US Banks Failure: Its Impact and Lessons for India | Dhameja, Dhameja, Khattar

Banks, an integral part of the financial system, affect and are affected by the economic activities and capital formation of a country. Banks failure is common in the US as bank failures happen more often, there have been 565 banks failure in the US since the new millennium; that is an average of almost 25 per year.

Banks in the US normally fall in three categories as, regional banks, community banks and National banks. Regional banks, are defined by the Federal Reserve, as banks with $10 billion to $100 billion in assets; these historically operated within a specific region of the country, but today, that’s not always the case.

A community bank is one with less than $10 billion in assets, National banks, on the other hand, operate nationwide, and are much larger with hundreds of billions or trillions of dollars in assets compared to less than $100 billion in assets that regional banks have. Thus, regional banks are essentially midsize banks; they’re too large to be considered community banks, but too small to be considered national banks. Regional banks offer the same services as national banks but with more personal relationships with community banks.

Bank regulation in the United States is highly fragmented compared with other G10 countries including India, where most countries have only one bank regulator. In the U.S., banking is regulated at both the federal and state level. Depending on the type of charter a banking organization has and on its organizational structure, it may be subject to numerous federal and state banking regulations. Apart from the bank regulatory agencies, the U.S. maintains separate securities, commodities, and insurance regulatory agencies at the federal and state level, Some individual cities also enact their own financial regulation laws (for example, defining what constitutes usurious lending).

In March 2023, three small–mid-size banks failed in the US; these three banks namely. Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank (FRB), have one thing in common that KPMG, their auditor gave the financial statements a clean chit in February 2023.

We discuss below, in brief, operations of these three banks, significance of their failure and its impact in other countries; lessons for India are also discussed.

Silicon Valley Bank (SVB)

SVB, Santa Clara, California, is the 40-year-old institution, and is the biggest US bank that failed since 2008 global financial crisis. It was the 16th largest bank in the US, had $209 billion in assets at the end of 2022 primarily serving clientele from start-up and technology start-up and wealthy individuals. Nearly half of U.S. venture capital-backed healthcare and technology companies were financed by SVB.

SVB collapse led to decline in global banking and financial stocks.
Why did bank fail? On pandemic 2020, the interest rates fell and the bank invested in long-term treasury bonds to capitalise on the increased deposits during pandemic. The then current market value of these bonds decreased as the Federal Reserve raised the interest rates to curb inflation. The treasury bonds lost significant value; and the bank sold its treasury bonds at a significance loss causing the depositors concern over banks liquidity. There was run to withdraw cash by the depositors, and the bank began to sell its assets at a steep loss, the bank realised a loss of $ 718 million on withdrawal related sales in the fourth quarter of 2022. SVB announced sale of over $ 21 billion securities and borrowed US $ 15 billion. As the market interest rates rose and the bank shifted its portfolio to longer maturity.

SVB financial group aggressively declined and it resulted 60 percent decline of its stock value, yielding a market loss of $ 80 billion. The bank announced to raise US two billion to plug the gap in the balance sheet, that lead to widespread panic among its clients and the bank shelved its plan to raise funds.

It would be of interest to know that the SVB crisis unfolded in just 48 hours, following the bank’s announcement that it was planning to raise funds worth more than $2 billion to plug gaps in its balance sheet. This led to widespread panic among its clients and depositors and also triggered a massive selloff.
As panic grew among its investors and depositors, SVB was forced to shelve its fundraising plan, but the damage was already done.

The financial crisis in SVB created a blood path in the start-up industry banking stocks and other major markets in the world. The bank was looking to sell itself and the bank told it employees to work from home.

SVB Financial Group’s collapse and takeover by the FDIC was unfolded in just a couple of days, but analysts reported that the bank became a victim of sustained high interest rates, and fears of more rate hikes in 2023.

Signature Bank

Signature banks founded in 2001 is the New York city bank, it had assets value of $ 118 billion in 2023. About forty percent of its loans were provided to multifamily home owners; these loans amounted to $ 15.8 billion.
Beginning 2018, the bank began crypto currency and moved away from dependence on real estate market. The banks became a big lender in the crypto industry and was part of only a handful of financial institutions allowing customers to deposit crypto assets. The bank did not bode well as the crypto plunged in 2022.

