More financial institutions may fail globally, but no direct impact on India likely: PM’s advisory council member

I would not be surprised if we see some more institutions failing in the West, Rakesh Mohan said.

After the failure of the Silicon Valley Bank (SVB) it will not be surprising if more financial institutions fail globally, but no direct impact is expected on Indian banks, though a reversal of capital flows and the consequent impact on the exchange rate could affect the economy, Rakesh Mohan, a part-time member of the Prime Minister's Economic Advisory Council (EAC) told Moneycontrol.

“I would not be surprised if we see some more institutions failing in the West. No direct impact is expected on India as we don't have exposure to either SVB or any other Western financial institution of significance. But as the interest rates keep increasing in the developed economies — Europe, US and UK — there could be some reversal of capital flows and the consequent impact on the exchange rate. Those are the kinds of issues that could affect the economy rather than any direct impact on the financial sector,” he said.

SVB and Signature Bank of the US failed in rapid succession last month following a rush for deposits by concerned customers. Credit Suisse collapsed in Europe. US and European regulators took a number of emergency measures in the days that followed, which appear to have calmed the financial markets.

“I don’t think what’s happened in the West in recent weeks will result in a financial crisis even there. But it can’t be ruled out because the expectation of the markets is still that the central banks there are likely to increase interest rates further. The question is whether adequate risk management is being done by the central banks and regulators, and also by the banks and non-bank financial institutions themselves in the face of increasing interest rates,” he said.

With all the repairs that have taken place in the banking system in the wake of a long period with large non-performing assets, Indian banks are now well-capitalised and financially stable.

“The Finance Minister and the RBI Governor have both announced that they are examining the risk management practices in banks and financial institutions. I presume the RBI will be doing some more due diligence of risks embedded in their balance sheets,” he added.

Mohan, who served as former RBI deputy governor from 2002-09, is also the President and Distinguished Fellow at the Centre for Social and Economic Progress.

ALSO READ: Asia set for outperformance; India to benefit from strong balance sheets, supply-side reforms: Morgan Stanley

Mohan said that the RBI ought to look at movements in global financial data that affect India. If the actions of the US Fed, the European Central Bank, the Bank of England, or the Bank of Japan affect India in terms of capital inflows and outflows and their consequent impact on domestic liquidity, then the RBI will have to take action.

“Interest rate increases by the RBI should not have the kind of effect they had on SVB and some other banks in the US,” he said.

SVB was the banker of choice for many tech firms, so they were impacted by the slowdown in the valley. The performance of many such firms has gone down over the past year, which led to the withdrawal of deposits. On the asset side, they had lent very little. More than 80 percent of their assets were in US Treasury bills in the held-to-maturity (HTM) bucket.

“When you put securities in the HTM bucket, the asset values don't have to be marked-to-market (M2M). So, as the interest rates were going up and T-bill values were coming down, they didn't see their asset value going down. However, they have a regulatory rule there that if you break even a small amount of your assets in the HTM bucket then the whole HTM portfolio has to be marked to market, not just the securities taken out and made available for sale.

“And that’s what happened because of the need for liquidity arising from significant wholesale deposit withdrawals. They had to break the HTM bucket to cash in their assets, i.e., US treasury bills, and mark the whole portfolio down, all of which led to a financial crisis as people lost confidence in the bank. It is possible that other US banks may also have similar problems,” Mohan explained.

None of India’s major banks has a majority of their monies in government securities in the HTM portfolio. RBI has a regulation that securities amounting to more than 25 percent of net demand and time liabilities (NDTL) cannot be in the HTM portfolio. There is better regulation and supervision of banking in India, Mohan added.

The PM-EAC member said that the situation is similar to the 2008 North Atlantic financial crisis.

“I am not expecting a global financial crisis. The 2008 crisis developed in the US, and much of Europe. No financial institution in Asia, Africa, or Latin America went down, and certainly not in India,” he said.