Stunning failure of three successive US banks within a fortnight had forced the Federal Reserve, the US Central Bank to create a lending facility large enough to cover all the insured deposits in the banking system. Shockingly, Barney Frank, the famed Congressman who wrote 2010 Dodd-Frank Banking legislation sits on the Board of New York-based Signature Bank. The Dodd-Frank Act established tougher regulatory measures on banks after the Great Financial Crisis of 2008-09.
Last week, the Federal Deposit Insurance Corporation (FDIC) seized the assets of SVB marking the largest bank failure in the US since Washington Mutual during the height of the 2008 financial crisis. Does the swift and stunning decision by the FDIC and Federal Reserve hint at a looming disaster on the global financial front? Are we staring at a repeat of the Great Financial Crisis of 2008-09? Is this crisis a Solvency Crisis of 2008-09 or a Liquidity Crisis of the 1930s on the back of bank run? And how the failures of Banks in the USA could impact Indian Banking and Financial system?
Will SVB failure impact the Indian banking system?
For starters, the balance sheet structure of Indian banks is quite different from US banks. For Indian banks, loans and advances are the biggest assets on the balance sheet while in US banks like SVB, Investment is the biggest part on the asset side of the balance sheet. For banks, deposits are liabilities while loans and advances are assets. In a balance sheet, assets should always be equal to liability plus equity.
Before the failure, SVB held $212 billion of assets against $200 billion of liabilities and the equity cushion was $12 billion. Almost 40% of SVB assets (worth $82 billion) were in mortgage-backed securities while loan, and advances correspond to $74 billion. When FED raised interest rates, prices of long-duration bonds like mortgage-backed securities fell drastically. Thus, the value of SVB assets fell with each hike in Interest rates. A general rule of thumb is for every one year of duration, each 1% interest rate move impacts the price of the bond by 1% multiplied by duration. So, a 1% hike on a 10-year duration is a 10% loss for the bond price.
Also, 55% of the loan and advances were short-term loans to venture capital and private equity funds. Also, SVB received most of its deposit from start-up companies. These companies made a bank run on SVB with a whiff of negative news and on a single day on March 10 depositors, primarily start-ups, withdrew $42 billion from the bank.
In India, such bank runs are rare due to stringent norms by the regulator. Reserve Bank of India has strict exposure norms for each sector thus Indian banks can’t take such high exposure (like 55% of SVB to VCs and PEs) to a specific sector. A banking expert from a rating agency told Fortune India that the credit-to-deposit ratio of the Indian banking system was 75.9% at the end of December 2022 while investment in bonds was just 23%.
As per RBI’s Financial Stability Report issued on December 29, 2022, the market value of investments in bonds stood at ₹19.5 lakh crore in September 2022. This is less than one-sixth of the total outstanding loan of ₹130.4 lakh crore of the Indian banking system at the end of September 2022. Total deposit at the same time stood at ₹175.4 lakh crore.
In India, interest rates have not moved up drastically, viz a viz US. Also, the weighted average change is not very high as interest rates spiked in the last one year but most of the bonds on banks’ books are from older duration.
Also, net interest income which is a major driver of banks‘ operating income gets a boost during rising interest rates as banks swiftly hike rates on lending but hike on deposits comes in a piecemeal. Even, RBI in its Financial Stability Report found that interest income and other non-interest income (such as fee and commission, underwriting, income from forex operations) partly offset treasury losses in a rising interest rate scenario.
An investment fluctuation reserve (IFR) mandated by RBI that transfers the gains realised on sale of investments during easing interest rate cycle, acted as a shock absorber in a tightening phase.
The IFR guidelines were revised in April 2018 under which banks were advised to transfer net profit on sale of investment to the IFR, until it reaches at least 2% of the Held for Trading (HFT) and Available for Sale (AFS) portfolios. The banking system’s IFR reached 2.2% of HFT plus AFS portfolios in March 2022. This has helped banks to absorb the losses associated with the rise in G-sec yields.
Public Sector Banks posted a net loss of ₹3,465 crore or (corresponds to 8% of Net Operating Income) on Securities trading in Q1 FY23 while it gained a profit of ₹2,376 crore or 2.4% of Net Operating Income. While Private banks cumulatively suffered a loss of ₹643 crore (corresponds to 1.4% of Net Operating Income) in Q1 FY23 while registered a gain of ₹471 crore or 0.4% of net operating income in Q2 FY23.
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