Raghuram Rajan on US banking crisis and government’s response

The profitability of midsize banks needs to be reassessed and there will be some situations where mergers will have to take place.

Raghuram Rajan, banking crisis, Taimur Baig, podcast, Silicon Valley Bank,
Entities make money in normal times taking risks and then throw the risk back to the government in bad times.

Raghuram Rajan, Former Governor of the Reserve Bank of India recently talked about the banking crisis in US and the way banks took on risks to earn profits but then threw the risk back to the government in bad times. This conversation was a part of the podcast ‘Kopi Time’, by Taimur Baig, Managing Director and Chief Economist at DBS Bank. Here are some edited excerprts from – ‘Kopi Time E100: Raghuram Rajan on fault lines in global finance and economy’.

Taimur Baig: Let’s start by talking about your view on the medium size US bank collapses that we saw in March, especially the response of the US authorities.

Raghuram Rajan: Well, I think the response of the US authorities is somewhat predictable, in the sense that they certainly are very worried about a cascade of failures. They’re worried about panic. And they do understand that there has been a significant increase in uninsured sort of liabilities in the banking sector over the last couple of years, partly as a result of the enormous quantitative easing that has taken place.

I think the short-term problem has been dealt with by the implicit insurance of all deposits. But the longer-term problem still exists. The profitability of midsize banks needs to be reassessed. And certainly, there will be some situations where mergers will have to take place.

Taimur Baig: Your assessment of the implicit guarantee; is that the right thing to do? I thought we were not supposed to do these things because of moral hazard.

Raghuram Rajan: I think that the real problem is no authority now has the backbone, or the risk tolerance to see what happens if they let entities fail. I think we have certainly for banks gotten into the zone of riskless capitalism, take all the risks you want, so long as you take it collectively, neither the Fed nor the Treasury or the equivalent in other countries, we saw a rescue in Switzerland.

They really don’t have the willingness to see entities fail, and perhaps precipitate a Lehman like moment. The talk is the Silicon Valley Bank was not a bailout. It was in the sense that the federal government, at least ex ante, absorbed USD20bn worth of guarantees, etc.

And, you know, it may turn out to be something which doesn’t produce significant losses. But that’s conjecture. At the point of rescue, there was certainly a bailout, if you define bailout as changing the
terms of the contract to the benefit of the private sector, there is a bailout of the uninsured depositors.

So, I worry. And, you know, I hope this wasn’t done because the depositors of Silicon Valley Bank were particularly influential.

The broader problem is, entities make money in normal times taking risks, and then throw the risk back to the government in bad times. And then the government, the government related authorities have not shown any willingness to tell people you took the risk, you must bear it, yes, equity holders got wiped out. But the uninsured depositors got a free pass.

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First published on: 26-05-2023 at 11:45 IST