Silvergate Bank, Silicon Valley Bank, Signature Bank and Credit Suisse are names that have caught the headlines in the last few weeks. While Credit Suisse is a well-known name in India, the other three are not too familiar as they operate mainly in the US. Yet, the way in which these stories unfolded sequentially is unsettling.
The question raised is how secure is the banking system? Post Lehman, the Bank for International Settlements (BIS) strengthened capital norms, with Basel III laying down the guidelines. Yet, this has not prevented a crisis from erupting. This raises the question: Is this the end of the meltdown or are there other banks in line which are waiting to explode? This is notwithstanding the fact that the factors driving these banks to a crisis state are different.
These stories are probably not directly related to banks in India. Silvergate is a bank which was involved with crypto trading which is now no longer a favoured activity. In fact, the concept of crypto will fade in the next few years as it has been realised that the model is not sustainable.
SVB collapsed not because of an asset quality issue but on account of a rather unique model that focused on start-ups. Deposits came mainly from start-ups, and while there was some lending again to start-ups, the bank invested most of its funds in government paper (our own payments bank model, where funds are invested in G-Secs and T-bills). Signature Bank was into start-ups and crypto, which naturally caused panic. A rescue in the form of New York Community Bancorp buying it is on the cards.
Last, Credit Suisse, a Swiss bank, had its challenges in terms of its lending portfolio which had caused some controversy last year. But the losses incurred due to its varied business activity which spanned wealth and investment banking besides commercial banking now has a bailout by the Swiss National Bank and a takeover by UBS. These episodes, some of which are related to one another, will go down in history as the next financial crisis coming as it is post-Covid, during the Ukraine war and recession in the West.
The difference from the Lehman crisis is that all the regulators have stepped in immediately, which makes a difference. The RBI too has given assurance that the Indian banking system is strong. In Europe, central banks are evaluating the spillover effects of the Credit Suisse debacle to ensure that similar strains are not in evidence in their systems. So what are the lessons or implications for us in India?
The first lesson is that the SVB story shows that while the focus is often on the asset portfolio, the liabilities structure is equally important. There are prudential guidelines on exposure levels when it comes to lending, to ensure that there is no concentration of risk. But the idea that there is risk carried when there is concentration on the deposits side is quite novel.
Having start-ups as major sources of deposits engendered the crisis as a sudden withdrawal created panic. Banks in India need to look at their deposits to ensure that such a structure has not developed. This would hold more for smaller banks which could see such concentration.
Second, the travails of having a large investment portfolio is another message from this episode. Holding on to US treasuries appeared to be a safe bet. But with interest rates going up, the revaluation of the portfolio and booking of losses can be significant. Clearly,banks must review their risk management and treasury practices keeping in mind this development.
Third, it has always been argued that banks need to ensure that they specialise in commercial banking and lodge other activities in subsidiaries with their independent capital structures. The problem with Credit Suisse is that losses made on investment banking and the withdrawal of funds in the wealth management business led to a threat on the commercial banking balance sheet, which was steady when viewed independently.
In India, this weakness was recognised earlier itself and hence all other activities like investment banking, merchant banking, insurance, mutual funds, etc., are operated through other arms. This ensures that there are strong risk walls across different businesses.
Crypto has anyway not been recognised in India, which keeps it insulated from the impact of the failure of the other two banks. In fact, post these incidents, there is a strong case for banks across the world to ensure they keep business away from crypto-related activity as the downside from a collapse is substantial.
No direct impact
While prima facie it appears that the Indian banking system is not going to be directly impacted by these episodes, there is a need for introspection. Individually, banks would need to go back to their balance sheets and evaluate the concentration levels in deposits and loans. The treasury departments need to work with the risk team to ensure that the investment portfolio is handled prudently. Further, the vulnerabilities of companies with respect to their debt service coverage ratios need to be evaluated on a continuous basis to gauge the risk carried on their portfolios.
There is also a case for the RBI to review the limit on deposits insurance, which is presently ₹5 lakh; this could be raised to ₹10 lakh. Maybe one can consider categorising banks into those more vulnerable, where the insurance level is increased. Banks incidentally have to pay the insurance premium to Deposit Insurance and Credit Guarantee Corporation.
At the global level, there may soon be discussion on whether there is need to create special buffers for such contingencies — Basel IV, probably? This can lead to higher capital requirements for banks. Also, there would be a need for more stress tests covering both market and credit risk as part of the learning.
The writer is Chief Economist, Bank of Baroda. Views are personal