

How big was SVB?

According to the regulators, SVB had assets worth $209 billion and customer deposits amounting to $175 billion at the end of 31st December 2022.

Did SVB collapse due to a scam?

No. SVB didn’t close down due to scams. It suffered huge investment losses because of the steep rise in interest rates.

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