the story So Far: The collapse of California-headquartered Silicon Valley Bank (SVB) in 40 hours last week sent shockwaves through the global tech-based start-up ecosystem. The California Department of Financial Protection (DFPI) closed the bank and took it private. Lenders – citing insufficient liquidity and bankruptcy. It appointed the Federal Deposit Insurance Corporation (FDIC) as its receiver.

Private banks have been particularly important in lending to the technology-based startup ecosystem. The development also classifies SVB as the largest bank to fail since the 2008 global economic crisis.

What was done immediately afterwards?

Treasury Secretary Janet Yellen ruled out giving full relief to the bank.

The White House said the Treasury Department is working with regulators on next steps. Meanwhile, on Monday the UK government along with the Bank of England facilitated the sale of the UK branch of the troubled bank to HSBC.

As previously mentioned, the FDIC was appointed a ‘receiver’ – in other words, a temporary custodian to facilitate the sale or liquidation of assets to pay off the entity’s outstanding debts. Insured depositors were given full access to their deposits from Monday, allaying concerns about the availability of deposits.

The bank management has been sacked. Shareholders will also not be protected. “Investors in banks will not be protected. They intentionally took a risk, and when the risk doesn’t pay off, investors lose their money. This is how capitalism works,” tweeted US President Joe Biden.

Furthermore, as Mr. Biden reiterated, “no loss will be borne by the taxpayer.”

In a joint statement with the US Treasury Department, the regulator announced that additional funds will be made available to eligible depository institutions to meet the needs of their depositors.

Losses to the Deposit Insurance Fund to support uninsured depositors would be recovered by special assessments as required by law. The Deposit Insurance System protects customer deposits—the standard insured amount is up to at least $250,000 per depositor per FDIC-insured bank—should an FDIC-insured bank or savings association fail. Any amount above this limit qualifies as uninsured.

Customers are not required to purchase deposit insurance separately; This works by default. Money is deposited in the fund through payments made by banks.

In his address, President Biden assured that the banking system and deposits are safe. “I also assure you this: we will not stop at this. Above all, we will do whatever is necessary.

What caused the situation?

The US Federal Reserve has been raising interest rates since last year in an effort to fight inflation. However, in a tighter interest-rate regime, debt and capital for the startup ecosystem, coupled with widespread investor enthusiasm, reduced investor appetite to invest in startups and companies. This in turn results in a passive environment for IPOs and fundraising for many startups as investors are unable to predict how they will be able to profitably exit their investment (or position) in a company.

SVB, which refers to itself as a “financial partner of the innovation economy”, is particularly exposed to the start-up ecosystem. It operates in four verticals: Global Commercial Banking, Private Banking and Wealth Management, Investment Banking and Venture Capital and Debt Investments. Since it provides credit facility to startup companies, it also exposes them to higher risk. CEO Baker, however, has said that early-stage loans, its highest risk segment, represent only 3% of its overall portfolio.

In January, the bank said it expected slower public markets, a further decline in venture capital deployment and continued high cash consumption in the first half of 2023 with a slight decline in the second half. It had already seen four consecutive quarters of decline in venture capital investment, albeit at a “slowing” pace.

To account for inflation and meet the liquidity needs driven by the slow IPO market for startups, customers started withdrawing their deposits from SVBs. This “cash burn” remained high and increased further in February. This resulted in lower-than-anticipated deposits, as companies rushed to withdraw deposits to keep their enterprises afloat.

To bridge the gap, the bank last week sold a $21 billion bond portfolio, mostly comprised of US Treasuries. Its portfolio was returning an average of 1.79%, which is much lower than the current 10-year Treasury yield of around 3.9%. This forced SVB to realize a loss of approximately $1.8 billion.

How did the downfall happen?

What set in motion a subsequent series of events was CEO Greg Baker’s letter to investors informing them that the bank would realize this one-time, after-tax loss of approximately $1.8 billion.

The bank’s funding gap was to be cushioned through capital raising using common equity and preferred convertible shares – amounting to $2.25 billion. The intent behind raising the capital was to reduce their asset sensitivity, partially lock in funding costs and mold their Net Interest Income (NII) and Net Interest Margin (NIM) – to assess the financial health of the bank The impact of the higher interest rates regime from the two most important metrics, which led to an increase in profitability. This was to be done through reinvestment of earnings.

“We continue to see healthy technology lending as clients opt for debt over equity, but slowing VC and PE investments keep overall debt balances from global fund banking payouts,” the CEO’s letter reads.

However, this announcement triggered a ‘bank run’ – large numbers of depositors withdrew their money in fear that the bank would go bankrupt. In other words, customers were worried because of the seeming inconsistency between deposit safety and the bank’s need to raise more capital. Depositors pulled $42 billion from the bank a day after the announcement. This resulted in the bank falling into a negative cash balance of $958 million. Regulators noted that “quick deposit withdrawals” had left the bank unable to meet its obligations as they fell due. As such, it was deemed insolvent and conducting business in an “unsafe manner” relative to its financial condition.

Gary Tan, CEO and chairman of startup-accelerator Y-Combinator, said the incident sparked concerns about “systemic contagion”, with negative effects spreading to other domestic banks. Concerns also arose about the effects spreading to global participants.

In addition, concerns emerged about 37,000 small businesses being unable to access their deposits—far exceeding the FDIC limit of $250,000. According to the US-based National Venture Capital Association (NVCA), this results in companies not being able to meet their payroll requirements. This in turn may lead to layoffs of employees or possible closure of companies. These effects were also expected to be amplified through the domestic ecosystem for startups exposed to the bank.

In context of the results, the S&P Regional Bank Select Industry Index <.SPSIRBK> It closed down 10.84% ​​on March 13. reutersMajor US banks lost nearly $90 billion in stock market value on Monday, bringing their losses over the past three trading sessions to nearly $190 billion. STOXX Banking Index in Europe <.SX7P> It closed down 5.7%.

Christopher Whalen, president of Whalen Global Advisors, blamed the bank’s failure on the fact that its management “naively invested half of the bank’s assets in ‘risk-free’ securities.” They observed that 43% of bank total assets were in mortgage-backed securities, compared to an average of 12% for the 132 largest banks in the states. “The expansion risk created by the Federal Open Market Committee (FOMC) killed the Silicon Valley bank. SVB shareholders have lost billions and other creditors may face losses as well,” he said. ,

Some experts, however, offer a different perspective. “Given that the FDIC has agreed to bail out all depositors, there is little financial impact,” said Puneet Pushkarna, chairman emeritus of The Indus Entrepreneurs (TIE)-Singapore chapter. Hindu,

However, he adds, “It (SVB) was a great institution supporting entrepreneurs, so its absence will affect not only Indian entrepreneurs but the entire ecosystem.”

, With inputs from John Xavier

• California’s Department of Financial Protection (DFPI) closed Silicon Valley Bank, citing insufficient liquidity and bankruptcy, and took over the private lender.

• Private banks have been particularly important in lending to the technology-based startup ecosystem.

• The White House said the Treasury Department is working with regulators on next steps