Cracks in US banking system is wake-up call for evolving foolproof antidotes

The Indian tech and start-up community had a big wake-up call last week with the collapse of the California-based Silicon Valley Bank. It showed that trusting the regulatory environment of developed economies is not necessarily a smart move. It goes without saying that banks are failing regularly in the U.S. despite lessons from the 2008 financial crisis and the subsequent toughened regulations. It is estimated that over 500 banks have failed since then.

Even in this backdrop, Indian start-up ventures have been shifting their domicile status to avail of banking facilities in the U.S. as well as in other countries like Singapore. Nearly 20 per cent 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. But it was slapped with a $900 million tax bill on its return.

Given the difficulties involved in reverse flipping, the latest Economic Survey identified this as an issue that needed resolution. It called for simplifying certification of start-ups, ESOP taxation and eliminating the uncertainty due to tax litigation for startups and investors.

In this light, it is reassuring for the tech community to see that the government is being supportive in this crisis to panic-stricken start-up founders. Yet it is also trying to highlight the once bitten twice shy syndrome from this episode. Minister of State for Information and Technology Rajeev Chandrashekar stressed that an important learning for start-ups was to rely on the 'trusted and robust'Indian banking sector. Of course, he suggested that changes were needed in bank products to suit the needs of start-ups, which are not conventional borrowers. He assured that many of the suggestions made by them at a meeting specially convened with about 400 startups would be conveyed to the Union Finance Ministry.

One of the issues raised was on 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 obtain loans to tide over the crisis.

In fact, 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. Around 50 per cent of venture capitalist-based startups in the U.S. are reported to have banked with SVB. It was, however, a large bank with assets estimated at over $200 billion and has been among the top 20 largest banks in the U.S. It now has the dubious distinction of being the second largest bank to have failed after Washington Mutual in 2008.

Its sudden downfall has been all the more surprising as it was rated highly and featured only recently in Forbes magazine list of Best Banks. There were several reasons for its collapse, a major one being the aggressive hike in interest rates by the U.S. Federal Reserve. This was the cause for the reduction in value of the bank's large portfolio of long-term bonds. It coincided with a higher demand for funds by tech start-ups facing 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 in a share sale last week along with a move to sell $21 billion 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 despite most financial analysts ruling it out. These worries have deepened with the failure of two more banks last week, a smaller one called Silvergate and the larger 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 and its failure has caused concern over contagion effect on smaller banks.These worries have spread to Europe with the latest reports about stock prices of Swiss flagship bank Credit Suisse having crashed over the past few days. Amidst the chaos, it is heartening that there is stability in the Indian banking system. 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 racks now appearing in the developed world's banking system it is for regulatory agencies there to take remedial measures to prevent such occurrences. In addition, efforts must be made to ensure that the contagion does not spread around the world as had happened in 2008.