Banks are usually seen as secure places. To keep your money safe, you put it in a bank. We place our live savings and our salaries go first in the bank. Many people do not trust the stockmarket or know much about the bondmarket. However, they readily keep their money and trust ‘their bank.’
Hence, the idea that the money you keep at a bank is ‘at risk’ and banks fail is deeply unsettling. Yet, bank failures do occur, even in the best governed, richest of places like the USA and Europe. Recently, Silicon Valley Bank (SVB), the 16th largest bank in the USA with of assets of over $209bn went under. This bank focused on doing business with technology companies and venture capitalists. The meltdown of the bank occurred after news went viral about the bank facing a lot of mark-to-market losses on the older US Treasury bonds it held on its books. The US Central Bank has been raising interest rates to combat inflation. Hence, old treasury bonds that pay lesser interest rates are less valuable than the current high-rate treasuries, leading to losses for SVB.
They bank also borrowed money on a short-term tenure basis, and invested it in longer-term, higher interest rates. This is called a taking on a duration-risk as your borrowing and lending time frames are mismatched. In the current environment, short-term rates have gone higher, while the long-term rates are lower (also known as an inverted yield curve), again causing losses for SVB.
While typically banks fail due to credit risk – where companies who borrowed from the bank can’t repay the loan. In the 2008 sub-prime mortgage crisis, we had defaulting home-owners. This time the reason was different. It was rising interest rates and duration risk.
This tells us something about a banking crisis – each time it is different. Experts say the current regulatory stress-tests in the US would not have detected anything wrong with SVB. The focus of regulations on banks is usually to check credit quality and ensure there is enough equity capital. Duration risk and interest rate risks are not monitored as much.
Making things worse is the speed at which is news travels these days. We live in times where we know which celebrity delivered a baby to which bank is having trouble, all in a matter of hours, if not minutes. As bad news about SVB spread, a panic ensued. Depositors rushed to the bank to withdraw their savings. No bank in the world, no matter how safe, how regulated, can survive a run on the bank where depositors just want to get out. Eventually, the US government had to calm nerves and guarantee all deposits. The crisis at SVB would have spread to other US banks, particularly the smaller regional ones, if the government had not stepped in.
In Europe as well, Credit Suisse, a Swiss financial institution in business since the last 156 years collapsed. Here too, UBS, another big Swiss bank had to take over Credit Suisse for a tiny fraction of the price ($2bn value, whereas Credit Suisse was valued at nearly $300bn in 2007). The Swiss government has agreed to provide capital and protect UBS from losses as well. For if big banks fail, they can have a massive impact on the economy. They take down many other businesses and other banks as well.
India is currently shielded from these two crises. The problems at SVB or Credit Suisse do not hit our shores as much. We are not so internationally integrated yet (although we are becoming more so). However, we do have a banking sector, which carries the same risks. We have been passing several regulations in the past decade to keep our banks credit quality and capitalization in check. However, we need to focus more on certain other risks not connected to credit – interest rates, duration risk and exposure to market instruments which can go up or down in value. We need have regulatory stress tests tosee the current level of duration mismatch, mark-to-market exposure and interest rate sensitivity.
We also need to account for ‘sudden panic’ situations, where some bad news about a bank’s losses spreads like wildfire, leading to massive withdrawals and a run on the bank. The banks need to have a clear communication policy in such a scenario. The government too can force banks to create a common consortium fund, to provide to any of their member banks as emergency funding should there be a sudden run on the bank.
The banking crisis in the USA is and Europe a demonstration of some unusual, uncommon risks in all banking systems. As India’s economy grows further, we will have a much larger banking sector. We must regulate and monitor all kinds of risks so an SVB type situation does not happen here, or at least is well managed when it does.
To bank on someone means to count on someone as reliable and trustworthy. When banks themselves become shaky and can’t be ‘banked upon,’ it affects the reliability and trustworthiness of the entire economy.
Let’s keep the Indian economy safe. Let’s keep our banks safe.
March 26, 2023 ()