Over the last few weeks, we have been reading a lot about the US banking system. The Silicon Valley Bank (SVB), which was the 16th largest bank in the US, has collapsed. So has the Signature Bank. As if this was not enough, the crisis also impacted Credit Suisse, the famous bank based in Switzerland.
Many would have wondered what happened to these financial institutions. That too in a country, which is popular for its rules and regulations.
Well, crises can strike anywhere, where things are taken for granted. In the case of SVB, the bank management did not focus on what is called asset-liability management. It did not notice that its deposits grew at a phenomenal rate, in fact, three times from 2019 to 2022. This was not followed by fund deployment due to limited opportunities in the wake of Covid-19.
The bank started investing its money in two types of instruments -- short-duration investments categorised as available for sale (AFS) and long-duration investments classified as held to maturity (HTM).
The focus was more on investing in HTM instruments, where money is invested until maturity and is literally free from market fluctuations. However, as the interest rates started increasing, the value of these investments started decreasing. In other words, the bank did not have much money left to service the demands of its customers.
People were taken aback when SVB made an announcement that it needed $2.25 billion to support its balance-sheet. The announcement certainly created havoc. People started withdrawing their money. In fact, $42 billion worth of funds were withdrawn in a day! In a couple of days, the Federal Deposit Insurance Corporation (FDIC) said that only those who had insured deposits would be able to get access to their money.
The bank was one of the favourite destinations for many start-ups. In fact, it provided many services to the early-stage tech start-ups. Its tailor-made investment plans made it an essential part of the Silicon Valley economy. This also became a major reason for its collapse. Had the bank diversified its operations over various sectors, the story would have been different.
Not only this, the records also indicate poor risk management practices. The bank lagged in creating enough interest rate hedging. Not only this, the bank was functioning without a proper risk management team. While its charter mentioned having a risk management committee, it did not even have a risk officer on board for about eight months in 2022. Only in the month of January, they appointed a new chief risk officer.
If one looks into the details of the risk management committee, one would be shocked to know that no one ever held a senior position like chief risk officer. Not only this, the SVB’s board also did not have people with much experience relating to risk management. Clearly, there was a huge disconnect between what was mentioned in the papers and the ground reality.
This gap would have kept the board in the dark about the kind of risks the bank is running into. Considering their experience, the board did not seem to have the expertise to even ask questions pertaining to risk management. Well, this issue may not be restricted to SVB alone. In fact, it is pervasive all across the banking sector. A majority of the people who constitute bank boards do not have expertise in complex fields like risk management.
While the government has stepped in to save the interests of the depositors and the general public, India has a lot to learn from this overseas banking crisis. If we look at our banking industry, especially the public sector banks, what we usually come across is a huge pile of bad debts. Yes, the SVB story is different as it does not have a lending fiasco similar to that of Nirav Modi or Vijay Mallya. But the management story could be the same.
The strict RBI regulations do mitigate many risks. Yet, many banks have failed to manage their affairs effectively. While the banking crisis in the western countries may not have a direct impact on the Indian banking sector, it is important to have a relook at our policies.
For instance, the Modi government has been on a merger spree. Smaller banks have been merged into bigger ones. It might be easier for the bigger banks to manage the affairs of the merged entity. However, this may not be the best policy. One major reason for these mergers has been the ever-increasing non-performing assets. However, bank merger is certainly not the solution to this deep-rooted problem, which starts with faulty loan policies, managerial influences, improper credit appraisal, deficient risk management policies, sluggish legal systems and so on.
Another important lesson is the need to diversify their portfolio to mitigate idiosyncratic risks. Our regulators must ensure that regular stress tests are conducted and capital requirements are strictly adhered to.
Banks often have a lot of focus on their assets. The SVB story certainly shows that it is important to pay attention to the liabilities’ portfolio as well. It is equally important to create sufficient interest risk hedging. With the interest rates going up, the investments may not yield enough returns as anticipated initially. The banks must look at their risk management practices closely.
The banking sector in the Western countries may have their own ailments. The Indian banking sector has its own set of problems. Many have taken banks for a ride. Many a time, those who default on their commitments are in a much better position to negotiate better terms for themselves. On the other hand, those who have been diligent in paying their dues, have to face the heat in difficult times.
At times, auditors, who have been appointed as watch dogs, have failed to live up to their promises. The case of Yes Bank might be still fresh for many people, where NPAs were grossly under-reported. Balance-sheets were window dressed to showcase the rosy picture. It was only when the bank lost its deposits worth Rs. 18,000 crore and restrictions were imposed on cash withdrawals that people came to know the actual story.
Such cases certainly led the government to increase the deposit insurance to Rs. 5 lakh per customer. However, it is still inadequate. Of course, the government and the RBI certainly came forward to bail out the bank. But why should the burden of weak governance structures, ineffective management/board be passed on to the taxpayers? Why can’t adequate steps be taken to ensure the safety of public money, which the banks hold in its custody? Why should the likes of Nirav Modi go scot-free while the aam janta bear the brunt of their behaviour?
The SVB story brings up all such questions which are often asked the moment a bank lands in a crisis. After a few debates and discussions, these questions are often pushed under the carpet. It is high time, we revisit these questions and find sustainable solutions to these problems, instead of blindly merging the banks.