CCalifornia’s Silicon Valley Bank was shut down by regulators in the United States last Friday, followed by New York-based signature bank on Sunday. There could also be a number of Indian startups having accounts in SVB rubbed off With this sudden closure. Bank runs or panic withdrawals and the resulting contagion effects have once again raised questions about banking regulation around the world.
SVB effect
When SVB announced last Wednesday that it needed $2.25 billion to shore up its balance sheet, it took most of its depositors by surprise. Panic broke out and depositors withdrew their money. $42 billion In a day, makes the bad situation worse and leads to its shutdown. The Federal Deposit Insurance Corporation (FDIC) said depositors would only have access to insured deposits (up to $250,000) as of Monday morning.
With deposits in SVBs, many startups in India have had difficulty accessing funds, especially those with deposits that exceed the amount. Losing access to their deposits would hurt the ability of these firms to make downstream payments. The Minister of State for Skill Development and Entrepreneurship in India is Rajeev Chandrasekhar meeting With startups to measure impact. Late Sunday evening, the Federal Reserve System (also known as the Fed) announced This will help the banks to meet the needs of their depositors. UK branch of SVB has already been sold to HSBC. What seemed to be a bank failure from a relatively small institution has turned into an event with global ramifications.
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an unusual bank run
Running SVB Bank is unusual for three reasons. First, it did not run into trouble due to its deteriorating loan portfolio. SVB clients were largely venture-capitalists who had made deposits but were not in need of loans. So SVB invested these funds in US government bonds. When the Fed raised interest rates, the price of bonds fell, creating a liquidity crisis. Thus the bank’s financial condition was the result of poor management of its interest-rate risk, not its credit risk.
Second, since the client base consisted mostly of venture-capitalists, their demands for funds to the SVB, for example to pay salaries to their employees, would be made at the same time. The homogeneity of the customer base meant that the bank itself was not diversified.
The third is the response of the government. Bank failures are nothing new to America. Resolution is a well-understood process in which bank assets are sold over time, and ownership changes hands. Initially, the FDIC’s response was as expected – it would only provide access to insured deposits and proceed with the sale of the bank. This was because SVB was not considered systemically important given its size (the 16th largest in the US in terms of deposits prior to its collapse). However, the Fed swung into action with the Bank Term Funding Program (BTFP). With this program, the government will make available up to $25 billion, thus guaranteeing all depositors access to their funds. This funding comes from an insurance fund, not taxpayer money.
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need for financial regulation
Banks are risky institutions. They take money from depositors and lend the same money to businesses. Repayment by creditors takes place over a longer period, while depositors can withdraw their balances at any time. Instead of lending to customers, banks sometimes invest in government bonds, whose prices fluctuate depending on the interest rate environment. Thus, the bank always faces a mismatch in the tenure of its funds. It maintains a capital buffer for such events, but this buffer may fall short.
If all depositors withdraw their money at the same time, the bank will not be able to meet the demand, causing a “bank run”. Countries around the world have instituted “deposit insurance” programs. If a bank fails, part of the insured deposits are returned to the depositors. Insurance is funded through premiums charged from banks. In the US, the FDIC, the nation’s deposit insurance agency, not only insures bank deposits but also acts as a receiver Bank’s – Selling or collecting the assets of the failed bank and settling its debts.
The SVB case has once again raised questions on the role of banking regulation and deposit insurance. We have generally considered bank runs as arising from credit risk and have paid less attention to interest rate risk. are standard Procedures To hedge the interest rate risk in the books of banks. The question is whether regulators will need to examine whether SVB’s exposure to interest rate risk has previously raised alarm bells. Should SVBs also be subjected to more regular stress tests? Should banks be asked to keep a Big A buffer of shareholder funds to absorb losses? Does this buffer fund turn into banks that serve only one community and therefore do not diversify themselves? Banking regulation has to evolve to deal with the problems related to interest rate risk.
Renuka Sane is Director of Research at TrustBridge, which works on improving the rule of law for better economic outcomes for India. Thoughts are personal.
(Edited by Zoya Bhatti)