A Reassuring Look at Bank Stability
All of us trust a bank not only with our money but also with confidential information which reveals a lot about our family and us.
That trust is facing another challenge again.
What has caused this?
The crisis was caused by a run on US-based banks Silicon Valley Bank (SVB) and Signature Bank.
What caused the alarm to ring?
A run on Switzerland-based Credit Suisse bank despite $54 billion support from the country's central bank, Swiss National Bank, led to fear of a contagion effect.
This ultimately led to SNB nudging UBS Group, the country's largest bank, to acquire Credit Suisse with the assurance of a $100 billion liquidity support.
What is a contagion effect?
The likelihood of, especially, a financial crisis spreading across asset classes and countries is called a contagion effect.
What causes contagion fear?
The global financial system is a series of relationships that are parallel, corresponding and interlinked in nature.
The fear of a "domino effect" if a contractual violation by the other party in an investment, credit, or trading transaction makes depositors and investors nervous.
Banks face agnipariskha periodically
A banking crisis serves as a crucial test for an economy, with the condition of banks during such a crisis determining whether the necessary safeguards are in place for the economy to function normally and achieve robust growth.
Major banks are not just responsible for maintaining liquidity but also have to ceaselessly offer proof of risk controls and retain the trust of depositors and investors.
RBI's commendable performance
It's worth acknowledging the commendable work of the RBI in maintaining stringent regulations for the Indian banking sector.
Tight capital requirements, such as capital adequacy ratio, cash reserve ratio, statutory liquidity ratio, and a reasoned approach to interest rates, have helped the domestic banking system manage liquidity and asset quality crises relatively easily.
This is why events like the 2008 Lehman crisis and the current crisis caused by SVB and Credit Suisse will not significantly hurt banks and financial institutions in India.
The genesis of the current crisis can be traced back to the aggressive fiscal and monetary policies, in the West, after the 2008 financial crisis.
These policies resulted in soaring inflation in the US and Europe, reaching levels not seen since the 1980s. To combat this inflation, the US Federal Reserve and some other central banks have raised interest rates by nearly five percentage points in 2022.
The interest rate hike raised the cost of capital and impacted the risk-return equation. This led to a fall in bond prices and hit treasuries and asset liability management.
Are banks past the danger zone?
Regulators have responded quickly, implementing emergency measures to prevent contagion risks, but markets remain uncertain.
This crisis will emphasize the importance of central banks and banking regulators in the long run.
Another potential consequence of the crisis is its impact on interest rates, as duration mismatches in the banking sector can lead to liquidity issues and trigger asset quality concerns.
With inflation remaining high, the US Federal Reserve's focus on combating inflation may be challenged.
What's the way ahead?
An immediate influx of fresh liquidity in financial markets is unlikely, and some argue that further rate hikes should not occur.
Monitoring the impact of any changes in interest rate direction is essential, as it will affect financial markets and the economy.
While raising interest rates could be risky as it could hit bond prices more, not raising them is riskier.
Inflation is a hydra-headed monster; pausing rate hikes could mean more significant rate hikes later.
The RBI is watching the situation closely. Systemically important banks in India are not expected to face significant effects on their asset quality, liquidity, or reputation due to the ongoing crisis.
Nevertheless, both depositors and investors must exercise caution in these uncertain times.
Never before have quality and discipline come into focus as it has now.
Protect your wealth by staying focused on top-rated financial instruments that are among the leaders in the industry and stay well within the regulatory ambit.
Be patient and stay attentive to opportunities that a crisis always presents. Consult your financial advisor before taking any decisions.
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