For centuries Indian sages and sages have explained Maya. He found that whatever is seen is maya and the world we live in is also maya. In this season of revelations, a world of savers, investors and governments is experiencing this eternal truth. As of Friday, nine out of ten people in the world may not have even heard of Silicon Valley Bank (SVB). On March 7, the bank celebrated being ranked among America’s Best Banks by Forbes magazine. And it was closed when it collapsed on 10 March.
US regulators have appointed the Federal Deposit Insurance Corporation. The collapse of SVB, with over $200 billion in assets, was the second largest bank collapse in US history. People who had deposits of more than two and a half million dollars had to stand in line. The resilience shown by the US government on Friday and Saturday ran counter to panic among other smaller and regional banks. The US government rolled out a plan for depositors to guarantee their money before Asian markets opened on Sunday so start-ups can use the funds to pay salaries.
The collapse of SVB (and Silvergate and Signature Banks) has caused investor panic. Borrowing the words of late famous Hindi poet Harivansh Rai Bachchan, if we look at the global market, it is visible, lath-path, lath-path, lath-path. Bank stocks in the US and Europe lost nearly $200 billion in value—about half a dozen banks in the US lost more than 50 percent of their market value, many ceasing trading.
The Bank Nifty (which measures the value of banks) in India fell nearly 1,800 points. SVB had an asset-liability mismatch – it had taken short-term deposits, but kept the money in long-term bonds. Simply put, when depositors demanded their money, the bank didn’t have money. What is the reason for this? How safe the savings are depends on the banking scenario. It is instructive to understand the sequence of changes that led to the collapse of the trust. For more than a decade, the US and other developed economies lent at low interest rates. Interest rates in the US were just above one percent and banks in Europe charged customers to keep their money in banks—in fact more than $180 trillion in loans worldwide reported negative earnings.
Then came the relief package after the pandemic. Governments invested more than $7 trillion in relief packages to save lives and livelihoods. This turned the low cost system into a virtually zero cost system! This increased redundancy. Money started getting invested in fancy and risky areas for better returns – in crypto assets led by bitcoin reaching a valuation of $3 trillion, in real estate and at low rates in fancy start-ups and ventures where ‘Not making a profit’ was the business model.
The world woke up to double digit inflation by March 2022. Central banks decided to raise interest rates. It was the end of easy money. This week (March 17) marks one year of new interest rate hikes initiated by the US Federal Reserve. Many others followed suit, including the Reserve Bank of India. The US Federal Reserve raised interest rates eight times in the last 12 months, triggering a global race to hike rates. Given the pace of the rate hike, such a crash was bound to happen.
The rise in interest rates led to a fall in the values of crypto assets, stocks, real estate and old bonds that were issued at low rates by banks such as SVB. US banks have recorded a loss of $620 billion in bond holdings. The sharp rise in rates did not prevent inflation, but it certainly increased systemic vulnerability. Flaws in business models and investment strategies have not yet been exposed and the exodus of funds from enterprises is associated with consequences. Central banks around the world, including India, for the first time made the assumption that inflation was temporary. With the global economy slowing down, it is being propagated that the slowdown will be temporary.
It is true that the systemic crisis in the US has forced a re-look at whether interest rates should be raised or not. The forecast was that interest rates in the US would reach six percent. It is also true that the prevailing interest rates will also affect and inhibit growth. There are lessons in this for India and other developing countries, which are caught in the inflationary and retrograde logic of the developed world. Rising cost of funds reduces the potential for venture capital in the US and elsewhere. This has implications for India’s start-up ecosystem. The growth of a start-up as a unicorn depends on the business model, but also critically on the funding sequential glide path to grow into a sustainable entity.
There are already growing signs of funding crunch, which has raised fears of zombie start-ups (companies that make money during the boom, but don’t last long). Falling valuations and stock markets also deter funds from exiting—and this is exacerbated by start-ups’ poor post-IPO record. Broadly speaking, the high cost and low growth scenario affects global consumption and hence trade, FDI and portfolio flows. It could be worse if this episode infects the US financial markets. Systemic risk usually comes to the fore only when it is one. In such a situation, it is advised to remember the lines of lyricist Neeraj – O brother, just take a look.