SILICON VALLEY BANK FAILURE

1. Background

• India remained a haven during the global financial crisis triggered by the collapse of investment bank Lehman Brothers in 2008, with domestic banks, backed by sound regulatory practices, showing strength and resilience.
• A decade and a half on, Indian banks remained unaffected by the failure of Silicon Valley Bank (SVB) and Signature Bank in the US last week, despite the global interconnectedness in the financial sector.
• Indian banks, especially the domestic systemically important banks (D-SIBs) that have operations overseas, are in the ear of startups and digitalisation.
• They are truly "Too big to fail" as is often assumed especially as ratings major Moody's issues a fresh warning of more pain ahead for the US banking system after the collapse of SVB.

2. Confidence in the resilience of Indian Banks

• A reason why an SVB-like failure is unlikely in India is that domestic banks have a different balance sheet structure.
• In India, we do not have a system where deposits are withdrawn in bulk quantities.
• Household savings constitute a major part of bank deposits in India this is different from the US, where a large portion of the bank deposits is from corporates.
• A large chunk of Indian deposits is with public sector banks and most of the rest is with very strong private sectors lenders such as HDFC Bank, ICICI Bank and Axis Bank.
  Customers need not worry about their savings and the government has always stepped in when banks have faced difficulties.
• In banking, confidence is important. You don't need any capital if the trust is 100 per cent and no amount of capital will save you if the trust is lost.
• In India, the approach of the regulator has generally been that depositors' money should be protected at any cost.
• The best example is the rescue of Yes Bank where a lot of liquidity support was provided.
• However, the failure of SVB did trigger nervousness in the stock markets, with bank shares taking a hit and investors losing money in the process.

2.1. ICICI Bank Crisis

• On September 30, 2008, as the benchmark Sensex fell 3.5 per cent to its lowest level in two years and panicked ICICI Bank Customers queued up outside ATMs in certain cities to withdraw their deposits, then Finance Minister P Chidambaram and the regulators SEBI and the RBI stepped in to calm the financial markets.
• Their assurances helped and the market closed 2.1 per cent up.
• In a rate statement, the RBI said the country's largest Private bank (ICICI Bank) was safe and had enough liquidity in its current account with the central bank to meet depositors' requirements.
• The RBI has arranged to provide adequate cash to ICICI Bank to meet the demands of its customers at its branches and ATMs.
• ICICI Bank closed 8.4 per cent higher, rebounding from a two-year low.

3. Classification of D-SIBs

• RBI has classified SBI, ICICI Bank and HDFC Bank as D-SIBs.
• The additional Common Equity Tier 1 (CET 1) requirement for D-SIBs was phased in from April 1, 2016, and became fully effective from April 1, 2019.
• The additional CET 1 requirement was in addition to the capital conservation buffer.
• It means that these banks have to earmark additional capital and provisions to safeguard their operations.
• Under the D-SIB framework announced by RBI on July 22, 2014, the central bank was required, from 2015, to disclose the names of banks designated as D-SIBs and to place them in appropriate buckets depending on their Systemic Importance Scores (SISs).
• Depending on the bucket in which a D-SIB is placed, an additional common equity requirement applies to it.
• Based on data collected from banks as on March 31, 2017, HDFC Bank was classified as a D-SIB along with SBI and ICICI Bank.
  The current update is based on data collected from banks as on March 31, 2022.

4. It's not the 2008 financial crisis again

• The Basel, Switzerland-based Financial Stability Board (FSB) an initiative of G20 nations has identified, in consultation with the Basel Committee on Banking Supervision (BCBS) and Swiss national authorities, a list of global systemically important banks (G-SIBs).
• There are 30 G-SIBs currently including JP Morgan, Citibank, HSBC, Bank of America, Bank of China, Barclays, BNP Paribas, Deutsche Bank and Goldman Sachs. No Indian Bank is on the list.

5. RBI's selection of D-SIBs

• The RBI follows a two-step process to assess the systemic importance of banks.
• First, a sample of banks to be assessed for their systemic importance is decided.
• All banks are not considered many smaller banks would be of lower systemic importance and burdening them with onerous data requirements regularly may not be prudent.
• Banks are selected for the computation of systemic importance based on an analysis of their size (based on Basel-III Leverage Ratio Exposure Measure) as a percentage of GDP.
• Banks having a size beyond 2 per cent of GDP will be selected in the sample.
• Once the sample of banks is selected a detailed study to compute their systemic importance is initiated.
• Based on a range of indicators, a composite score of systemic importance is computed for each bank.
• Banks that have systemic importance above a certain threshold are designated as D-SIBs.
• Next, the D-SIBs are segregated into buckets based on their systemic importance scores and subject to a graded loss absorbency capital surcharge, depending on the buckets in which they are placed.
• A D-SIB in the lower bucket will attract a lower capital charge and a D-SIB in the higher bucket will attract a higher capital charge.

6. Importance for the creation of SIBs

• During the 2008 crisis, problems faced by certain large and highly interconnected financial institutions hampered the orderly functioning of the global financial system, which negatively impacted the real economy.
• Government intervention was considered necessary to ensure financial stability in many jurisdictions.
• The cost of public sector intervention and the consequential increase in moral hazard required that future regulatory policies should aim at reducing the probability and the impact of the failure of SIBs.
• In October 2010, the FSB recommended that all member countries should put in place a framework to reduce risks attributable to Systemically Important Financial Institutions (SIFIs) in their jurisdictions.
• SIBs are perceived as banks that are "Too Big To Fail (TBTF) due to which these banks enjoy certain advantages in the funding markets.
• However, this perception creates an expectation of government support at times of distress, which encourages risk-taking, reduces market discipline, creates competitive distortions and increases the probability of distress in the future.
• It is therefore felt that SIBs should be subjected to additional policy measures to guard against systemic risks and moral hazard issues.
• While the Basel-III Norms prescribe a capital adequacy ratio (CAR) of the bank's ratio of capital to risk of 8 per cent, the RBI has been more cautious and mandated a CAR of 9 per cent for scheduled commercial banks and 12 per cent for public sector banks.

7. Need to take precautions

• The failure of a large bank anywhere can have a contagion effect around the world.
• The impairment or failure of a bank will likely cause greater damage to the domestic real economy if its activities constitute a significantly large share of domestic banking activities.
• The impairment or failure of a large bank is also likely to damage confidence in the banking system as a whole.
• As a measure of systemic importance, size is more important than any other indicator and size indicators are assigned greater weight.
• The impairment or failure of one bank could potentially increase the probability of impairment or failure of other banks if there is a high degree of interconnectedness (Contractual obligations) between them.
• This chain effect operates on both sides of the balance sheet there may be interconnections on the funding side as well as the asset side.
• The larger the number of linkages and the size of individual exposures, the greater the potential for the systemic risk to get magnified, which can lead to nervousness in the financial sector.
• The greater the role of a bank as a service provider in the underlying market infrastructure like payment systems, the larger the disruption it is likely to cause in terms of availability and range of services and infrastructure liquidity in case of failure.
• Also, the costs for customers of a failed bank for the same service at another bank would be much higher if the failed bank had a greater market share in providing that particular service.

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