VCs want start-ups to park money in ‘too big to fail’ banks, avoid GIFT City

"We have communicated to our portfolio companies to diversify their deposits in any of the top 5 or 10 commercial banks in the US and India. And they should avoid investing company capital in money market funds," said Ashish Fafadia, partner at Blume Ventures.

While the Indian government has been encouraging startups to move their deposits to GIFT City in Gujarat, VCs think it’s best to avoid the financial hub for now.

The government estimates that over $200 million of startup deposits have already been moved to GIFT, whereas the total amount that the country’s startups was projected to have deposited in SVB was upwards of $1 billion.
According to VCs, this is just a temporary trend as GIFT City regulations and infrastructure is not yet attractive enough.

"I think that the government needs to do a bit more to communicate and commit that the money in GIFT City banks are insulated from domestic capital and companies can use them the way they would have used any US account. This will go a long way in ensuring confidence building and near-shoring of companies and capital,” said Fafadia.

VCs are of the opinion that the banking system in GIFT City is still a long way from being similar to the US.

During a recent meeting after the SVB collapse, the government asked entrepreneurs why they were not using the services of Indian banks as the country’s banking system is considered to be one of the most stable in the world. The broader line of response to this was that foreign investors ask them to incorporate in the US and prefer to transfer funds to US-based bank accounts. “Our international customers, such as those in the US or Europe also prefer to send payments there,” highlighted the founder of a SaaS company.

After officials buttressed the point that IFSC banks in GIFT City can be used as a foreign bank, one founder said that he was worried about being hauled up by regulators in case he missed any compliance requirements.

“GIFT City is not a viable option for many startups that are domiciled in the US. For companies with HQs in India it still looks possible. It is expensive due to SWIFT transactions and the KYC is three times or even five times more in GIFT City than US bank deposits,” said the partner of a top US-based venture capital firm.

According to industry insiders, the regulations surrounding GIFT City are still not clear about how much control the Reserve Bank of India (RBI) will have in the financial hub. Another misgiving is that not all the major foreign banks are fully operational in GIFT yet and Indian banks have set up their branches in the city rather than operating through subsidiaries.

“The reason they are talking about subsidiaries is that the moment the money is in a subsidiary and not a branch, it will be insulated against the bank’s failure in India. When a bank fails, its branches also fail, but a subsidiary may not be impacted,” explained Rajesh Gupta, a senior banking lawyer at SNG & Partners.

“The general trend that is expected is that more companies will have accounts in GIFT City banks over time. Yes, there is a lot of paperwork involved, but it is just one-time. The checks are important because you also have to prevent frauds and keep foreign exchange rules in view,” he added.