Risk is embedded in the business of banking. Borrowers may not pay back their loans on time and depositors may withdraw their deposits any time. Banks thrive on the assumption that depositors will space out their withdrawals and borrowers will pay their dues. There could possibly be no bank in the world that can survive a run — an event where most of their depositors withdraw their deposits in a matter of days.
Silicon Valley Bank (SVB) could not survive as a going concern after its depositors withdrew around $42 billion over two days. The withdrawals were spooked by the loss on securities held by the bank and a statement (probably made at the wrong time) made by the top management not to panic. Asking investors not to panic after incurring loss on sale of securities and being unable to raise additional capital, isn’t convincing, to say the least.
One could argue that losses are normal in the business of banking and SVB selling securities at a loss was no big deal. It appears that SVB sold the securities due to a desperate need for capital. And this need arose due to the classic asset-liability conundrum that SVB got itself into — its investments were quoting at a loss while its depositors had to be paid more interest since the Federal Reserve kept hiking interest rates.
Could SVB have been more aggressive with their investment portfolio in order that some quick gains could be made to recoup the losses? Could the Federal Reserve been a little bit more pro-active by keeping an eye over the asset-liability mismatch that kept increasing at SVB?
Could the run have been prevented by the Federal Reserve (instead of SVB) asking investors not to panic? On hindsight the answers to all the above questions would be ‘Yes’. Over the next few weeks, the Federal Reserve would ensure that the insured depositors are paid off, and the uninsured depositors get receivership certificates.
Depending on the extent of the problem, the bank could soon be handed over to someone else. Ripple effects of the SVB collapse are being felt in India. As is the wont of regulators after such events, new laws will be implemented and stricter restrictions would be imposed.
At this time, a theoretical question that needs to be asked is: ‘Can Indian banks survive after a run on them?’ Indian banks operate in a different environment. The Reserve Bank of India has not let a SVB-type situation to occur to any Indian bank.
Wherever such a situation was perceived, the RBI has been quick to put them in the arms of other banks. For instance, Nedungadi Bank, Global Trust Bank and Bank of Rajasthan were all given to other Indian banks. Some time back, six public sector banks were amalgamated and, earlier, some subsidiaries of State Bank of India were merged with the bank. The credit deposit ratio (CD ratio) of most Indian banks is healthy. For the financial year 2021-22, the CD ratio of public sector banks in India was 65 per cent. The CD ratio of private banks would be a bit higher since they have more aggressive lending habits.
One of the issues at SVB was that the losses were accounted for only when the investments were sold and were not marked to market at fair value in the books. This is because accounting standards still permit some investments (such as instruments that are held to maturity) to be accounted for at cost. Since accounting standard-setters also react to SVB-type events, one can expect them to mandate disclosure of fair values even when investments are recorded at cost on the books.
The RBI has held back implementing Ind AS for banks — possibly due to the impact it could have on both provisioning for doubtful as well as treasury gains or losses. While Ind AS cannot prevent banks from collapsing, if implemented properly, the standards would present a more realistic picture of the financial position of banks. Post SVB, can one expect the Ind AS implementation notification from the RBI earlier than scheduled?
The writer is a chartered accountant
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