Banking crisis in US, Europe is an alarm for India

- Continuous increase in interest rates also had an adverse effect on banks

Silicon Valley Bank, America's 16th largest Silicon Valley bank, collapsed last March 10. Depositors rushed to withdraw their money, marking only the second major bank failure in US history since the 2008 collapse. The Federal Deposit Insurance Corporation wasted no time. It took steps to calm the Silicon Valley bank's customers, and the bank was back to normal operations on Monday.

Similar scene is in India. Here the customers of the distressed banks lose sleep while the Reserve Bank of India closes the operations of the bank concerned and negotiates behind the scenes and announces the deal in the shortest possible time. A similar thing happened in July 2004 when Oriental Bank of Commerce acquired Global Trust Bank Ltd. State Bank of India led a consortium of banks that rescued Yes Bank in March 2020. But this similarity ends here. Silicon Valley Bank had $200 billion in assets in January and is a very large bank. While most banks did not back high-risk startups, Silicon Valley Bank did. But it did not lead to his downfall. The bank failed because it could not hedge interest rate risk.

Many tech startups, including Indian startups, placed their funds in Silicon Valley Bank, which invested in long-term securities. As interest rates rose, the yield on these assets began to rise and fall in value. In March 2022, the US central bank Federal Reserve raised policy rates for the first time since December 2018. It has increased by 4.5 to 4.75 percent in the last one year and may increase further. As a result, the value of government securities in Silicon Valley Bank's portfolio fell.

As unsecured investment losses began to mount, the faith of tech startups to keep their money in Silicon Valley banks began to waver. When investment in such startups fell, they too had to withdraw their money as they needed money for operational expenses. Silicon Valley Bank had no choice but to sell the assets. One incident after another happened. Due to losses, the capital began to decrease but the bank could not raise new capital. Startups had a competition to raise money. Thus the 40-year-old bank collapsed. He managed high-risk tech startups but was not immune to interest rate risk. It was a case of asset-liability mismatch.

Like other countries in the world, Indian stock markets were also affected last week and prices of bank stocks tumbled. In September 2008, this case was related to Lehman Brothers Holding Inc. So much was the panic that more than a century old SVC Cooperative Bank had to issue an announcement that it was an Indian bank and had nothing to do with America's Silicon Valley Bank.

Indian markets overreacted and Indian banks should definitely learn lessons from the Silicon Valley Bank episode. Indian and American banks are quite different, but when the risk is calculated, the result can be similar. Unsecured loans, mortgages and loans to micro, small and medium enterprises have also started showing problems. If the borrower is unable to pay the loan installments for more than 90 days, it turns into a bad loan. It remains a stressed but standard loan for 90 days.

Some types of debt are beginning to show stress. The primary reason for this is the rise in interest rates. All such loans are floating rate loans linked to either the RBI's repo rate or an external benchmark such as the bank's marginal cost of funds. RBI's policy rate has increased by 2.5 percent from May 2022. Meanwhile, interest costs for retail investors rose by 16 percent. Borrowers either have to pay higher installments or extend the loan tenure. But there is a limit to extending the loan tenure and it depends on the loan amount and the age of the borrower. After the rate hike, the home loan tenure has increased to 50 years.

According to a survey of over one lakh enterprises, the turnover of small MSMEs has either stagnated or declined over the past five years. Or they are closed. In the past five years, 72 percent of responding companies were either stagnating, downsizing, or closed. Only 28 percent said that their business is growing. It is like a warning. High cost of interest has also affected the affordable housing sector. The number of affordable units in total unsold homes in the January to September quarter fell 11 percent from pre-Covid levels. In 2019, 51 percent of all unsold homes in the nation's seven largest real estate markets were affordable houses.

Before stricter risk management standards were implemented, some banks extended loans liberally to increase credit. They will have to pay the price in time to come. Between January 2022 and January 2023, personal loans in the banking industry increased by 20.4 percent. This includes loans taken for mortgages and consumer durables. During this period credit to large enterprises increased by 8.5 percent.

The collapse of Silicon Valley Bank will not put pressure on the RBI. Although the rate hike cycle in India is not as rapid as in the US, there is growing clamor to reduce it. However, inflation has also gone beyond limits. Will RBI limit hike in next monetary policy meeting in April? We will have to wait to find out.