Recently, we heard about the collapse of Silicon Valley Bank, Signature Bank, First Republic Bank and Silvergate Capital Corp in the US besides Credit Suisse in Switzerland. Neither this is the first instance of a banking crisis, nor is it that after this, more banks would not fail. In fact, immediately after the rescuing of the above-mentioned banks (by the last week of March this year), news about the abrupt fall in shares of Deutsche Bank broke out. Though the regulators quickly swung into action and made appropriate efforts to stop the banking crisis from swirling, yet there is a divided opinion as to the complete wipe out of this banking crisis.
In the US, Federal Deposit Insurance Corporation (FDIC) stepped in to take over Silicon Valley Bank and Signature Bank besides a conglomerate of 11 banks including big names like Bank of America, Citigroup, J.P. Morgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley etc. that came forward for the rescuing of First Republic Bank. Similarly, in Switzerland, mighty bank Credit Suisse, a 167-year-old entity was taken over by UBS in no time. However, economists like Nouriel Roubini, Keneth Rogoff, Mohamed El Erian etc. lamented that high inflation, high level of debt and financial instability have ripened the conditions for the financial crisis in general and the banking crisis in particular. Also, it is cited that even before the failure of Lehman Brothers in September 2008, many banks and financial institutions like Bear Sterns, Silver State Bank, Merill Lynch, Fannie Mae and Freddie Mac etc. had already collapsed despite efforts by the regulators to stop the crisis from spiralling. The scare of the banking crisis in the West has raised doubts on the security of the Indian financial system too.
Causes of failure of banks in the West
In this article, causes of failure of two major banks viz. Silicon Valley Bank in the US and Credit Suisse Bank in Switzerland are highlighted. The Silicon Valley Bank crisis can be viewed from two points of view. Firstly, the bank conveniently forgot the fundamental rule of finance i.e. don’t put all your eggs in one basket. Instead of building a robust ecosystem in terms of deposit and lending amongst a wide spectrum of sectors, the working of Silicon Valley Bank remained highly concentrated on venture capital and start-ups. Since 2007-08 till 2020-21, when the interest rates remained low, economic activities sailed smoothly. However, when with the Russia Ukraine war, supply chains choked and prices started shooting up, then in order to tame inflation, interest rates were raised by almost all the Central Banks functioning in different countries of the world. An increase in interest rate made the borrowings costlier and in Silicon Valley Bank’s case, the primary clients being venture capital and start-ups, they started feeling the heat. Even the Initial Public Offer (IPO) route did not remain lucrative as portfolio investment started getting attracted towards the US where interest rates peaked leaving other currencies bleeding, particularly in the mid-sized and emerging economies. Amid costly fundraising and with alternative channels like IPO Dr. Rajiv KhoslaGlobal Banking crisis scaring Indiadrying up, Silicon Valley Bank clients faced problems in debt servicing and these clients started pulling money (whatever was invested) out from the bank to meet their liquidity needs. Secondly, Silicon Valley Bank deposited incessantly in the US government Treasury Bills and mortgage-backed securities which largely had the yields below 2%. Though with an increase in the interest rate, the yields increased to more than 4%, yet these were dwarfed in comparison to the simultaneous increase in interest rate paid to the depositors of the bank. It simply connotes that deposits in old bonds at 2% interest rate fetched lower income to the bank, whereas the bank had to pay more interest rate to its depositors. Eventually, the distressed sale of old bonds by the bank resulted in a loss of $1.8 billion to the bank.It is not only the bank which is at fault, rather the regulators too are equally accountable. The tinkering with Dodd Frank Act that was brought in the year 2010 during President Obama’s government to prevent any other financial crisis in the world like 2008 was deliberately weakened during Donald Trump’s reign. In 2018, the stress test under Dodd Frank Act, through which every bank, may it be big, small, or mid-sized had to undergo, was amended and required only 10 big banks to undergo strictest regulations. Hence, the wrongdoings of financial institutions continued to remain buried under the carpet and the regulators failed to notice erroneous investing in private equity and hedge funds, ultimately leading to the problems for bank customers.
