Silicon Valley Bank collapse sends Indian start-ups into panic mode; what can happen next?

Silicon Valley Bank (SVB), renowned for its association with tech startups and venture capital, faced a classic banking issue - a bank run - which resulted in its collapse on Friday. This is the most significant financial institution failure in the US since Washington Mutual's collapse during the financial crisis more than ten years ago, and it had an immediate impact, reported AP. Some startups that had connections with the bank struggled to pay their employees and were concerned that they might have to halt projects or terminate or furlough staff until they could obtain their funds.

The bank served mostly technology workers and venture capital-backed companies, including some of the industry’s best-known brands. “This is an extinction-level event for startups,” said Garry Tan, CEO of Y Combinator, a startup incubator that launched Airbnb, DoorDash and Dropbox and has referred hundreds of entrepreneurs to the bank.

“I literally have been hearing from hundreds of our founders asking for help on how they can get through this. They are asking, ‘Do I have to furlough my workers?’”

The news has sent Indian start-ups into panic mode

“Shit hits the fan. Then, if you tell people that no, we sold very good loans, not bad loans, please don’t panic, guess what happens? People panic. Stocks are down 60% and VCs are telling their startups to get their money out. Perception, in a banking system, is reality,” Deepak Shenoy, the founder & CEO of Capitalmind, said on Twitter.

Since everyone's making a thread about SVB, here's my contribution. Silicon Valley Bank is an old boring conservative bank. It is in trouble not because of bad lending practices, but because of a combination of
- strange way to invest short term money
- announcing a capital raise… https://t.co/KxOjM816oG

— Deepak Shenoy (@deepakshenoy)

Based on the latest Tracxn data, the US-based bank had investments in 21 startups in India, but the exact amount of investment is not clearly specified. Other startups that received funding from SVB include Bluestone, Carwale, InMobi, and Loyalty Rewards. Accel Partners, among the VC players, has a partnership with SVB. The SVB website stated that the Accel India founders opted for SVB to accelerate growth.

However, Indian founders and investors are now concerned about the transfer of assets as a restriction may be placed on withdrawals, which could result in several challenges. Startup founders are now reportedly considering alternatives to transfer their raised capital overnight, even though SVB has reassured clients not to worry.

Gokul Rajaram, a board member of Pinterest and Coinbase, has stated that founders based in India are uncertain about whom to approach as an alternative to SVB. This is likely to be true for founders in other countries as well.

India-based founders don’t know who to turn to as an alternate to SVB. Likely true for founders in other countries too.

From what I hear, SVB was the only bank who’d bank a Delaware C Corp with founders who didn’t have a SSN. Unique, tech forward bank. Shame what’s happening.

— Gokul Rajaram (@gokulr)

Why did Silicon Valley Bank fail?

Silicon Valley Bank was hit hard by the downturn in technology stocks over the past year as well as the Federal Reserve’s aggressive plan to increase interest rates to combat inflation.

The bank bought billions of dollars worth of bonds over the past couple of years, using customers’ deposits as a typical bank would normally operate. These investments are typically safe, but the value of those investments fell because they paid lower interest rates than what a comparable bond would pay if issued in today’s higher interest rate environment.

Typically that’s not an issue, because banks hold onto those for a long time — unless they have to sell them in an emergency, according to AP.

But Silicon Valley’s customers were largely startups and other tech-centric companies that became needier for cash over the past year. Venture capital funding was drying up, companies were not able to get additional rounds of funding for unprofitable businesses and therefore had to tap their existing funds — often deposited with Silicon Valley Bank, which sat in the centre of the tech startup universe.

So Silicon Valley customers started withdrawing their deposits. Initially, that wasn’t a huge issue, but the withdrawals started requiring the bank to start selling its own assets to meet customer withdrawal requests. Because Silicon Valley customers were large businesses and the wealthy, they likely were more fearful of a bank failure since their deposits were over $250,000, which is the government-imposed limit on deposit insurance.

That required selling typically safe bonds at a loss and those losses added up to the point that Silicon Valley Bank became effectively insolvent. The bank tried to raise additional capital through outside investors but was unable to find them.

The fancy tech-focused bank was brought down by the oldest issue in banking: an excellent ol’ run on the bank. Bank regulators had no other choice but to seize Silicon Valley Bank’s assets to protect the assets and deposits still remaining at the bank.

What happens next?

There are two large problems remaining with Silicon Valley Bank, but both could lead to further issues if not resolved quickly.

The most immediate problem is Silicon Valley Bank’s large deposits. The Federal government insures deposits to $250,000, but anything above that level is considered uninsured. The Federal Deposit Insurance Corporation said insured deposits would be available on Monday morning. However, the vast majority of Silicon Valley Bank’s deposits were uninsured, a unique characteristic of the bank due to its customers being largely startups and wealthy tech workers.

At the moment, all of that money can’t be accessed and likely will have to be released in an orderly process. But many businesses cannot wait weeks to get access to funds to meet payroll and office expenses. It could lead to furloughs or layoffs.

Two, there’s no buyer of Silicon Valley Bank. Typically bank regulators look for a stronger bank to take on the assets of a failing bank, but in this case, another bank hasn’t stepped forward. A bank buying Silicon Valley Bank could go a long way to resolving some of the problems tied to the money that startups can’t get to right now.

(with AP inputs)