What can Nepal learn from the collapse of America’s Silicon Valley Bank?

This article was originally published in www.nepallivetoday.com on March 30, 2023 by Anmol Purbey. Mr. Purbey ​​is a researcher at Samriddhi Foundation, an economic policy think tank based in Kathmandu. The views expressed in this article are the author’s own and do not represent the views of the organization. Author can be reached at [email protected]

“When America sneezes, the whole world catches a cold.” The recent collapse of Silicon Valley Bank (SVB) shook the financial world, raising concerns about the banking industry’s stability and the risks connected with innovative financial products. There are many things that Nepal’s Banks and Financial Institutions (BFIs) can learn from SVB’s downfall as they continue to navigate the difficulties of the current economic environment.

The necessity of risk management is one of the most important lessons that Nepal’s BFIs can take away from the collapse of SVB. According to reports, a number of reasons, including the high levels of risk connected with its lending procedures and investments in the tech industry, contributed to SVB’s collapse. This emphasizes the significance of appropriate risk management measures that can aid in reducing the risks involved with making loans to borrowers that pose a high chance of default or making investments in volatile markets. Despite a massive credit expansion in the domestic sector, the non-performing loan (NPLs) ratio of the banking system of Nepal was understated at 1.4 percent as of October 2021, according to the IMF. IMF postulated that this was possibly due to banks ever-greening their loan portfolios and increasing the proportion of revolving loans they made. In addition, despite low NPL, loan loss provisions are insufficient, and the banking sector’s capital adequacy is artificially inflated.

Another thing that Nepal’s BFIs can take away from the failure of SVB is the value of diversification. Reports suggest that SVB’s downfall was due in part to its investment botch. SVB amassed a large bond investment portfolio of over USD 120 billion at the end of 2022 (USD 26 billion in ‘Available for Sale’ securities and USD 91 billion in ‘Held-to-Maturity’ securities as of the end of 2022 as per the financial statements of SVB). Most of this was investment in long term mortgage-backed security. This emphasizes the significance of a bank’s investment and lending activities, which can help to lessen the risks connected to any one sector or borrower. Paritosh Poudyal, Chairman of the Nepal Federation of Savings and Credit Cooperative Unions, said cooperatives invest heavily in asset classes like real estate and stock trading as opposed to production-oriented businesses which led to financial difficulties like liquidity crisis. There has been a severe liquidity crisis affecting Nepal’s banking and financial institutions. They are severely short of loanable money. More than 13 billion in interest on loans still need to be repaid.

The insured amount for depositors in America is $250,000. However, American President Joe Biden while addressing the nation said that the depositors will get 100 percent bailout (even the amount that was not insured). The government of America committed $167 billion for which $300 billion was printed by the Fed overnight. The US government has a long history of leading economic bailouts. Bailouts can create moral hazard by incentivizing risky behavior with the knowledge that they will be bailed out if they fail, and could lead to negative economic consequences in the long term. This, in turn, can lead to a cycle of bailouts and continued risky behavior. This also creates an unfair situation where the benefits are privatized (enjoyed by the bank and its shareholders) but the risks are socialized (borne by the taxpayers). This can lead to public dissatisfaction and a loss of trust in the government.

The failure of SVB also highlights the necessity of strong regulation and oversight. According to reports, SVB was able to function with little supervision, allowing it to engage in reckless lending and investing activities that ultimately led to its demise. This emphasizes the value of robust regulatory frameworks that can support ensuring that banks function securely and soundly and that they are held accountable for their conduct. Nepal’s financial sector has grown substantially over the years. However, the poor regulatory framework has led to an increase in regulatory arbitrage. The Nepal Rastra Bank’s dual role as a monetary and regulatory authority has led to ineffective supervision and an “I-control-everything” mindset. Many economies have bifurcated the monetary policy function and regulatory functions to create dedicated institutions, but Nepal has not yet had meaningful discussions in that direction. The unwillingness of central bank mandarins to relinquish their traditional role as regulator and supervisor is at the heart of this inertia. The lack of adequate legal space for provincial governments to collaborate and support in regulatory functions is also a concern.

Nepal’s BFIs can learn a number of crucial lessons from Silicon Valley Bank’s demise. They include how crucial it is to manage risks effectively to diversify, to have efficient regulation and oversight, and to be innovative and adaptable. BFIs in Nepal can contribute to ensuring their long-term stability and success, even in the face of economic instability and changing market conditions, by heeding these lessons and putting these measures into practice.