We are all aware that the easing of credit by the US and European central banks and the sharp cuts in interest rates during the Covid-19 pandemic have led to the inflationary demon reviving. Inflation concerns prompted US and European central bankers to suddenly change their positions and withdraw liquidity from financial markets, accompanied by increases in bank interest rates.
The above had an impact on asset/liability mismatches where financial instruments held by different banks were valued at cost rather than at market rates. When large depositors (corporations and wealthy individuals) became aware that regional banks were under pressure, they withdrew significant amounts of money and transferred the money to safer banks. This resulted in the regional banks having to liquidate their holdings of bond instruments at significant losses, putting the regional bank under liquidity and survivability pressures. A domino effect emerges when one bank’s “failure” impacts the other regional banks – all battling the same contagion.
This is similar to the original UTI institution’s US-64 scheme. This program had declared value for the month, but large companies holding US-64 stock felt something gave off a dirty odor and declined the program in order to seek a payback. UTI was unable to survive this mass redemption and completely closed the program’s redemption window, severely impacting many small US-64 holders.
The problem with bank failures is that the whirlpool effect affects the entire economy. When banking is perceived as unstable, there is a loss of confidence that accompanies the withdrawal of funds from such banks, adding further pressure. All countries have some form of insurance coverage for depositors – how much that helps is the question that needs to be answered.
It is immediately considered whether the quality of the bank’s audit carried out by the auditor met the desired standards. While there is no reason not to thoroughly review the review process and procedures in place, the problems in the US and Europe appear to lie in a sudden change in monetary policy course, leading to time-based mismatches between assets and liabilities. Whether regulatory oversight in these countries has been lax is a question that needs to be examined and answered.
We need to see the case of India, where regulatory oversight of credit unions was multi-agency. Only when RBI was appointed supervisor are cooperative banks regularly asked to shut down their operations.
The fact remains that banking health and wellbeing is a good measure of the health and wellbeing of the economy. Each influences the other positively or negatively. Both need constant unsupervised tracking for signs of risk – because of the contagiousness.
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The views expressed above are the author’s own.
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