SVB’s collapse didn’t just affect American depositors, but also many Indian start-ups. Hundreds of Indian startups with millions of dollars in their accounts found themselves stuck.
On March 11, 2023, the US President Joe Biden was seen reassuring Americans that their money in banks is safe and the American banking system is strong. This was following the news of the collapse of Silicon Valley Bank (SVB) and Signature Bank. The banks were shut down by the US regulator. Before being closed, SVB Bank was the 16th largest lender. It had $209 billion in total assets, while Signature Bank had $110 billion as of December 2022.
What went wrong?
SVB invested in debt like the US treasuries and mortgagebacked securities, but as the US Federal Reserve began to increase interest rates to contain inflation, this reduced returns for banks and the value of SVB’s investments fell. Amidst venture capital money drying up, clients rushed to withdraw funds, leading SVB to sell assets which created $1.8 billion in losses. The incident spooked the customers of Signature Bank as well who rushed to withdrew large sum of deposits. The run led to its failure.
Many Indian start-ups affected
The collapse didn’t just affect American depositors, but also many Indian start-ups. Hundreds of Indian startups with millions of dollars in their accounts found themselves stuck. The fear and panic reflected in the share prices too. The shares of the mobile gaming company Nazara Technologies plunged 7 percent on the day it informed stock exchange that the two of its subsidiaries together had more than $7.75 million in balances at the failed bank.
However, the company now heaves a sigh of relief after getting the amount back in full. “SVB was a very reliable bank and the current situation took us by surprise. However, we have got our full money back, and we have parked it at another bank in the US,” says Nitish Mittersain, Founder, Nazara Technologies.
Why did start-ups park funds with SVB?
The SVB fiasco raised an important question: What made so many Indian startups park their funds with American bank SVB in the first place and not with the bank domiciled in India.The answer lies in conditions imposed by foreign entities while agreeing to invest. If a start-up raises funds from a foreign-based VC, it may require you to have a parent company in the US where they will invest, and also a subsidiary in India. It will not invest if the company is domiciled primarily in India. A case in point is the famed Silicon Valley accelerator Y Combinator (YC). Therefore, many founders backed by it found themselves in a soup as they had parked their money with SVB. According to news reports, at least 40 YC-backed Indian startups had $250,000 to $1 million in deposits with SVB, while more than 20 of them had deposits of more than $1 million. Besides this, another reason for banking with SVB was that it was one of the friendliest banks for startups in terms of lending.
Bank failures not new
While the collapse of SVB and Signature bank has shaken the belief of depositors in the American banking system, bank failures are not a new thing. Prior to it, many banks in the US including Washington Mutual Bank (2008), IndyMac Bank (2008) and Colonial Bank (2009) collapsed. However, SVB’s failure was the second largest in US history and the largest since the financial crisis of 2008. Back home, there haven’t been big bank failures in in recent years, but few cases like Yes Bank, Lakshmi Vilas Bank, PMC, were dealt swiftly or bailed out by stronger banks.
Insured deposits-a savior?
To protect depositors in case of bank failures, deposits insured by the regulators play a big role. In the United States and many other countries, the government guarantees a certain amount of each customer’s deposits in the event of a bank failure. Currently, the Federal Deposit Insurance Corp (FDIC) guarantees deposits of up to $250,000 per person, per bank. When a bank goes bust, the FDIC tries to sell it to a peer institution, which would then take over all the deposits.
In cases where the sale is not possible, the FDIC winds the bank down and pays out on the insured deposits. The whole process takes around three months. The depositors can claim their uninsured deposits from the failed bank’s liquidated assets. In the UK, the Financial Services Compensation Scheme (FSCS) gets kicked in if a bank goes bust. The latter protects 100% of the first £85,000 of depositors per financial institution.
In India too, all commercial and cooperative banks are insured by Deposit Insurance and Credit Guarantee Corporation (DICGC). In case of a bank failure, each depositor in a bank is insured up to a maximum of INR 5 lakh for both principal and interest. However, the amount held in the different right and different capacity commands separate insurance. Also, if one has deposits with more than one bank, deposit insurance coverage limit is applied separately to the deposits in each bank.
However, there is a view that even the INR 5 lakh deposit insurance cover that was hiked just three years back (in 2020) is not enough. “This is too small an amount for companies even if held in different rights and capacities as they handle a vast sum of money ” says Suresh Sadagopan, Founder, Ladder 7 financial advisories.
Diversification is key
Thanks to the involvement of the US government, most of the depositors have got their money bank, but the incident has been nothing short of a lesson in financial management. Several Indian start-ups found themselves in dire straits, struggling to meet payroll and keep their operations running smoothly after the SVB’s collapse. The scenario could have been averted if these companies had spread their funds across multiple banks. “The key is to distribute your money. In our old risk management, we used to have 10 percent in any bank. Now it is reduced to 5 percent ,” adds Mittersain.
“I don’t know how to prepare ourselves for such an eventuality like SVB but to have multiple banking partners. So far our funds are parked with just one bank. Though we believe that the Indian regulator is strong enough, we have started contemplating on spreading our funds,” says Shubham Gupta, Co-founder, ConnectedH. But diversification isn’t limited to banks.
Experts advise to look beyond it. Adds Sadagopan, “If spreading funds across banks, restrict it to 3-4 for better manageabilty. Also, companies can put money in ultra-short term, overnight and debt wschemes of MFs, with good credit rating. These are good alternatives to banks.”