US Fed  Ke Side Effects : Indian Banking System

Over last weeks , we have seen a lot of news coming out of US & Europe regarding  the banking sector and crisis it seems to be in. There are some banks that have collapsed and some have secured loans to prevent a collapse. So , how prepared is the Indian banking system ?

What was the main issue with the SVB( Silicon Valley Bank )  ?

For this we have to understand the nature of SVB ,it is a tech focused bank , it’s  depositors  base is focussed only in the technology based sector and mostly the start-ups , VCs are the main clients of SVB.

Now, recap the situation during the Covid period , because of the ultra-low interest rates and a flush of liquidity the starts up were able to raise a lot money at low rates of interests, they deposited this money with the SVB and therefore we saw since the covid time till march 2022, there was more than two fold increase in deposit of SVB . When the deposit rise there are two options, the one is that banks lends and other is the bank invest in government securities. During this period the covid times, the demand was suppressed we didn’t have enough demand for loans , so most of the deposit of the SVB was investment in long term US government securities . They are safe investment options . Now coming to 2022 we saw that during this period the feds have raised rates by 450 basis points, so there have been massive increase rates hikes , which led to reduction in the price of these tradable and available  for sale securities. Due to hike in rates, all the start-ups started facing funding crunch so they started withdrawing their deposits from SVB . The bonds that were holding were sold at loss ( mark to market losses) as the money was asked by depositors back . Unrealised losses became of realised losses, the CEO of the SVB issued a letter saying that they will have to raise capital through of shares , but this announcement   triggered a panic among depositors , more so because the limit upto which money is assured by the government is 250,000 dollars, but since the accounts were mostly corporates so it meant the risk was too high for depositors . In one day almost 40 Billion dollars’ worth of deposit were withdrawn just because of the announcement  of CEO , thereby turning the bank insolvent . All of this happened in less than a week. .

A lot of basic elements of this story played out in India also , where the RBI also started raising interest rates in India too .

What prevents such things  happening in India?

Since 2018 , We do have some counter cyclical tools , but the rules governing those tools were refined in 2018.

There is something called as  Investment fluctuation Reserve , that’s what each bank is supposed to maintain , in year , in  which a bank is earning profits from the sale of government bonds , they have  to transfer some of the profits to this reserve . So , when will the bank earn profits ? In an easing interest rate regime ,this investment fluctuation reverse became very important where the profits from the sale of bonds went to this reserve , and this was used at the time of 2022. It’s not that Indian banks have not suffered , there are 15,000 Cr loses were incurred by banking sector in the first quarter of 2022, but we had investment fluctuation reserve where they had moved profits equalling to 2% o bond portfolio , which is available to sale. There are three kinds of bond holding by commercial banks , available for sale, tradable securities and Hold to maturity . The first two types are mostly sold before they mature, they are subject to interest change risk and their prices are changed every now and then . 2% of the profits from this fluctuation is transferred in the investment  fluctuation reserve. This was a rule that was announced by RBI in 2018 , and therefore it helped in preventing in mark to market losses in banking sector. Therefore one needs to have these counter cyclical tools which serve as buffer when you have high possibility of losses.

( Indian banks are doing ok )

This was the problem with SVB , their depositor base is only one class which is not the problem with other banks like in India. There was stress test conducted by Jefferies( Investment banking firm in US)  , which showed that Indian banks are well positioned to avoid such crisis, because our depositors are mostly households which are sticky .

We have an investment fluctuation reserve also which also minimised the possibility  of crisis. Also, as per RBI all banks have to confirm to BASEL -III requirements which are the global standards set up for banks . These came up after global financial crisis , in the US ,this is not the case . These norms are very tough to confirm to, in US there was a lobby which promoted the idea that smaller banks need not to confirm to those norms.

Learnings from the actions of US regulators?

Within a matter of two days , we saw there a swift coordination between the treasury secretary , and regulator and most importantly between FDIC. They swung into action , they close the bank . The most important thing is continuity of operations for depositors. Any crisis can be survived if , depositors are secured. They insured depositors , and also uninsured depositors too. They also said that this will be done without using taxpayers money .

These things can be learnt from US episodes, that while we do have  counter cycle tools put in place, which were place after 2018 crisis , YES Bank and other NBFCs. Despite the fact that we may have strong regulations , there are possibilities of bank failure happening , so there needs to be institutional framework , so that there is continuity  of services for depositors. In the US  , the FDIC has taken over SVB and they have setup something called a bridge bank .

It is kind interim arrangement till they could find a buyer for SVB,  Central  bank of Santa Clara is the bridge bank set up by the FDIC , which will carry out the day to day operations of the SVB .

By doing all this the panic is address because the depositors have all the money. So, the regulatory response should be very prompt  and secondly there is gap between in the Indian banking system wrt to financial regulation corporation.

In 2018 , the Finance minister came up with the financial regulation and deposit insurance bill ( FRDI ) , but it was shelved because of certain concerns, the good of point of that is it will help in setting up of resolution system , it will monitor and supervise firms and banks and will look for early sign of trouble and take over the bank when everything is not over,

In the case of YES bank disaster , it was merged with SBI which is basically tax payer bailout only , so we  should have measures for smaller banks to create market based resolution mechanism .

Written By: Ankur Kushwaha, Sr. Consultant, Invest Punjab | Govt. of Punjab.

DISCLAIMER: Views expressed are personal.

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