In the wake of the collapse of Silicon Valley Bank (SVB) in the United States of America on March 10, 2023, the United States Federal Reserve (Fed), on April 28, 2023, released its report on the review of the bank’s supervision and regulation.
The report is highly relevant in the Indian context and should serve as a template for the Reserve Bank of India (RBI) and other Indian regulators in its objectivity, lucidity and self-critical analysis. The report not only reveals the unusual causes of SVB’s failure, which have been documented in the media, but, most importantly, repeatedly highlights the failure of the Fed in not taking action sooner. It is also noteworthy that the Fed published its report a mere 49 days after the collapse of SVB.
The abruptness of SVB’s collapse caught all stakeholders, including the regulator and the financial market, by surprise. This was on account of the concentration of uninsured deposits and the high composition of securities classified as held-to-maturity. In earlier bank collapses where credit risk is the major cause, the deterioration in loans normally takes a longer time to impact equity capital, but when interest rates rise sharply and banks have a disproportionate number of securities as compared with loans on their balance sheets, the impact on equity capital is more immediate. The problem in SVB got compounded by the social media and the high concentration of deposits amongst a select group of customers, who collectively decided to pull out their deposits, precipitating a run on the bank. This is a lesson for banking regulators and bank management. In future collapses, on account of the electronic round-the-clock transfer of funds and social media, the time frame to implement remedies is much shorter.
SVB Vs Peer Large Bank Organisations
In the case of Yes Bank, the UBS sell-side analyst had highlighted the bank’s high-risk loans in a report in July 2015, and this analyst had regularly highlighted mismanagement in the bank since May 2017; yet the RBI finally acted only in September 2018, when it declined to renew the three-year term of Rana Kapoor (the founder-CEO) from February 1, 2019. In both IL&FS and Yes Bank, the RBI, which had access to non-public information, allowed both institutions to continue to grow their assets (thereby exposing the financial system to more risk), even when there was public information available that the institutions were inadequately capitalised for their high-risk assets. The shock to the financial system of their collapse was immense, yet the RBI maintained a studious silence on its abysmally poor oversight of these institutions.
The RBI regulates the system with little accountability regarding its own shortcomings, and there is a lack of transparency on its own role when financial calamities take place. In the case of demonetisation and the failures of IL&FS and Yes Bank, there is ample evidence that the RBI’s conduct required considerable improvement.
Michael S. Barr, the Vice Chairman of Supervision of the US Fed., concludes the report stating,
This report is a self-assessment, a critical part of prudent risk management, and what we ask the banks we supervise to do when they have a weakness. It is essential for strengthening our own supervision and regulation. We welcome external reviews of SVB’s failure, as well as congressional oversight, and we intend to take these into account as we make changes to our framework of bank supervision and regulation to ensure that the banking system remains strong and resilient.
The RBI and other regulatory agencies in India would do well to pay heed to these words, as for long they have operated in a system and culture where they are unaccountable for any failures. It is through such candid, self-critical reviews that the regulatory systems are strengthened, contributing to financial stability.
The Wire.in published this article which can be read here
I, Hemindra Hazari, am a Securities and Exchange Board of India (SEBI) registered independent research analyst (Regd. No. INH000000594). I own equity shares in Yes Bank. Views expressed in this Insight accurately reflect my personal opinion about the referenced securities and issuers and/or other subject matter as appropriate. This Insight does not contain and is not based on any non-public, material information. To the best of my knowledge, the views expressed in this Insight comply with Indian law as well as applicable law in the country from which it is posted. I have not been commissioned to write this Insight or hold any specific opinion on the securities referenced therein. This Insight is for informational purposes only and is not intended to provide financial, investment or other professional advice. It should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security.