Post-SVB collapse, India should plug macro-economic loopholes

According to RBI Financial Stability Report (December 29, 2022), the gross non-performing assets (GNPA) ratio of SCB fell to a seven-year low of five per cent while the net non-performing assets (NNPA) dropped to a ten-year low of 1.3 per cent in September 2022. Similarly, macro-stress for credit risk reveals that SCB would be able to comply with the minimum capital requirements even under severe stress scenarios

Recently banking crises hit the United State due to the sudden increase in interest rates by US Fed leading to heavy losses in the investment portfolio of Silicon Valley Bank (SVB). The bank had to sell the investment portfolio at a heavy loss in order to meet the sudden demands by its customers for withdrawals. The SVB could not raise required capital and that gradually led to the collapse of SVB. Finally US Government and FED had to assure depositors about full money payment.

Meanwhile, close on its heels there was the collapse of Signature Bank in the US. It was on March 19 that Credit Suisse Bank had to be bailed out by UBS for $3.2 billion in an all-stock deal brokered by the government of Switzerland and the Swiss Financial Market Supervisory Authority.

There are different reasons for the failure of each of these banks. What was certain is that these failures have indicated impending risks to banking given the current macro-economic situation. All central banks are trying to control inflation by continuing to raise interest rates. However, the pace of increase in interest rates has shown a downward trend and meant tightening of liquidity. Both will impact the bonds markets at different maturity levels and banks have to reckon with a steady decline in their investment portfolio valuation.

In the light of what has happened elsewhere, we in India will have to remember that RBI has also increased Repo rates in line with other central banks to contain inflation, which is still above the RBI's tolerance level of four per cent with a upper limit of six per cent as inflation by the end of February stood at 6.44%. The RBI is expected to hike the key repo rate by 25 basis points when MPC meets from April 3 to 5 making Repo rate 6.75 %. Another important measure to be watched is whether RBI will move from withdrawal of accommodation to neutral. The ten-year bond yield in India stood at 7 .315 as of December 31, 2022.

According to RBI Financial Stability Report (December 29, 2022), the gross non-performing assets (GNPA) ratio of SCB fell to a seven-year low of five per cent while the net non-performing assets (NNPA) dropped to a ten-year low of 1.3 per cent in September 2022.

Similarly, macro-stress for credit risk reveals that SCB would be able to comply with the minimum capital requirements even under severe stress scenarios. The system level capital to risk weighted assets ratio (CRAR) in September 2023 under baseline, medium and severe stress scenarios, is projected at 14.9 per cent, 14.0 per cent and 13.1 per cent, respectively.

The provision coverage ratio of SCB as at the end of September 2022 was at a comfortable level of 70 per cent. In India, deposit growth of 9.2 per cent of SCB is lagging behind credit growth at 16.8 per cent as at the end of December 2022.

These indicate that the country’s banking system is well-capitalised with adequate provision cover. However, in view of what happened to banks in the US and Europe, those in India have to enhance further capital and make additional provisions towards large exposure.

Banks have to focus on depositors by providing adequate positive rate of return on deposits as it is necessary to develop depositors’ franchise. Liability management by banks will have to get greater focus with large diversified retail depositors.

The dependence on wholesale deposits and certificate of deposits should only be a short-term measure and it is necessary for banks to develop strong relationships with their depositors for a mutually beneficial continued patronage.

Banks have to further strengthen their assets liability management tools and policies. The periodicity of ALCO meetings can be increased and effectiveness of the outcome of such meetings can come in handy while going about an appropriate strategy and continued evaluation.

Banks should also rethink on the risk limits, including duration, modified duration and cut loss limits in the investment portfolio. The investment committee must evaluate investment strategy and make portfolio study every day.

Indian banks have to study the asset portfolio and evaluate and refix large exposure limits, entry level limits and credit exposure limits.

RBI and the banks in the country have in recent times done a fine job and we are in a much better position when it comes to financial stability. However as advised by the Union Finance Minister Nirmala Sitharaman recently, it is necessary for Indian banks and the regulator to be on a continuous watch.

(The author is former Chairman & Managing Director of Indian Overseas Bank)