In March 2023, when the bank failed to muster any financial support for itself, Switzerland’s authorities permitted the takeover of Credit Suisse by UBS without even the approval of shareholders from either side. Though the regulators stepped in at the right time, yet the future of 50,000 employees of Credit Suisse around the world became uncertain. The depositors lost faith in the bank and within the first three months of this year they withdrew nearly $75.2 bn, the trend which is continuing. Even the investors had a harrowing time as the shares of Credit Suisse plunged by nearly 63% on March 20, when the crisis broke out. Same remained the fate of stakeholders in the US. In nutshell, the banks in the US have run into the crisis because of the slackness of the regulators, whereas in the case of Credit Suisse it is the continuous indignities that put curtains on the bank. Even if the regulators have now tried to nip the bud through a series of mergers and takeovers yet, this crisis may have a widespread impact for quite some time.
Banks in India
Indian banks have also yet not remained unscathed from the increase in interest rate. During Covid, the banks purchased G-Secs in good quantity at a low-rate coupon rate but with the geo-political tensions when the interest rates increased, Indian banks too suffered. Secondly, credit offtake remained very high in FY23 against FY22, as per RBI estimates. In fact, credit growth in FY23 remained at 12 years high i.e., since 2011-12. Here lies the catch.It is surprising that credit offtake is exceptionally high when the interest rates are rising. Further, had the credit been taken by the corporate or industrial sector, the same would have been reflected by way of investment or an increase in employment. Hence, an ostentatious increase in credit disbursement is likely to give the big picture a miss. RBI data shows that credit disbursement is led by an increase in personal loans that goes for either discretionary consumption and to meet emergencies. Such a consumption is negative in nature and does not produce any amount of goods or services. Also, another trend has been revealed which shows that lending by banks to NBFCs has increased which in turn is financing the small businesses. It may implicitly be analysed that loans are floating from banks to NBFCs and from them to the small businesses which do not have a sound goodwill and are ready to borrow at still a higher interest rate from the market (through NBFCs).Though credit disbursement remained high, yet the deposit mobilisation remained tough for the banks.
The data shows that credit disbursement rose from Rs.17.83 trillion in FY23, from Rs.10.43 trillion in FY22. Against this, the banks raised Rs.15.78tn through deposits in FY23, vis-à-vis Rs.13.51tn in FY22. The lag in deposit mobilisation and credit disbursement is being made good by big banks through borrowings. Recently, the Board of State Bank of India approved long-term fundraising ($2bn) through debt in FY23. Punjab National Bank geared up to raise Rs.12,000 crore in this year. HDFC Bank too proposed to raise Rs.50,000 crore via bonds in 2023-24. Problem is for the small banks who have lesser securities to raise money. The inter-bank call money rate jumped to a 4-year high on 31st March this year indicating that small banks may continue to get short term loans at an increased rate. Any default in debt servicing by small bank’s customers will lead to a default in making payments to the sources from where these banks have raised liquidity.
Summing up the discussion, it can be concluded that no doubt Indian banks suffered market losses in the recent past, yet the overall capital position of the banking system in India is strong enough to safeguard itself from any overseas contagious crisis. Of course, credit off take remained high, but most of it is in the form of personal loans. NBFCs remained the major providers of loans to small businesses at higher rates. Banks have resorted to borrowing to make good the gap between the deposit mobilisation and credit disbursement. As of now, the situation is under control but Indian regulators are required to remain vigilant with respect to debt servicing by the personal loan takers, small businesses, small banks and NBFCs.
— Dr. Rajiv Khosla is Associate Professor at DAV Institute of Management, Chandigarh
The opinion/s expressed in the article are that of the author’s and do not necessarily represent or reflect the policy or position of this magazine.
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