The sudden collapse of a high-profile and reputed bank in the U.S. has stunned the Indian tech and start-up community. The Silicon Valley Bank (SVB) that shut shop in early March after a run on the institution was recently placed on the Best Banks list of Forbes magazine. It was the 16th largest bank in the U.S. with assets estimated at nearly 200 billion dollars. It now has the distinction of being the second-largest bank to fail in that country.
It was a salutary lesson for those using foreign banking facilities since it is clear that the regulatory environment in many countries is not as stringent as in India. It turns out that banks have been failing regularly in the U.S. even after lessons were learned from the 2008 financial crisis and regulations tightened over there. It is estimated that over 500 banks have closed down since then.
Despite this dismal backdrop, start-up ventures based in India have been shifting their domicile status to avail of banking facilities in the U.S. as well as other countries like Singapore. Nearly 20 percent of Indian unicorns are reported to have relocated their bases abroad. Shifting headquarters outside this country is known as “flipping” and recently a major online player, PhonePe, did a “reverse flipping” and returned to this country. It faced a 900 million dollar tax bill on its return.
Given the difficulties involved in reverse flipping, the latest Economic Survey identified this as an issue that needs a resolution. It called for simplifying the certification of start-ups and taxation of employees' stock options (ESOP)
while eliminating the uncertainty due to tax litigation for start-ups and investors.
In this light, it is reassuring for the tech community to see that the government is being supportive in this crisis of panic-stricken start-up founders. Yet it is also trying to highlight the learnings from this episode. Minister of State for Information and Technology Rajeev Chandrashekhar stressed that important learning for start-ups was to rely on the Indian banking sector which is“trusted and robust”. Having said that, he conceded that changes were needed in bank products to suit the needs of start-ups that are not conventional borrowers. He assured that many of the suggestions made by them at a meeting specially convened with about 400 start-ups would be conveyed to the Finance Ministry.
One of the issues raised was finding ways to bring the funds parked in SVB back to India without facing taxation issues. He is reported to have spoken about the possibility of the government working with banks and stakeholders to help them to obtain loans which are needed urgently in this crisis.
It is the special requirements for start-ups that led to the creation and popularity of SVB in the cradle of new technology and innovation, Silicon Valley. It was unique in that it provided services almost exclusively to the tech world and companies backed by venture capitalists. As many as 50 percent of venture capitalist-based start-ups in the U.S. are reported to have banked with SVB.
Despite its strong deposit base, it faced a crisis due to the aggressive interest rate hikes by the U.S. Federal Reserve. This led to a sharp fall in the value of the bank’s large portfolio of long-term bonds. It coincided with a higher demand for funds by tech start-ups. The reasons are a financial crunch owing to depressed global demand for digital products in the wake of the boom of the pandemic years.
The bank’s decision to raise 2.25 billion dollars in a share sale along with a move to sell 21 billion dollars of securities created uncertainties among its key venture capitalist clients. Many urged their start-ups to pull out money leading to the sudden run on the bank and its eventual closure.
The Biden administration’s decision to bail out depositors came as a huge relief to the tech community and was likely motivated by the need to protect the credibility of the American banking system. But fears of the contagion effect as in 2008 are not going away. These worries have deepened with the failure of two more banks last week, a smaller one called Silvergate and a large one, the Signature Bank. The U.S. President’s assurance on depositors’ money being protected extended to the latter for which a bridge bank has already been created.
Silvergate which provided services largely for the crypto-currency sector was in bad health after the decline in crypto prices and FTX bankruptcy. But the Signature Bank had an asset base of 100 billion dollars and its failure has caused concern over the contagion effect on smaller banks. These worries have spread to Europe with the Swiss flagship bank Credit Suisse faltering and having to be taken over by another Swiss bank, U
Amid the upheaval in the banking systems of the developed economies, it is heartening that this country is stable. Such events are unlikely to take place here as the regulator would not allow any bank to park such a major chunk of funds in bonds alone. Besides, unlike foreign banks which have a much greater share of corporate deposits, there is a reliance here largely on domestic deposits and investments in government securities. In this context, it must be noted that recent comments in the western media over regulatory issues in the financial sector of developing economies like India seem to have been vastly exaggerated. With the cracks now appearing in western banking institutions, it is for regulatory agencies there to take remedial measures. Efforts must be made to avoid contagion and prevent a repetition of the 2008 financial crisis.