Lessons for the RBI from the US review of its 2023 bank failures

Unlike the US which has a fragmented regulatory system, the RBI pretty much regulates most of the banks and financial institutions in India.

In March 2023, the world financial markets were rocked by the failure of three US-based banks: Silicon Valley Bank, Signature Bank and Silvergate Bank. The 2023 bank failures evoked memories of the 2008 crisis when a spate of bank failures in the US led to the Global Financial Crisis. Some suggested that the crisis was similar to the 1980s when several savings and loan associations failed as interest rates rose sharply.

The 2023 crisis once again pointed fingers towards the regulators of the US banking system. Unlike most countries, the regulation and supervision of the US banking system are highly fragmented. In the US, a bank could be chartered either at a national level or at a state level. Accordingly, there are regulators at both the federal and state level. At the federal level, there are four regulators: Federal Reserve, Federal Deposit Insurance Corporation (FDIC), Office of Comptroller of Currency and National Credit Union Administration (NCUA). Banks can decide whether they wish to be a member of the Federal Reserve system, FDIC, OCC, etc and accordingly organise themselves.

To take our discussion forward, let us simply note that while the Silicon Valley Bank was registered with the Federal Reserve, the Signature Bank was registered with the FDIC.

Reports on Failed Banks

In response to the criticism of the 2023 banking crisis, the two regulators, the Federal Reserve and the FDIC decided to release detailed supervisory reports of the failed banks under their supervision. While the FDIC does release information about the failed banks, the Federal Reserve does not do so. In March 2023, Federal Reserve Vice Chair for Supervision Michael S Barr in a testimony noted, “Typically, the board does not disclose confidential supervisory information. We are sharing confidential supervisory information in the case of SVB because the bank went into resolution, and its disorderly failure posed systemic risk.”

Last week the Fed released its report on SVB while the FDIC released one on Signature Bank. The analysis of both reports is quite similar. The root cause of the failure of both banks was poor management. The management did not pay adequate attention to the risks from the high-growth strategy followed by the two banks. Both banks had high uninsured deposits and invested heavily in mortgage bonds. Once interest rates started rising in 2022, they should have acted and hedged the risks. But they did the opposite and reduced the interest rate hedges.

The regulators also failed to understand the vulnerabilities of the two banks. The regulators were impeded due to the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act in 2019. The Act raised the threshold for large banks from $50 billion of assets to $250 billion of assets. The stringent prudential regulations on liquidity and banking applied only to large banks. As the asset size of both SVB and Signature Bank was lower than the new thresholds, the regulators could not impose the prudential requirements.

Regulatory Failure

Despite the change in laws, the supervisors did identify the interest rate risk deficiencies from 2020 onwards. But they did not issue warnings and instead allowed the banks to accumulate risks. This is perhaps the most bizarre of all the findings. What is the purpose of supervision if the supervisor cannot caution against the rising risks and rectify the situation?

Both reports say that the regulators have learnt the lessons and will streamline their regulation and supervisory processes going forward. We will only know in the event of the next set of bank failures.

As one was reviewing these reviews, one could not help but draw lessons for India and the RBI too.

While we can criticise the US banking regulators for missing the banking bus quite regularly, there is some transparency and accountability in their policies. Even during the Global Financial Crisis, the US government instituted a Financial Crisis Inquiry Commission (FCIC) which analysed the crisis in detail. Apart from FCIC, the lawmakers constantly ask the regulators, the Federal Reserve and FDIC, to appear before several Senate Committees and explain the reasons for the crisis and their response to an unfolding crisis.

India’s Banking Crisis

India faced a major banking crisis from 2013 onwards where all kinds of banks and financial institutions – public sector banks, new and old private sector banks, cooperative banks, non-banking finance companies and housing finance companies – either failed or were in trouble.

Unlike the US which has a fragmented regulatory system, the RBI pretty much regulates most of the banks and financial institutions in India. Even the Deposit Insurance and General Insurance Corporation (DICGC) is a subsidiary of the RBI.  However, we do not see similar transparency from the central bank.

Take the case of the failure of Yes Bank. The RBI press release on the failure of Yes Bank was as pithy as it can get. The Banking Regulation Act (1949) requires the RBI to submit a ‘Report on Trend and Progress of Banking in India’ on an annual basis. In its 2019-20 report when Yes Bank failed, the RBI barely shared any details.  Additionally, the RBI on its own releases a biannual Financial Stability Report (FSR). The July 2020 FSR did not even mention Yes Bank and just called it ‘Contagion Losses due to Bank Failure - March 2020’. The DICGC’s annual reports have a list of banks that have failed and resolved but not a wider discussion on why the banks failed in the first place. Facts on bank failures are covered in detail in RBI history volumes but they come after a large lag.

We also do not see similar scrutiny by the lawmakers. In 2018, the Parliamentary Estimates Committee had asked former governor Raghuram Rajan to share his views on the crisis and non-performing assets (NPAs) in Indian banks. Ideally, governors and officials should be asked to testify during their tenure.

We might say that despite transparency and scrutiny, the US keeps failing to preserve the safety of its banks. But it is not as if secrecy or limited information has helped us do better in terms of banking regulation and supervision. More information leads to both criticism and lessons. The government and the RBI should learn these lessons and share more details on the failures of banks and other financial organisations.

Amol Agrawal is faculty at Ahmedabad University. Views are personal and do not represent the stand of this publication.