How the collapse of Silicon Valley Bank will affect Indian companies

By Srikanth Navale, Counsel, Arbitrator and Mediator at Simha Law Pte Ltd Singapore, and Shreyas Jayasimha, Advocate, Arbitrator and Mediator at Aarna Law LLP.

There has been a lot of noise since the collapse of Silicon Valley Bank (‘SVB’). The news of the bank being put under receivership coupled with stories on social media of depositors­—largely from the tech start-up community—not being able to access their accounts and funds, led to widespread speculation about the wider fate of banks amid fears of a contagion hastening a recession.  

Sensing that possibility, the US Federal Reserve Board (‘the Fed’) moved swiftly by releasing a statement assuring depositors of SVB (and Signature Bank, New York, another bank that collapsed) that their deposits would be fully protected. However, this protection was not extended to shareholders and unsecured debtholders of the bank.

What really happened

There have been a lot of explanations for the meltdown at SVB. We attempt to break it down.

During the pandemic and soon after, banks took in record volumes of deposits. The appetite for loans did not match the influx of money into the bank. Excess funds were therefore invested in securities (typically US Treasury securities) at prevailing interest rates. There are two kinds of securities that banks could have invested in:

  • Held-to-maturity (‘HTM’)
  • Available-for-sale (‘AFS’)

Where banks designated their investments as HTM, they could hold on to these until maturity without being impacted by changes in their yields, market rates and the like in the interim.

On the other hand, where such investments had been designated AFS, the assets needed to be reported on the books on a marked-to-market (MTM) basis.  A significant portion of SVB’s investments were in AFS securities.

While this meant gains as interest rates went lower, SVB was faced with unrealised losses as interest rates began to rise and the value of the securities plummeted. The need to report such losses and stay solvent led to a series of misjudgments (including a failed attempt at a capital raise that caused panic amongst its depositor base) that eventually led to a run on the bank and the announcement of receivership. 

What does the Fed move mean

While the move to secure the interests of the depositors in SVB has provided some calm to the markets, it is the decision by the Federal Reserve to extend funding to banks through a new “Bank Term Funding Program” that is of wider interest.

Under this program, banks will be able to borrow against US Treasury securities at their par value as against their marked-to-market value. As the Wall Street Journal notes, this allows banks to “borrow at 100 cents on the dollar for securities trading potentially well below that value”. 

Beyond the protection extended to depositors, this move is seen, in our view, as a more powerful systemic measure that should allow banks in a similar position to SVB to ride out the crisis brought about by the increase in interest rates. With the US central bank absorbing the risk associated with the securities being pledged as collateral for funding released to banks, we expect the potential contagion to be contained in the near term.

However, the extent of the problem – it is reported that US banks’ unrealised losses on securities held by them totaled US$620 billion at the end of 2022 (Source: Wall Street Journal) – means that unless we see interest rates stabilizing and indeed reversing their upward march, this measure may only prove to be a band-aid over a deepening wound.

The impact on the start-up community

According to some experts, the collapse of SVB is unlikely to pose a systemic risk to the U.S. financial system.

However, the bank’s collapse created hardships among some tech startups, and companies holding significant uninsured deposits and among those with cash flow challenges.

A majority of Indian start-ups that were incubated by Y Combinator held more than US$250,000 with SVB with some holding over US$1 million when the collapsed bank. Most Indian clients of the bank are holding their accounts with SVB in the US.

The already negative sentiment with respect to funding of startups is likely to be exacerbated. Start up at the end of the funding cycle may contemplate voluntary winding up procedures. Creditors both financial and operational need to examine restructuring and insolvency options to protect their interests.

In so far as depositors of SVB who are either Indian original Startup funders or Indian startups, are concerned, the Indian Government has tried to pitch foreign branches of Indian Banks or Foreign Banks with branches in International Financial Services Centres, India as potential recipients of funds being withdrawn from SVB.  

Finally, given the international community of entrepreneurs, investors, depositors and creditors impacted, cross-border contractual and statutory remedies are likely to be explored including mediation, arbitration, litigation and insolvency. aDV