India’s financial markets need more depth for US-style bank bailouts

The California Department of Financial Protection and Innovation took over the troubled bank and placed it under receivership of the Federal Deposit Insurance Corporation (FDIC). The FDIC invited bids for the California-based lender, and regional banks — including PNC Financial Services Group Inc., Citizens Financial Group Inc. and Fifth Third Bancorp — submitted bids.

In the end the FDIC chose the bid from JPMorgan Chase, the largest US lender, because it required the lowest cost to the regulator. Once JPMorgan takes over all of First Republic’s deposits and most of its assets, the FDIC will incur some $13 billion in losses and $50 billion in debt to JPMorgan to cope with the acquisition.

Like most places, banks in the US do not have the same bankruptcy process as non-financial companies. Regulators intervene to protect the financial system from systemic damage. Silvergate Bank voluntarily shut down in March, brought down by its massive exposure to the cryptocurrency ecosystem and the collapse of crypto exchange FTX.

Silicon Valley Bank and Signature Bank failed in quick succession, primarily because they failed to update the maturity profile of their investments and deposits, while the Fed was raising interest rates at a record pace. Long-term government paper, in which banks had invested a portion of their deposits, declined sharply in value due to rising interest rates. When depositors panicked in the wake of Silvergate’s self-liquidation and began moving money from smaller banks to larger banks, the banks could not give depositors their money back by selling these depreciated assets.

Trump’s presidency loosened regulatory and supervisory norms for US small banks, which compounded the problems in these banks. These dormant problems started when interest rates rose sharply over the course of a year.

What is striking in the resolution of the First Republic Bank failure is the effort by US banking regulators to let market forces do the work in the resolution process. It was fair enough when regulators took over the bank when its collapse seemed imminent, but sold it off after writing down its equity and debt to zero, and then inviting bids for the insolvent entity. Gave. The FDIC needed to take some losses on the bank’s assets, and chose the bid that would minimize these losses.

This is in contrast to the Reserve Bank of India (RBI), for example, in the case of Yes Bank and Lakshmi Vilas Bank, both of which were restructured and placed under new management at the discretion of the regulator (sold to LVB ) Indian subsidiary of Singapore-based DBS) rather than through a formal, market-based process. The Swiss authorities also arranged for UBS to take over the troubled Credit Suisse through its privileged access to bank management, rather than through a market-based process.

The bottom line is that regardless of the intervention model, onward infection was prevented and minimal disruption to stakeholders was caused. Of course, holders of Yes Bank’s Additional Tier 1 (AT1) bonds are dissatisfied, with their bonds being written off while the equity was not.

The truth is that the AT1 bondholders’ complaint is based on confusing terminology. AT1 bonds are bonds in name only. They are a form of insurance against the collapse of a bank, meant to be written off before it gets into serious trouble. They are similar to catastrophe bonds that reinsurers issue to create a payment pool in case a disaster, against which insurance has been sold, strikes.

Investors know that they get a higher rate of return on these bonds only because they bear the risk of being written off in whole or in part in the event of a disaster. Credit Suisse’s additional Tier 1 bonds were also written off in full before being sold to UBS, while its equity remained, albeit at a fraction of its previous value.

Uday Kotak lauded the way JP Morgan acquired First Republic Bank and urged such well-funded domestic banks to play a similar role during the crisis in India. Fair enough. India makes up for the lack of depth in financial markets with regulatory activism. But deepening of financial markets is the only way to ensure market-based solutions to financial problems.