Is 2008 back to haunt 2023? Lessons from SVB, Credit Suisse failures for India

The focus of SVB on startups led to a concentration of risk, with many clients being interconnected, facilitating a run on the bank rather too quickly.

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The ripple effects of one of the biggest US bank runs in over a decade are reaching a wide variety of businesses. Image: Bloomberg

By Rajesh Mehta & Sandesh Dholakia

The tremors from the collapse of Silicon Valley Bank and Signature Bank in the United States have reverberated across the financial world, particularly in the startup and venture capital space. It is not the first time we have borne witness to such a catastrophic event; the memories of the 2008 financial crisis still linger in our collective consciousness. The collapse of Lehman Brothers and the ensuing fallout had far-reaching implications not only for the United States but for the global economy as a whole. 

As we cast our gaze towards the present-day and the unfortunate fall of Silicon Valley Bank, we must reckon with the potential impact on economies around the world, including India. 

Is it 2008 again?

The years 2005 to 2008 saw a massive rise in subprime mortgage lending fuelled by loose lending standards, low-interest rates, and a housing market that appeared to be perpetually rising. As more and more people took out subprime mortgages to buy homes, the value of those homes continued to rise, creating a housing bubble. However, when interest rates began to rise and housing prices began to fall, many subprime borrowers were unable to make their mortgage payments, leading to a wave of foreclosures and a sharp decline in housing prices, causing significant losses for banks and other financial institutions.

Also read: New York Community Bank to buy failed Signature Bank

However, the fall of Silicon Valley Bank (SVB) is a case of asset liability management (ALM) mismatch concerns that turned into solvency issues for the bank. Deposits at the bank grew more than triple from the end of 2019 to March 2022, reaching $198 billion, while deployment opportunities for funds were limited due to Covid. As a result, deposits were channelled towards investments in two types of instruments: shorter-duration investments classified as available for sale (AFS) and longer-duration instruments classified as held to maturity (HTM).

The bank had invested heavily in HTM bonds, typically held until maturity and not subject to market fluctuations in value. However, as interest rates began to rise, the value of these bonds dropped, creating a loss on a mark-to-market basis. This was a particular challenge for the bank, as depositors began demanding their money back, creating a run on the bank.

Despite the HTM bonds being held until maturity, the bank was forced to liquidate them prematurely at a loss to meet depositors’ demands. This further eroded the bank’s financial position and ultimately led to its collapse.

From VC’s Favourite to Bankruptcy

Silicon Valley Bank (SVB) was a major player in the startup world, providing financial services specifically tailored to the needs of early-stage tech companies. Its deep understanding of the startup ecosystem and focus on venture capital made it an essential part of the Silicon Valley economy, with a major presence not only in California but also in tech communities across the world.

The failure of Silicon Valley Bank (SVB) emphasizes the advantages and disadvantages of having a narrow focus on a particular industry. While SVB’s focus on venture capital and startups increased its risk and was a major factor in its collapse, it also provided significant benefits to specialization that allowed SVB to become a dominant player for startups. By offering customized products and services, including venture debt lending and wealth management for entrepreneurs, SVB gained insights into investing trends and provided credit and other services to startups.

However, SVB’s single-sector concentration increased its idiosyncratic risk, which was compounded by the hyperconnected nature of its clients. This made it possible for a run on the bank to occur too rapidly.

It’s not just SVB – Credit Suisse finds itself in deep troubles

Credit Suisse, Switzerland’s second-largest bank by assets, has been facing a series of troubles in recent years. The bank, has been burned by its connections to the collapses of now-bankrupt Greensill Capital and Bill Hwang’s Archegos Capital Management. The bank has also undergone multiple changes of CEOs in short durations.

The recent events have only added to the bank’s woes. Credit Suisse’s largest shareholder, Saudi National Bank, has said that it’s not considering adding to its investment due to regulatory rules, raising concerns about the bank’s ability to make money and its potential need to tap shareholders for funds. 

The comments have amplified concerns about the bank’s ability to weather market crises and have led to a surge in credit-default swaps, as investors rush to protect themselves against a possible Credit Suisse default. The bank’s shares plunged by 24% on last Wednesday – its largest one-day drop in recorded history, and prices on its bonds fell to distressed levels. Following these troubles, in a historic move, UBS, the largest Swiss banking group is now set to buy Credit Suisse for USD 3.3 Bn to put an end to the crisis.

Lessons to Learn and Impact on India

The high-interest rate environment is like a strong wind blowing through a forest. The trees that are weak or diseased will start to sway and eventually fall over. 

Also read: UBS acquires Credit Suisse for $3.3 billion, chairman says will shrink loss-making investment bank unit

In both cases central banks intervened to prevent the contagion from spreading, this creates a moral hazard by sending a message to investors that they will not face the full consequences of their risky behaviour, potentially leading to even riskier behaviour in the future. This also results in a transfer of losses from shareholders and bondholders ultimately to taxpayers, which has even deeper negative economic and social implications.

SVB’s focus on startups made it a crucial player in the Silicon Valley ecosystem, and its failure could potentially affect the funding landscape for Indian startups that rely on the bank’s venture debt lending and other services. This could result in a funding gap for Indian startups, and in turn, affect innovation and growth in the startup ecosystem.

The failures of SVB and Credit Suisse serve as a reminder of the importance of regulatory oversight and the need for banks to diversify their portfolios to reduce idiosyncratic risks. Policymakers in India and around the world must prioritize measures to ensure the health of the banking system, including conducting regular stress tests, promoting diversification of loan portfolios, and implementing capital requirements. 

It is very important to strike a balance between preventing economic collapse and ensuring accountability and efficiency in the banking sector through measures such as promoting competition and responsible risk-taking. Failure to do so could lead to another 2008-like crisis.

(The authors – Rajesh Mehta is a leading consultant & columnist working on Market Entry, Innovation & International Affairs. Sandesh Dholakia is the founder at Case Ace and a strategy consultant. Views expressed are personal)

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First published on: 20-03-2023 at 12:38 IST
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