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Independent markets commentator. Media columnist. Board member. Corporate & Startup Advisor / Mentor. CEO coach. Strategic counsel for 25 years, with leading corporates across diverse sectors including automobile, e-commerce, advertising, consumer and financial services. Works with leaders in enabling transformation of organisations which have complexities of rapid-scale-up, talent-culture conflict, generational-change of promoters / key leadership, M&A cultural issues, issues of business scale & size. Understands & ideates on intersection of BFSI, digital, ‘contextual-finance’, consumer, mobility, GEMZ (Gig Economy, Millennials, gen Z), ESG. Well-versed with contours of governance, board-level strategic expectations, regulations & nuances across BFSI & associated stakeholder value-chain, challenges of organisational redesign and related business, culture & communication imperatives.More From The Author >>
Ten Banking Lessons From Silicon Valley
What did the era of cheap money and relaxed regulations do to the business of banking? Answer: it injected lethargy and glamour into it! The banks forgot the basics of banking – risk management, balancing their assets and liabilities, and having cash needed to pay on demand!
Photo Credit : svb.com
Silicon Valley Bank
It took 40 years to build what was the Silicon Valley Bank (SVB) – the darling of the tech world. It took just 40 hours of depositors’ distress signals to withdraw deposits prematurely, to bring it down to bankruptcy. What went wrong for a bank who was the darling of the startup ecosystem, and whose clients were half of the US’s venture-capital backed technologies and life sciences companies?
The business of well-run banks is simple – have a long term business model, with some short-term assets. Their assets and liquidity cover any liabilities that are due to mature. They get additional capital to cover any business losses, and liquid assets to cover out-of-turn withdrawals. If all depositors were to withdraw their money at the same time, then the bank would not be able to meet those demands, causing a “bank run”.
So, here are ten lessons from the collapse of the Silicon Valley Bank:
Lesson 1: Bank-runs are possible, even in well-run banks.
The Federal Reserve, the central banker of the US, hawkishly increased interest rates eight times in a year, to fight inflation. This reduced the value of assets held by the bank, and did not appropriately tally with its liabilities.
Lesson 2: Even money at near zero interest rate has a severe cost attached to it.
Suddenly with the SVB experience, the US Fed focus is more on financial stability, than on inflation. Something that they can learn from the Reserve Bank of India (RBI), who juggles its multiple roles of inflation-manager, sovereign-debt manager and monetary regulator in charge of financial stability.
Lesson 3: Not all things West, are the best. Just because it’s low key and asks tough questions, doesn’t mean that we need to underestimate regulators like the RBI.
With interest rates increasing, and the bulk of its investments in US government bonds, the SVB saw the values of its assets eroding fast. Yet it did not adjust the valuations on its books and did not raise adequate liquidity as a comfort. When it sold a part of its assets at discounts to raise liquidity, and had to raise equity capital to make up for that asset value loss, it’s tech clients thought it was going under. And they withdrew the deposits further, causing a run. In India, the RBI supervises its entities to be able to keep a grip on their Asset-Liability Management (ALM), and to have Mark to Market valuation of the assets it holds. That’s how they manage interest rate risks.
A Marginal Standing Facility (MSF) is a provision made by the Reserve Bank of India through which scheduled commercial banks can obtain liquidity overnight, if inter-bank liquidity completely dries up. Such a simple provision was not available in the US (it’s Standing Repo Facility could not provide liquidity to SVB on time).
Lesson 4 : Asset Liability management is a real-time job. In interconnected digitally linked global markets, any asset value can be wrapped to near zero.
Digital Age Issue
In most banks, especially with non-technology businesses as clients, what happened at SVB may not have even started a panic. Banks constantly have liquidity problems and keep raising buffer capital to solve for them, as well as sell assets. But then the SVB customers were those who minutely read all the statutory filings, and who are inter-connected with one another as part of the same Silicon Valley ecosystem. So when someone raised questions about the bank’s solvency, it actually quickly became one with liquidity problems. The bank had its business concentrated in a sector and had not diversified to spread the risk and to hedge against price fluctuations in the bond market.
Lesson 5 : Concentration risk – be it products or consumer segments or geographies – can hurt at times. Or simply be fatal as the SVB example shows. Banks are in the business of pricing the risks.
Appropriate Size for Serious Scrutiny
After the 2008 global financial crisis (GFC), the US adopted the Dodd-Frank Act of 2010 that established extra regulatory supervision for financial institutions deemed “systemically important.” The US government under the Trump regime decided to liberalise their banking system and the US Congress further deregulated the sector. What was initially a threshold number of $50 billion assets for tightened supervision, was shifted to $250 billion assets. Coincidentally, the SVB’s assets when it went under was $213 billion.
In a December 2022 testimony to the US Congress, the Federal Deposit Insurance Corporation (FDIC), which protects customers’ bank deposits, had articulated its worries that banks had unrealised losses on their bond holdings. But then, most of them did not report those losses or provide buffer capital for it.
Lesson 6 : Short-term pain is better than – we are all dead in the long term – scenario. Financial institutions are better off with more regulations, than less.
What Next in the US?
As more stock market investors will pull back from banking stocks in the US, worries about a recession is trending. The contagion issue of lack of confidence in the banking sector could hurt the smaller and regional banks, who are dependent on wholesale funding for their existence. To reduce their new capital needs, to tighten their belt and businesses, these banks would raise credit assessment norms and end up choking credit access. If these banks start losing customer deposits, their business margins would get reduced, which would mess up the ALM balance.
Lesson 7: Finance is both the cause and effect of confidence. It cuts both ways. One crisis will have a lingering effect, even if the contagion effect has been solved for.
The US government did act quickly in the wake of the 10 March collapse of SVB, to stop a panic that could have furthered a domino effect in the banking sector crisis. The learning for India for sure, is how quickly can a financial regulator move and effect an insolvency transition of a stalled financial institution into a healthier one. That’s something Indian regulators might want to emulate in replacing their current process.
In a digital and social media led society, rumours and whispers can do more damage than only monetary transactions. In a financial world, time and reputation are also equivalent to currencies.
Lesson 8: Speed of resolution for financial worries is of the essence. Time quickly erodes valuations of stalled entities.
This only advances the need for real-time digital supervision of all the financial entities, and not just the Systemically Important ones – irrespective of whether they are ‘too big to fail’ or ‘too critical for contagion effect’.
Lesson 9: Real- time regulatory supervision is not a long term wish list, but a need in Industry 4.0.
Regulators have to ensure that financial institutions don’t exist only on paper, but also conduct business. Indian financial services have a huge number of licensed entities that simply exist on paper. Regulators must look at closing the financial institutions that only exist because of their perceived licence value and have no actual business.
Lesson 10 : The business of finance needs serious intent, concentrated interest and patient investments. Not a licence to hoard!
Author, Policy Researcher & Corporate Advisor
Twitter : @ssmumbai