Deposits with the banks increased from about $36.3 billion at the end of the 2018 fiscal year to $104 billion by August 2022; and one-fourth of the deposits were from large crypto currency clients. By early 2023, the bank had become the second largest provider of banking services to the cryptocurrency industry-second only to Silvergate Bank

The services provided by the bank included traditional banking services to crypto currency clients and it opened a proprietary payment network for use among its cryptocurrency clients. The payment network, Signet, was opened in 2019 for approved clients, and allowed the real-time gross settlement of fund transfers through the blockchain without third parties or transaction fees. By the conclusion of 2020, the Signature Bank had 740 clients using Signet; the network expanded and both coin-base and the dollar-pegged stablecoin had become integrated with Signet in 2022 and 2021, respectively.

First Republic Bank (FRB)

The First Republic Bank started operations in 1985 with a single San Francisco branch. It was known for catering wealthy clients in the coastal states and had branches in high income communities such as Beverly Hill, Brentwood, Santa Monica, and Napa Valley California. It was the nation’s 14th largest bank and had assets valued at $ 229. 1 billion as of April 13 and had 7,200 employees.

Bank’s stock plunged more than 97 percent since the problems of Silicon Valley Bank surfaced on mid-March 2023, that worried investors about the state of the banking sector.

The deposits up to $ 250,000 are insured with the Federal Deposit Insurance Corporation (FDIC), and the FRB had $ 19,8 billion deposits exceeding the insurance limit; this did not include $ 30 billion uninsured deposits from other banks as part of the attempt to keep the bank afloat. The uninsured deposits were 68 percent of its total deposits as of December 31, 2022 but were 27 percent of its non-bank deposits as on March 31, 2023. In other words, 63 percent of total deposits were from business clients and the rest were from individuals; business clients normally need cash only bio-weekly to meet their payroll payments.

US banks failure: common reasons

One reason reported for the collapse of SVB, is the easing of the restrictions and rolling back tough requirements like Dodd-Frank Law by the previous regime in 2018 to take care of 2008 financial crisis. The relaxation was with the objective to help small and mid-sized banks to compete with larger banks. President Joe Biden reported that banking regulations would be strengthened to make the banks failure less likely to protect American jobs and small businesses. The three major U.S. federal bank regulators announced in a joint communiqué that extraordinary measures would be taken to ensure that all deposits at Silicon Valley Bank and Signature Bank would be honored

As mentioned earlier banking regulation in the US is fragmented, is regulated at both federal and state level, depending on the type of charter a banking organization has and on its organizational structure. A bank’s primary federal regulator could be the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board, or the Office of the Comptroller of the Currency. Further, within the Federal Reserve System, there are 12 districts centered around 12 regional Federal Reserve Banks, each of which carried out the Federal Reserve Board’s regulatory responsibilities in its respective district.
In addition, the three banks had the characteristics as:

• Banks business was heavily concentrated in single sector and was mainly confined to a region;
• These sectors and regions experienced boon and their business grew rapidly;
• Business clients for the banks were primarily of high income group and had little need to borrow;
• Banks normally have high leverage with high debt and low capital base; there is financial mismatch in their assets-liabilities; deposits are for short period while advances normally are for long period.

Banks failure Impact

Impact of banks failure could be presented in brief under:

o Though the US President Joe Biden had announced that all deposits with these banks would be taken care of, the US Credit Suisse announced its largest annual loss since 2008 financial crisis; $ 147 billion had been withdrawn in the fourth quarter of 2022; its share prices plunged by 25 percent. It also announced that, it had found “material weakness” in its financial reporting. Its largest investor, Saudi National Bank announced on March 15, 2023 that it would not provide more support to Credit Suisse.
o The Australia’s Central Bank governor indicated a potential pause in the recent rate hike.
o ABC News reported that the challenge for the central banks was to determine whether the banking turmoil was close to crashing the real economy, or the inflation still was the greater threat.
o The UK’s banking index fell around three percent led by falls of around six percent for both Barclays and Standard Chartered and four percent drop for New West shares.
o The Business Times reported that Asian Central banks were “unlikely to be greatly influenced by the banking crisis in the US
o Japan’s Central Bank held the crisis meeting and the Toxis Bank Index fell by 17 percent; Japan’s regional banking sector feared risk because of its exposure to US interest rate hikes.

