I’ll start with my favorite quote: “Whatever has never happened before always does.” An example was the collapse of Silicon Valley Bank (SVB) in the US. This was due to a ‘liability-side risk concentration’ curveball and none of the triggers that have caused bank failures in the past.
The best analogy for the SVB collapse was the inevitable implosion of illegal supertech towers close to home. It happened in a flash and in plain sight for all to see. One could also argue that the actions and events leading to its downfall were all in the public domain and their implications were clearly visible to all stakeholders. Apparently, SVB’s mark-to-market losses (even with assets in the maturity-to-maturity book) were being disclosed to its board and regulators. Somehow, the stakeholders have assumed that these are ‘hypotheticals’ and nothing that can bring down the bank. No liquidity-coverage mandate and stress-testing metric turning red, and it was business as usual until the deposit-withdrawal whirlwind struck.
While the primary focus has been on SVB’s mark-to-market losses on its investment portfolio as the root cause of its collapse, the depression brought on by the tornado was a concentration of risk on the liability side. Its homogenous profile of depositors and reliance on large-ticket deposits from a single industry (and sector) was a risk that was not included in any of the stress tests. It is time to look at the ‘persons acting in the organisation’ on the liability side as well. Many startups have disproportionate involvement in their operations, with large venture capital funds (VCs) having physical investments. With VC instructions flying to their portfolio companies, it was akin to people acting in concert (never happened before). Social media had its own role in the tornado going from level F0 to F5 within hours, leaving crisis-management teams at the bank and regulator with little time to react.
All this said, Indian banks are an oasis of stability and the SVB crisis seems more like another nail-biting Netflix thriller to watch from afar than anything else.
However, are there any lessons for regulatory prescriptions in India? What changes can we make to make Indian banks more robust and agile?
An important question for all global regulators is whether we need to classify some large banks as systemically important banks (SIBs). If the regulator is ready to back-stop every bank, big or small, in the system, why do we need to have SIBs and put additional burden on them?
While regulators have set several metrics for liability concentration and liquidity, the SVB episode has brought to the fore one very important thing: the ratio of uninsured deposits to total deposits. In the case of SVB, this ratio was more than 90%, indicating heavy dependence on large deposits.
In India, banks categorize retail and wholesale deposits (each with its own definition) and disclose the profile of such deposits. The lesson from the SVB is that this classification serves no purpose. What matters is the proportion of deposits that are insured, be it in current, savings or fixed deposit accounts. Considering that only bank deposits 5 lakhs and below are insured in India, it should be mandatory for Indian banks to disclose the percentage of their deposits below 5 lakh per customer in the deposit rate card published on their websites. Could the regulator have graded insurance premiums such that banks with higher-than-average uninsured deposits pay higher deposit insurance premiums than banks with an appropriately granular insured deposit?
Here is another pertinent question: If the deposit is insured and a Cash Reserve Ratio (CRR) is maintained thereon, what is the requirement to maintain statutory reserves (Statutory Liquidity Ratio or SLR) on the insured deposits? If the regulator feels that removing it immediately is a drastic step, can we have differential reserve prescriptions between insured and non-insured deposits? For example, an SLR of 10% on insured deposits and 23% on uninsured deposits is mandated, resulting in maintenance of a blended SLR close to the currently mandated SLR. The Reserve Bank of India (RBI) may adjust these ratios appropriately, taking into account the systemic data available with it. This will encourage banks to focus on granular deposits to reduce their gross-up deposit costs.
Can the regulator introduce definition of ‘persons acting in concert’ in the case of deposits? For example, excessive reliance on bulk deposits from departments and entities of a state government or multiple entities within a corporate group or entities in the same industry. Data on the correlation of deposit behavior between such groups can be studied and concentration metrics can be introduced to track the proportion of such deposits.
Finally, come the Non-Banking Financial Companies (NBFCs) that accept deposits. Each insolvency resolution of such a large NBFC has 5 lakh and below, and is now seen as an expected norm in any resolution plan. Since deposit taking NBFCs maintain reserves on public deposits and RBI has virtually eliminated all regulatory intermediation between banks and NBFCs, why not go all hog? Let such NBFCs pay insurance premium and get their deposits insured, as banks do, and let RBI regulate and supervise such NBFCs like banks, which are already on the cusp.
While the SVB whirlwind has not created even a mild ripple in India, there are things we can do to further strengthen our banking system. Let’s not waste someone else’s trouble. Let’s get the ball rolling right away.
Srinivasan Varadarajan is the non-executive chairman of Union Bank of India
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