Why A US-bank Failure Highlights A Strong RBI

The fear mongering in India about the collapse of the 16th largest US bank - Silicon Valley Bank (SVB), and it’s impact on Indian economy is completely unfounded. The Indian startups whose funds were in SVB are safe. There is no contagion effect on the Indian banking sector. But there sure are learnings for the Indian private investors whose investments have shaped Indian startups - to keep their treasury operations well-run and diversified. They should not be swayed by greed of higher interest rate to put all their deposits in one single entity.

The lesson for the Indian financial institution is simple. Improve their risk management framework and have real time analysis of the Asset Liability Management (ALM). With every interest rate swing, the ALM needs reinforcement. Here is where RBI’s abundant caution and perceived-intrusive-regulations and supervision comes useful.

US bank failure

SVB had been in business for forty years, and had been a banker of first choice for the technology firms and venture capital industry. SVB, Silicon Valley’s largest bank by deposits, just before its collapse, held assets worth $209 billion and deposits of $175 billion. In the US history, this is the second-largest bank failure, and the first blowup after the 2008 Global Financial Crisis (GFC). SVB was not large to be ranked as a systemically important financial institution (SIFI) in the US. For the India bank watchers, only SBI, HDFC bank and ICICI bank are in SIFI tag from banking perspective.

SVB held excellent assets, such as the U.S. Treasury and government-backed mortgage securities, which are safe bets. But when the Fed aggressively increased the interest rates, the value of the SVB holdings reduced drastically.

After the 2008 financial crisis that emanated from the US, the interest rates in the US have been muted. This allowed for cheaper loans, and the private investing communities funded more money into startups. With flush treasury pockets, many of these startups in turn, put their deposits with banks like SVB. But then the interest rates which were hovering in 0.25-0.50 per cent in March 2022, shot to 4.5-4.75 percent. The Fed chairman had also recently indicated that the interest rates could go upto 5.75 percent. This upward interest rate simply reduced the returns on bonds, and also reduced the startup funding cycle. SVB failed in its risk management - they simply did not act fast enough to derisk a rising interest rate regime. The depositors of SVB were withdrawing their deposits, faster than what SVB could pay using it’s own cash reserves. To meet it’s obligations, the bank sold $21 billion of its securities portfolio at a loss of $1.8 billion. This triggered a fresh capital call to raise similar amount, which further sent panic message in the market - thereby accelerating its deposits to be withdrawn by worried customers.

Banks business

A bank run like this can happen in any market, and anytime. In the era of digital and social media, rumours and whispers have to be dealt with carefully.

A bank accepts deposits (called liabilities) from its customers, and uses the deposits to extend loans (called assets) to other customers. The surplus of any deposits is invested elsewhere. The banking regulators have norms about minimum amounts of statutory investments in safe assets. This business of banking is with the premise that all of the depositors won’t show up to seek their deposits back, at the same time. This is a textbook case of classic bank runs, in which too many depositors withdraw their funds from a bank at the same time. A healthy bank, with no governance issues, can go bankrupt in few days. This SVB failure was not a governance failure. It’s insolvency was due to poor ALM, and not any impropriety.

A big risk staring at the US government is this : Over $1 trillion of bank deposits are uninsured. Only deposits up to $250,000 are insured by the Federal Deposit Insurance Corporation. How will the US banking system face the challenges of such bank-runs in the future ?

No India impact

The quick resolution of the SVB crisis by the Fed has saved the depositors funds. This includes nearly $2.5 billion of the 600 numbered Indian or Indian-origin SaaS entities funds with the SVB. While some of the Indian startups have their funds tied in SVB, these should not be of concern.

One, they will access their funds as the US Fed will ensure continuity of banking business. Two, the overall exposure of the Indian entities in the SVB is far insignificant proportion of their own liquidity investments across their treasury investments. Third, these entities funds will now hopefully be questioned by their Boards to ensure stricter and better risk governance. Four, the Indian banks including Axis Bank, Kotak Mahindra Bank, ICICI Bank using their branches in GIFT city, have quickly setup product-migration operations for these startups to shift their SVB accounts to their branch.

Flawed -ism ?

Staunch dyed-in-the-wool capitalists, who are India-cynics, keep talking ill of the Indian regulatory actions for any insolvent financial entity. They are generally vociferous about the so-called slow or delayed action by the banking regulator RBI. They oppose RBI writing off equity of defunct financial institutions (FI) and to get new owners and management to run the revamped FI. Yet the same capitalists go positively delirious when the US regulator does the same. Why this double standard ?

Silicon Valley Bank failure is a text-book case of an asset liability mismatch. Its genesis was a cosy feeling of no need for any ALM action, due to zero interest rate that the US faced for long. It’s deepest flaw was in the poor risk management practice, for it relied on large sized corporate deposits instead of diversified pool.

A positive point for the banks in India is the CASA deposits are well diversified across corporates and individuals. The Indian banking regulator - RBI and the securities regulator - SEBI are sticklers to the mark-to-market approach to the securities and assets their regulated entities hold. This very basic risk management aspect is a real-time tracker of ALM. While the critics might throw water at these regulatory institutions that they are difficult or have conservative approach, it is essentially the same approach that has shaped a safe and sound Indian markets.

The developed economies’ capitalists want private capture of all profits, and want the society to bear all losses. They want governments and regulators to stay away and not intrude, calling it free markets. But then, they also want the same regulators to dole free or cheap money for their financial misadventures or mistakes. The same folks protest against government intervention and continue to harangue the policy makers against stricter regulatory oversight.

Financial institutions, by nature, should not be glamorous. They should run well, and probably be seen as a boring-business with routine operations and with high risk management standards. This is where one sees RBI being active, with their prudent approach. They might be slow, but are sure. They might be cautious, but careful. They might be not worry about valuations, but respect Values. They might not be exuberant about capitalistic approach, but surely have consumer-empathy.

It is not as if the Indian markets have not seen tough situations or insolvent crisis. It is not as if we don’t have our flaws, and opportunities to move towards light-tough activity based supervision. These global hiccups are a reminder that our regulators have been quick to act, when needed. They have tolerated criticism as well as cynicism. But then, regulatory supervision is a thankless job. We want our regulators on that market-watch and financial-stability-wall, keeping us safe, while we sleep well. Probably, one needs a ‘Regulators Day’ celebrations, to remember their silent efforts to keep our markets safe.

Dr. Srinath Sridharan - Author, Policy Researcher, Corporate Advisor

Twitter: @ssmumbai