The US government surprised markets on Sunday. Its Silicon Valley Bank (SVB) emergency rescue plan has no precedent. It neither tapped on the taxpayer shoulder to bail out the bank, nor abandoned uninsured depositors -- perhaps, a first in the history of banking. Treasury secretary Janet Yellen and her team should be lauded for avoiding bank runs at other lenders and for shoring up confidence in the banking system. That said, there are critical questions dominating the discourse.
How good are banking regulations? Are there more small and regional lenders suffering from the interest rate shocker? Do other lenders have similar asset portfolio mismatch? If so, will the next financial crisis, if any, come from small and mid-size banks, where regulations are somewhat lenient? Will the US Fed, which championed 'higher, longer and faster' rate hikes, tone down the pace of hikes to stem unseen shocks among lenders? How riskier is the under-regulated new-age financial lending business including startups and cryptocurrencies?
Chief among all is the regulatory aspect. SVB's CEO Greg Becker incidentally was also on the board of none other than the San Francisco Federal Reserve Bank! He was ousted days after the crisis unfolded. But if a mid-size bank like SVB was shut down, despite being run by a star CEO, who couldn't even handle interest rate risk -- a core function of banking business -- it does say a lot about banking regulations and supervision.
As of December 2022, SVB had $209 billion in total assets and about $175 billion in total deposits. According to Federal Deposit Insurance Corporation (FDIC), all insured depositors were entitled to recoup $250,000. However, its data showed that 89% of its $175 billion in deposits were uninsured. Yellen, who first stated that the regulators “have effective tools,” followed it up with an unprecedented bonanza protecting all uninsured depositors, largely comprising startups, who socked away billions of raised funds. Would a similar protection be extended should another bank with high uninsured retail deposits go belly up?
The US banking norms became stricter following the 2008 financial crisis, with capital requirements, portfolio diversification and others becoming prominent. Unfortunately, these regulations were largely limited to bigger banks like JP Morgan Chase, Bank of America, Citi Bank, Wells Fargo and others, perhaps considering their too-big-to-fail stature.
Thankfully, India can breathe with both lungs. The RBI's stringent norms, which saved the Indian banking system during the 2008 crisis, were further fine-tuned following the 2014 bad loans bout. And unlike the US, RBI's regulations on capital, provisions, and reserves apply uniformly to all commercial banks, big or small. And as research firm Jefferies noted, SVB Financial Group poses low potential risk to India, as SVB's India subsidiary was sold in 2015 and a rebranded version of that company has good credit rating and stable liquidity. The Indian banking system, in general, too is unlikely to be affected as our banks are well-secured. That said, startups and investors maintain caution, though the initial fears have somewhat subsided.
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For SVB, troubles began with the Fed raising policy rates, and as the value of government bonds issued at lower interest rates started falling, leading to unrealised losses. The regulatory oversight allowed SVB to invest aggressively when interest rates were low, without maintaining adequate reserves to tackle the unforeseen crisis. Banks are expected to hedge such interest rate risks, but SVB didn't.
The bigger question is, are there more lenders with similar liquidity troubles? While stock market movements may or may not be an indication, shares of regional and small US-based lenders seem vulnerable. No bank, big or small, has a cap in hand, yet, the Fed announced an emergency lending programme for cash-starved banks on Sunday. Was it just in case or do they see firm signs?
SVB's outlandish failure was preceded by two other banks that saw a similar fate. Silvergate Capital suffered a run on deposits last year, when its predominantly crypto-based clients withdrew funds amid the collapse of the FTX exchange. Another lender Signature Bank with ties to the crypto world was closed down by the regulators, who are liquidating assets and winding up operations. These unrelated bank failures may not cause a systemic crisis on their own, but a series of similar problems can trigger a full-blown crisis, causing a bloodbath across global markets.