I must confess that it is a strong statement to make, especially when I have typically confined myself to the realms of probabilities in the past. Nonetheless, I am unequivocally convinced that the circumstances that led to the collapse of SVB are not replicable within the banking system of India.
An extensive literature has detailed the steps taken by FDIC to assume control of SVB, the bankruptcy filing of its parent organization, SVB Financial Group, and its eventual sale to First Citizens Bank — it is not my intention to dwell on these matters.
Instead, this article seeks to explain why such an outcome is implausible for Indian banks. Since the announcement of the collapse of SVB, banking stocks in India, particularly those of public sector banks, have come under significant pressure. In this article, we shall analyse two key aspects: (a) the quantitative differentiation between the balance sheets of SVB and
Indian banks, and (b) the regulatory measures in place that make it highly unlikely for such an event to occur in the Indian banking sector.
investments amounting to $124 billion (of which AFS accounted for $29 billion and HTM accounted for $95 billion), and deposits worth $176 billion.
Read more at:It is worth mentioning that the investments constituted around 71% of SVB’s deposits, of which, 77% were classified as HTM. However, before we delve further, it is essential to define the aforementioned terms. In brief, HTM stands for securities Held Till Maturity, while AFS refers to securities Available For Sale. The increase in interest rates results in a decrease in the value of investments due to an inverse price-to-yield relationship. While changes in the fair value of the AFS portfolio must be reflected in the profit and loss statement, changes in the fair value of the HTM portfolio need not be.
SVB’s AFS portfolio was yielding 1.6%, while the HTM portfolio was yielding 1.9%. However, when the 10-year US yields surpassed 4%, both the AFS and HTM portfolios incurred significant losses, with marked-to-market losses amounting to $16 billion, equivalent to SVB’s entire net worth of $16 billion.
Ironically, SVB had non-interest-bearing demand liabilities, akin to current accounts in India, worth $94 billion. If the deposits had not been withdrawn, and interest rates had subsequently fallen below 2%, the bank would have remained financially stable.
However, as we are aware, the funds in current accounts are meant to be withdrawn at any given time, and as in the case of SVB, $42 billion worth of deposits were withdrawn in a single day. Hence, the timing of cash flows assumes paramount significance in assessing the risk exposure of banks.
There exist regulatory safeguards to prevent such fundamental vulnerabilities. However, in 2018, the US passed a law that stipulated enhanced requirements, such as stress testing, stricter capital requirements, and risk management practices, to be applicable only to banks with assets exceeding $250 billion.
This requirement was raised from the previous threshold of $50 billion under the Dodd-Frank Act. SVB simply fell between the regulation cracks!
Let us now delve into why such a scenario is unlikely to occur with Indian banks. In India, the Reserve Bank of India (RBI) mandates that a portion of banking deposits must be invested in approved government securities, referred to as the Statutory Liquidity Ratio (SLR) requirement. The SLR currently ranges from a minimum of 18% to a maximum of 40%.
Thus, no Indian bank can emulate SVB’s strategy of investing 71% of its deposits in government securities. Secondly, in India, the Asset-Liability Management (ALM) framework is regarded as a critical aspect of banking and is taken seriously by both the banks and the RBI. The primary
objective of this framework is to manage the volume, mix, maturity, rate sensitivity, quality, and liquidity of assets and liabilities to achieve a predetermined acceptable risk/reward ratio.
An efficient system of real-time monitoring is implemented and is overseen by the Asset-Liability Committee (ALCO), comprising the bank’s senior management, including the CEO.
In 1999, the RBI mandated banks to report a statement of structural liquidity that breaks down their assets and liabilities into 8 maturity buckets, in line with the Bank of International Settlements (BIS) Basel Committee on Banking Supervision (BCBS) framework for prudential regulation of banks.
The latest combined maturity gap analysis is presented below. It allows RBI to keep a strict vigil on the timings of the cash flows.
The timing of cash flows is one aspect, however, a government security with a maturity of 10 years, a yield-to-maturity (YTM) of 7.26%, and current yields of 7.34% has a modified duration of approximately 7. This implies that a 1 percentage point increase in interest rates would result in a 7% decline in the quoted value of the investment. Although if banks retain
these assets until maturity, they will receive the prevailing yield at the time of purchase.
Nonetheless, this requires that liabilities do not crystallize during the holding period, which would force banks to sell the security prior to maturity (and incur losses if yields have moved up).
This complicated exercise is managed by looking at the weighted average duration of assets and liabilities. While banks must hold G-Sec as SLR for the long term, unless a bank can generate liabilities which has commensurate duration, higher interest rates will impact its net worth calculations. And since a large part of SLR will be held as HTM, the losses from rising interest rates will not flow through P&L and many investors will simply not find out.
