‘Cash Burn’ Strategy Threatens Financial Sector

Three banks in the United States have collapsed in just five days.

Their closures are unlikely to have a direct impact on Indonesia, but they offer a valuable lesson that a "cash burn strategy” is threatening the financial sector.

NEW YORK, TUESDAY — The United States is facing its biggest banking crisis since the 2008 financial crisis, following the collapse of Silicon Valley Bank, Signature Bank, and Silvergate. Their closures offer a valuable lesson that a business that relies on a strategy of burning cash and does not have a sound foundation for business will only threaten the financial sector, which can in turn lead to a financial crisis.

Atmajaya Jakarta Catholic University lecturer Agustinus Prasetyantoko said on Tuesday (14/3/2023) that SVB went bankrupt because it carelessly financed a company that lacked prudence. The situation was safe for the moment, because the US central bank, the Federal Reserve (Fed) was disbursing extra cheap funds. The potential for bankruptcy could not be detected early.

With an abundance of cheap liquidity and the lack of banking supervision, Prasetyantoko said, SVB provided huge loans to vulnerable business sectors. When the interest rates increased, the interest expenses grew as well. At the same time, the loans it gave to tech start-ups turned sour as they failed to make a profit. This eventually led to the bank’s collapse.

”The lesson for us is that we need to go back to basics so that banks finance sectors with clear incomes, not businesses full of dreams. The ‘cash burn strategy’ must end," he said.

The lesson for us is that we need to go back to basics so that banks finance sectors with clear incomes, not businesses full of dreams

Big expenses

The term “cash burn” refers to the condition of a company that has more expenses than income. The strategy is commonly adopted by companies during their start-up phase until they have sustainable income streams.

In recent years, many tech start-ups burn through cash over long periods of time. Many of SVB’s borrowers also used the strategy.

SVB said on Wednesday (8/3) that its clients, mostly start-ups, continued burning through cash, even though their source of funding had decreased. "Client cash burn remains two times higher than pre-2021 levels and has not adjusted to the slower fundraising environment," SVB said, as quoted by CNBC on March 9.

CNBC reported that SVB served clients that were generally too risky for traditional banking services.

Also read :

Closure of Silicon Valley Bank Will Not Directly Impact Indonesia

SVB’s collapse exposed its real condition. Start-up funding, which once entered the bank on a massive scale, also flowed out fast. SVB was the backbone of companies with high-risk businesses.

Founded in 1983, SVB focused on providing loans to start-ups in the technology sector. Before its collapse, SVB suffered a liquidity problem after depositors started withdrawing their money because they were worried about the bank's condition.

AFP/GETTY IMAGES/GETTY IMAGES NORTH AMERICA/JUSTIN SULLIVAN

SANTA CLARA, CALIFORNIA - MARCH 10: A Brinks armored truck sits parked in front of the shuttered Silicon Valley Bank (SVB) headquarters on March 10, 2023 in Santa Clara, California. Silicon Valley Bank was shut down on Friday morning by California regulators and was put in control of the U.S. Federal Deposit Insurance Corporation. Prior to being shut down by regulators, shares of SVB were halted Friday morning after falling more than 60% in premarket trading following a 60% declined on Thursday when the bank sold off a portfolio of US Treasuries and $1.75 billion in shares to cover declining customer deposits. Justin Sullivan/Getty Images/AFP (Photo by JUSTIN SULLIVAN / GETTY IMAGES NORTH AMERICA / Getty Images via AFP)

On Friday (10/3), the US banking regulator announced its closure and confiscated SVB's assets. Two days later, on Sunday (12/3), the Federal Deposit Insurance Corporation (FDIC) announced the bankruptcy of Signature Bank, headquartered in New York.

Signature Bank board member Barney Frank said the bank had experienced massive withdrawal of its clients’ funds on Friday. This was triggered by fears of a domino effect from the SVB collapse. Signature Bank's collapse was also partly due to its exposure to large cryptocurrencies. As of September 2022, almost a quarter of Signature Bank's deposits came from the cryptocurrency sector.

Meanwhile, Silvergate Capital Corp. announced on Wednesday (8/3) that it was self-liquidating. The bank, which focused on cryptocurrencies, went bankrupt due to the crash of the cryptocurrency exchange, FTX.

Also read:

Bank Failure in a Time of Tight Money

Changes in Direction of Start-up Business

Different from reality

“SVB’s struggle shows the dangers of doing business with bad companies. Basically, many tech start-ups are zombie companies with unclear business models and unsecured loans,” said David Trainer, CEO of New Constructs, a Nashville-based investment research group.

Researcher Eisha Maghfiruha Rachbini at the Institute for Development of Economics and Finance (Indef) said the Indonesian banking industry had not provided many loans to technology start-ups. However, movement in that direction was already visible.

“The SVB case reminds us of the importance of exploring the feasibility of financing a business. The situation with SVB also reminds Indonesia to be wary of companies with assets and share prices that have skyrocketed rapidly, but then plummeted drastically," she said.

Yose Rizal Damuri, executive director of the Centre for Strategic and International Studies (CSIS), also stressed the same thing. "SVB's meltdown is not just a matter of oversight, but the result of the Fed's tight liquidity policies, as well as technology companies' business model, which tends to be difficult to survive in the long term."

According to Yose, not all technology companies were gloomy. In fact, many have skyrocketed. What needs to be watched and realized is the potential risk posed by companies whose business is not based on sound fundamentals.

The situation with SVB also reminds Indonesia to be wary of companies with assets and share prices that have skyrocketed rapidly, but then plummeted drastically.

KOMPAS/FERGANATA INDRA RIATMOKO

Startup office in Bangunharjo Village, Sewon, Bantul, Yogyakarta.

Finance Minister Sri Mulyani Indrawati explained that the impact of SVB's collapse would not be as big as that of investment giant Lehman Brothers during the 2008 financial crisis. The reason was that SVB had a specific market segment, namely start-ups. It was deemed that the impact on Indonesia would not be too large, because the link between SVB's portfolio and the country’s financial sector was relatively limited.

According to the minister, SVB's collapse occurred due to the declining performance of start-ups in 2022. The sluggishness of the sector affected SVB's lending. At the same time, deposit rates tripled. As a result, SVB's balance sheet became problematic and led to a crisis.

Although not as big as the 2008 financial crisis, Sri Mulyani continued, the case still had an impact on the financial sector, particularly in relation to public trust in banks.

"We need to be vigilant, because perceptual and psychological transmission to banking can be significant for the financial sector, as happened in the United States," she said.

the case still had an impact on the financial sector, particularly in relation to public trust in banks.

BPMI SEKRETARIAT PRESIDEN

Finance Minister Sri Mulyani Indrawati

Eddi Danusaputro, chairman of the Association of Indonesian Venture Capital and Start-ups (Amvesindo), said the association was still gathering data. Early indications suggested that only a few venture capital firms in Indonesia did business with SVB. "Very few Indonesian venture capital companies invest in start-ups in the US," he said.

According to Eddi, there are a few Indonesian start-ups that have received investment from venture capital firms based in Silicon Valley. However, Amvesindo is still looking for concrete data.

“There are no banks with a business model like SVB in Indonesia because Indonesian regulations prohibit it. Thus, the collapse of SVB has no relevance to the ecosystem in Indonesia," said Eddi.

(REUTERS/AP/AFP)

This article was translated by Hendarsyah Tarmizi.