By Nilesh Shah, Managing director, Kotak Mahindra Asset Managemet Co. Ltd. Views are personal
Will there be more SVBs in the US? The answer is a resounding yes. What about India? The chances are remote, despite chinks in the armour in the form of unregulated entities like collective investment schemes
The US Federal Reserve (Fed) cut rates by 150 bps in early 2020 and pumped trillions of dollars to support the economy during the Covid crisis. The after-effect of the ultra-loose fiscal/monetary policy was reflected in elevated inflation from early 2021. The Fed termed the rise of inflation as transitory. In early 2022, the Fed raised rates at the fastest pace in its history to curtail Inflation and regain credibility, though it didn’t cut its balance sheet meaningfully to remove the liquidity, which was the underlying cause of elevated inflation. The Fed was doing delicate balancing, hoping that higher rates would check inflation and excess liquidity would support growth. This strategy could have been sustained had there been no accidents. Unfortunately, the SVB crisis opened a Pandora’s box.
SVB was the 16th-largest bank in the US, having a geographic concentration in Silicon Valley with an industry concentration amongst startups. It had the highest deposit growth among US Banks during the low-interest days of 2020 & 2021. 97% of its deposits were wholesale, i.e., over $ 250,000 outside the FDIC deposit insurance cap. It had a high ESG ranking based on restrictive lending policy. SVB invested ~45% of its balance sheet in long-duration mortgage-backed securities (MBS) to earn a higher return than its cost of deposits. The Fed’s sharp U-turn in mid-2022 from “inflation is transitory” to rates being “higher for longer” pushed the SVB MBS portfolio into losses. Every rate hike by the Fed kept increasing the losses, though they were not accounted for being part of held to maturity (HTM) portfolio. They just had to survive the negative carry as the yield on MBS was lower than their deposit cost. This was possible till such time deposits kept flowing. Depositors of SVB, viz. startups, started withdrawing deposits as they needed to fund losses and could not raise capital from their sponsors. SVB had to sell securities and book losses to meet deposit outflows. The senior management of SVB sold their holdings under a trading plan, probably resulting in accelerated flows from savvy depositors. SVB announced a capital raise of $2 billion but found no takers.
As the word spread about losses and tighter liquidity, deposit outflow accelerated. FDIC had to take SVB into receivership to stop panic. The US Treasury, Fed, and FDIC stitched a rescue package by guaranteeing all deposits to stop the panic among small bank deposit holders. The trinity was probably driven by the experience of the 2008 sub-prime crisis and the HTM portfolio loss of over $ 650 billion in US Banks. Signature Bank and First Republic Bank followed SVB, keeping all three busy.
Will there be more SVBs in the US? The answer is a resounding yes. Most parts of the US banking system are optional to follow Basel III prudential norms. The US exempted banks with less than $ 250 billion in deposits from the Dodd-Frank Act provisions in 2018. In essence, many banks like SVB in the US optionally follow prudential norms like liquidity coverage ratio, a cap on HTM portfolio as a percentage of balance sheet, and net stable funding ratio.
The Fed, Treasury, and FDIC will work overtime in days to come to ensure that SVB doesn’t become a contagion like the 2008 subprime crisis. Of course, they wouldn’t mind losing the war on inflation (seeing that inflation persists a little above the target of 2%) and growth (a mild recession in 2023). Still, they will hope to win the battle of keeping intact the depositors’ and investors’ trust in the US financial system.
What are the chances of SVB happening in India? The answer is very remote, despite ILFS, DHFL, and Yes Bank (which were credit/governance issues). RBI has proactively prescribed prudential norms like liquidity coverage ratio and a cap on the HTM portfolio. Banks have an excellent asset-liability framework. More importantly, the mark-to-market loss on the HTM portfolio is a tiny percentage of net worth and well-covered by FY23 profit before tax. Banks also have diversified CASA and deposit base across geographies and industries. Banks also have a good balance between retail and wholesale deposits. Implicit sovereign guarantee also gives the confidence to deposit holders. We do have a chink in our armour in the form of unregulated entities like collective investment schemes (more than 1.8 crore Indians have lost more than `2 trillion in Ponzi schemes from plantation to gold across India) or poorly regulated entities like co-op banks (PMC Bank).
Will our economy and market suffer from the US and European banking crises like the 2008 subprime crisis? In the market, one can never say never. But hopefully, investors have learned from the 2008 subprime crisis panic. Hence, the impact will be temporary and transitory, and correction, if any, will be an excellent opportunity for long-term investors.
