On March 10, 2023, America’s 16th largest Silicon Valley bank drowned. Just two days later, on March 12, the news of the sinking of America’s Signature Bank came to the fore. After this, the assets of these two banks were taken under the control of the American regulator. Investors around the world have lost more than Rs 38 lakh crore due to the collapse of Silicon Valley Bank alone. 21 Indian companies have also been badly affected by this.
Today we will know what is the reason for the sinking of these big banks and what will be its effect on the world including India.
What are the reasons for the sinking of these 2 big banks of America?
- Interest Rate Risk
- Liquidity Risk
Now understand these two reasons for bankruptcy of a bank one by one…
Interest Rate Risk: A bank faces this risk when interest rates are raised multiple times in a short period of time. Inflation in the US is at a 40-year high. This is the reason why the Federal Reserve has increased interest rates several times after March 2022 to control inflation, which has now reached close to 4.5%. This is the highest in the last 15 years.
The effect of this was that the yield in the treasury of the Federal Bank suddenly increased by 2%. Because of this, banks and other investors started investing money in Federal Banks instead of buying corporate bonds and government treasury bills. Then, in no time, the prices of corporate bonds and treasury started falling. According to a Wall Street Journal report, a 2% yield increase can cause bond prices to fall by 32%.
Silicon Valley Bank had 55% of its total assets invested in US government bonds. In such a situation, Silicon Valley Bank suffered huge losses as soon as the price came down. To overcome the shortage of cash, this bank started withdrawing money from the treasury even before maturity. Because of this, the bank came close to bankruptcy.
Liquidity Risk: When a bank has to benefit its customers by incurring losses, it is called Liquidity Risk. Think of it like you bought a flat at the beginning of 2019 by investing all your capital and taking a loan from the bank.
After this suddenly the corona epidemic came. In such a situation, now you do not have money to pay the loan and its interest. On one hand, the income of the bank decreases and on the other hand, the people whose money is deposited in the bank start withdrawing. Banks become bankrupt due to a lack of money due to this.
The same has happened in the Silicon Valley case. People were withdrawing more money than they had in their cash reserves. To avoid a cash crunch, Silicon Valley decided to sell $21 billion from its securities portfolio. The bank lost $1.8 billion due to selling the portfolio at a lower price than expected.
Customers started withdrawing money as soon as the news of the bank sinking
In March 2023, as soon as the possibility of the sinking of Silicon Valley Bank began to appear, customers suddenly started withdrawing money deposited in this bank. This caused the complete failure of the Silicon Valley banking system on 10 March. Something similar happened with Signature Bank, which became famous through cryptocurrency. In America, the Federal Reserve has a rule that insurance is done only on the amount deposited in the bank up to Rs 2 crore.
More than this money is deposited in your bank and if the bank sinks, you will not get the money. Most of the people and companies had deposits of more than Rs 2 crore in these two banks, so as soon as people started withdrawing the money, the bank started getting completely empty.
What was the loss to the customers and investors due to this?
On March 12, US regulators said that the money of all the people whose money is deposited in Silicon Valley Bank is completely safe. Not only this, startups who have money in these banks can continue to transact for their work.
US Treasury Secretary Janet Yellen said that the way investors’ money was returned in 2008 when Washington Mutual Bank collapsed, this time investors’ money will not be returned. He said that our priority is that the needs of those whose money is deposited should be taken care of first.
Is there a risk to the world’s banking system?
Governments around the world are increasing interest rates at a rapid pace to control inflation. In such a situation, like Silicon Valley and Signature Bank, many other banks of the world are also in trouble.
According to a report, by December 2022, there has been an unrealized loss of Rs 51 lakh crore on the balance sheets of banks. However, due to liquidity risk, the chances of most banks sinking are low.
The situation of other banks is different from these two American banks because of these reasons…
- The rest of the banks held an average of 13% of their total assets in cash, while Signature held only 5% of its assets and Silicon Valley held 7% in cash.
- The rest of the banks invest 24% of their capital in fixed-income securities, and bonds, while Silicon Valley Bank had 55% of its capital in bonds and securities.
- Due to this sudden panic, most of the people withdrew their deposited money. Due to this, the cash money with the bank decreased and there were more securities.
However, even now there is no insurance for money deposited in banks around the world more than Rs 8 lakh crore. In such a situation, it can be assumed that such crises have not been reduced yet.
Is the sinking of Silicon Valley a sign of a 2008 recession?
Economist Arun Kumar says that most startups and people associated with the business sector have accounts in Silicon Valley Bank. There is a possibility that this type of incident may happen in some more US banks now.
In such a situation, it will have a bad effect on investment in America and around the world. The reason for this is that banks like Silicon Valley and Signature themselves invest in other companies in the world. Not only this, the world’s largest investors are in America. Due to such incidents, they avoid investing money. For this reason, such an event is considered a bearish signal.
2 dozen Indian companies in danger due to American bank collapse
According to Traxon data, Silicon Valley Bank has invested in 21 Indian startup companies. Although this figure could be higher. These include names of companies like Bluestone, Carvel, Loyalty Rewards, Paytm, Paytm Mall, and One97. According to the report, after 2011 this bank has not invested in Indian companies. Silicon Valley Bank has made maximum investments in these 10 Indian companies…
After all, why do Indian companies open accounts in this bank?
When Silicon Valley Bank invests in a company, it is natural that that company would also like to open an account in Silicon Valley for transactions from abroad.50 to 60% of IT and other sector companies have accounts in this bank.
The reason for this is that apart from being a bank, Silicon Valley was also a wealth manager, financial advisor, and networker and it was the bank of choice for start-ups.
