SVB spillover weighs on bank stocks but India’s financial sector stable

SVB (Silicon Valley Bank) logo and decreasing stock graph are seen in this illustration taken March 10, 2023. REUTERS/Dado Ruvic/Illustration

“When the US sneezes, the world catches a cold.”

This adage is time and again proven to be true, especially in the financial markets. So, when the US markets fell overnight on March 9, led by a 60 percent fall in the shares of technology-focused lender Silicon Valley Bank, the heat was felt by the Indian market on March 10.

An unexpected loss of $1.8 billion on the sale of bonds worth $21 billion by SVB highlighted the perils of rising interest rates. This soured sentiment and investors feared the worst, leading to a dramatic fall in shares of banks, not just in the US but also across Europe and Asia. Indian banks were not spared either, with the Nifty Bank dropping close to 2 percent.

Experts were quick to point out that the fall in share prices of lenders was a kneejerk reaction and the issue at SVB has no bearing on Indian banks because of the stability of the financial sector.

To be sure, the Reserve Bank of India, just like central banks across the world, has been tightening interest rates, reversing the easy liquidity and rate cycle that was started to keep the financial markets afloat during the pandemic.

Accident waiting to happen

In a tweet March 10, billionaire banker and Kotak Mahindra Bank chief Uday Kotak said that an accident was waiting to happen, in what was seen as a reference to the SVB issue.

“Overnight developments in US banking: markets, analysts, investors underestimate the importance of financial stability for the balance sheet of a bank. When interest rates move up 500 bps from zero in a year, an accident was waiting to happen somewhere,” he wrote on the micro-blogging site.

The US Federal Reserve has hiked rates 450 basis points since March 2022. Earlier this week, Federal Reserve chair Jerome Powell said the Fed is prepared to take large quantum rate hikes in a meeting later this month if data suggests more measures are needed to tame inflation. This led to economists penciling in a terminal rate of 5.50-5.75 percent as compared to 5 percent before.

In comparison, the RBI is expected to hike interest by 25 bps in April. Since May, India’s central bank has hiked the repo rate by 250 bps.

While the RBI gave the much-needed stimulus to the economy during the pandemic by keeping rates low and supplying liquidity for the productive sectors, all the measures were targeted and time-bound. Almost all of them were rolled back gradually, without hampering market functioning, analysts said.

Now, rising interest rates are a big negative for banks as they erode the value of their bond portfolio. In the case of large mark-to-market losses, it led to capital erosion and losses. This is exactly what unfolded at SVB. The Santa Clara, California-based bank floated a plan to sell shares worth $2.25 billion to shore up its balance sheet but investors feared a potential liquidity problem at the bank.

Banks in India also invest a portion of their deposits in bonds, mainly government securities. Such investments are partly done to meet the mandatory Statutory Liquidity Ratio. In periods of lower credit growth and higher deposit accretion, banks keep the SLR higher than the regulatory requirement. The situation has reversed for the past couple of months. So the excess SLR has come down to some extent as credit growth has remained strong and mobilising deposits has been a challenge.

In addition, the RBI has extended the dispensation of enhanced held-to-maturity portfolio till March 2023. Bonds under this portfolio are insulated from daily movement in yields and banks don’t have to make any provision in case of mark-to-market or MTM losses.

Low default probability

“Yields have gone up since the RBI started hiking interest rates. But those on the longer maturity bonds have not risen to an extent that it will lead to big MTM losses. The yield on the 10-year paper had risen above the psychologically important 7.50 percent mark in June but it retreated and did not breach that level again. Short-term rates have risen sharply but those are manageable,” said Venkatakrishnan Srinivasan, founder of debt advisory firm Rockfort Fincap.

The yield on the 10-year benchmark government bond, which is the barometer for India’s bond market, ended at 7.43 percent on March 10.

Dealers said the corporate bond holdings of banks are not large and the probability of a credit default is low, given that companies have repaid high-cost debt during the pandemic. At the same time, asset quality levels of banks have improved with a fall in gross bad loans while both provisions coverage ratio and capital buffers have increased.

RBI Governor Shaktikanta Das, in his foreword to the central bank’s Financial Stability Report released in December, said the banking system is sound and well-capitalised.

“Stress test results presented in this issue of the FSR indicate that banks would be able to withstand even severe stress conditions, should they materialise. Furthermore, in spite of formidable global headwinds, India’s external accounts remain well-cushioned and viable,” he said.

According to the RBI’s macro stress test, banks would be able to comply with the minimum capital requirements even under severe stress scenarios. The system-level capital to risk-weighted assets ratio (CRAR) in September 2023, under baseline, medium, and severe stress scenarios, is projected at 14.9 percent, 14.0 percent, and 13.1 percent, respectively.