Further, it would be appropriate to mention what the IMF reported; “IMF downgraded its financial forecast for GDP growth globally in 2023 from 2,9 percent to 2,8 percent saying that, “uncertainty is high and the balance of risks has shifted to the downside so long as the financial sector remains unsettled”.

Impact and lessons from US banks failure in India

o Reserve Bank of India, the bankers bank, regulates commercial banks operations, it has provided norms for the investment portfolio of banks and laid out detailed guidelines for the regulations and governance of Banks.
o The new norms for the classification and valuation of the investment portfolio of banks, have been prescribed with a view to align them with the global prudential framework and accounting standards.
o As per the investment norms, the investment portfolio of banks will be divided into three categories: held-to-maturity (HTM), available for sale (AFS), and fair value through profit and loss account (FVTPL). The new bank portfolio classification norms will come into effect from April 1, 2023.
o In addition, the RBI has assigned priority sector lending (PSL) status to India’s startup sector to help startups free up their equity and raise low cost debt. RBI guidelines for PSL for scheduled commercial banks are as under:
o 40% of the total net bank credit should go to a priority
sector advance.
o 10% of the priority sector advances or 10% of the total net bank credit, whichever is higher should go to weaker section.
o 18% of the total net bank credit should go to agricultural advances of which 8 percent is prescribed for Small and Marginal Farmers.
o Provision is also made for advances to Micro
Enterprises.

As regards the impact of banks failure, RBI governor Shaktikanta Dass put any further hikes in interest rate and said, “it’s a pause not a pivot”., while 25 basis point increase had widely been expected. It may be mentioned that deposits up to Rs 5 lakh are insured.

In addition to the internal issues concerning the performance and governance of banks looked after by the RBI, there are strategic policy issues of governance arising from externally imposed constraints. The P. J Nayak Committee appointed to review governance of boards of banks in India made far-reaching recommendations in 2014 concerning strategic policy issues.

These are as under:

• Financial position of public sector banks is fragile, partly masked by the regulatory forbearance.
• Governance of banks necessitates the separation of ownership from regulation, and that too regulation not by two agencies-RBI and the Central government. RBI should be the single regulator and the government should desist from issuing of instructions.
• For safeguarding the ownership interest of the government, government shareholding in public sector banks (PSBs) be moved to a special vehicle similar to a holding company, called Bank Iinvestment Committee (BIC). This Committee would have the power also to make appointments of whole-time directors and directors that represent the State.
• The BIC be headed by a professional banker, should have the autonomy, and carry out the ownership functions and sets its objective in terms of financial returns from the banks it controls.
• The Government should distance itself from several bank governance functions which it presently discharges with necessary legislative changes including repealing the necessary statutes under which banks are constituted and registering them under the Companies Act

References

• Agrawal Amol, “Lessons for the RBI from the US review of its 2023 bank failures” May 1, 2023
• Dhameja, Nand, Deepti Dabas Hazarika, Manish Dhameja, “Banks Mergers in India: Historical Perspective & Strategic Policy Issues” (The Indian Journal of Industrial Relations, Vol 56, No. 3, Jan. 2021)
• Elisabeth Buchwald, Francesca Chambers, Bailey Schulz Medora Lee, “Silicon Valley Bank, Signature Bank collapses explained, live updates on new developments”, (USA TODAY)
• Howard Marks, Lessons from Silicon Valley Banks, Oaktree Clients
• Nayak P. J. (2014), “Report of The Committee to Review Governance of Boards of Banks in India,” Government of India.
• Wikipedia Us Banks Failure

(Authors: Dr. Nand L. Dhameja Professor Emeritus, MRIIS, Faridabad; Manish Dhameja, Senior Banker having experience in South Asia, Africa and Middle East; Dr. Ridhi Khattar, Associate Professor, MRIIS, Faridabad)

Note: Views expressed are of the authors and not the organisations to which they belong

7/5/23