Experts pointed out that the decline in lenders’ share prices was a knee-jerk reaction and the SVB issue has no impact on Indian banks due to the stability of the financial sector.
“When America sneezes, the world catches a cold.”
This saying is true again and again, especially in the financial markets. As US markets fell overnight on March 9, led by a 60 percent drop in shares of tech-focused lender Silicon Valley Bank, the Indian market felt the heat on March 10.
An unexpected $1.8 billion loss on SVB’s sale of $21 billion in bonds highlighted the dangers of rising interest rates. This gloomy sentiment and investors fearing the worst has led to a dramatic fall in bank stocks not only in the US but also across Europe and Asia. Indian banks weren’t spared either, with the Nifty Bank falling nearly 2 percent.
Experts were quick to point out that the decline in lenders’ share prices was a knee-jerk reaction and the issue at SVB does not concern Indian banks due to the stability of the financial sector.
Of course, the Reserve Bank of India, like central banks around the world, has been raising interest rates, reversing the loose liquidity and interest rate cycle that began to keep financial markets afloat during the pandemic.
Accident waiting to happen
In a March 10 tweet, billionaire banker and head of Kotak Mahindra Bank Uday Kotak said an accident was imminent, which was taken as an indication of the SVB issue.
“Overnight developments in US banking: Markets, analysts, investors underestimate the importance of financial stability on a bank’s balance sheet. If interest rates rise 500 basis points from zero in a year, an accident was waiting to happen somewhere,” he wrote on the microblogging site.
The US Federal Reserve has hiked interest rates by 450 basis points since March 2022. Earlier this week, Federal Reserve Chair Jerome Powell said the Fed stands ready to make big rate hikes at a meeting later this month if data suggests more action is needed to tame inflation. This led economists to use a final interest rate of 5.50 to 5.75 percent, compared to 5 percent previously.
In comparison, the RBI is expected to hike rates by 25 basis points in April. Since May, the Indian central bank has hiked the repo rate by 250 basis points.
While the RBI provided much-needed stimulus to the economy during the pandemic by keeping interest rates low and providing liquidity to productive sectors, all actions have been well-targeted and time-bound. Almost all have been gradually scaled back without affecting the functioning of the market, analysts said.
Now, rising interest rates are a major detriment for banks as they erode the value of their bond portfolios. In the case of large mark-to-market losses, this led to capital depletion and losses. This is exactly what happened at SVB. The Santa Clara, California-based bank unveiled a plan to sell $2.25 billion worth of stock to shore up its balance sheet, but investors feared a potential liquidity problem at the bank.
Banks in India also invest part of their deposits in bonds, mainly government bonds. Such investments are made in part to meet the statutory liquidity ratio. During periods of slower loan growth and higher deposit growth, banks keep SLRs higher than regulatory requirements. The situation has reversed in recent months. So the SLR surplus has declined to some extent as credit growth has remained strong and deposit mobilization has been challenging.
In addition, RBI has extended the exemption for extended held-to-maturity portfolios until March 2023. Bonds in this portfolio are isolated from daily yield movements and banks do not have to take precautions in the event of a mark-to-market valuation or MTM losses.
Low probability of failure
“Yields have risen since the RBI started raising rates. But longer-dated bonds have not risen to the extent that it will result in large MTM losses. The 10-year yield rose above the psychologically important 7.50 percent mark in June, but fell and failed to break through again. Short-term interest rates have risen sharply, but these are manageable,” said Venkatakrishnan Srinivasan, founder of debt advisory firm Rockfort Fincap.
The benchmark 10-year government bond yield, which is the barometer for the Indian bond market, ended March 10 at 7.43 percent.
Traders said banks’ corporate bond holdings are not large and the likelihood of a loan default is low as companies have been paying down expensive debt during the pandemic. At the same time, banks’ asset quality has improved as bad loans (gross) have fallen, while both reserve coverage and capital buffers have increased.
RBI Governor Shaktikanta Das said in his foreword to the central bank’s Financial Stability Report, released in December, that the banking system is sound and well capitalized.
“The stress test results presented in this edition of the FSR demonstrate that banks would be able to withstand even severe stress situations should they materialize. Furthermore, despite the formidable global headwinds, India’s overseas accounts remain well cushioned and viable,” he said.
According to RBI’s macro stress test, banks would be able to meet minimum capital requirements even under severe stress scenarios. The system-level capital to risk-weighted assets (CRAR) ratio is projected to be 14.9 percent, 14.0 percent and 13.1 percent, respectively, in September 2023 under baseline, medium and severe stress scenarios.
Alekh Angre is a Mumbai-based journalist with 12 years’ experience covering the Indian banking and financial services sector, bond market and Reserve Bank of India, including monetary policy. Views are personal and do not represent the status of this publication.
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