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Home  » Business » Banks Fallout: Time For RBI To Be Alert

Banks Fallout: Time For RBI To Be Alert

By T N Ninan
March 31, 2023 10:24 IST
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The broader economy risks a potential flight of foreign portfolio capital, therefore pressure on the rupee and more bad news on the stock market, warns T N Ninan.

IMAGE: The Credit Suisse building in Hong Kong, March 21, 2023. Photograph: Lam Yik/Reuters

Financial crises follow faithfully Ogden Nash's description of ketchup coming out of a bottle: 'First a little, then a lottle.'

Consider the financial collapse of 2008.

The action actually began two years earlier, when house prices in the US began to fall.

In early 2007, some of those who had lent for sub-prime housing began to file for bankruptcy.

In June that year, two big hedge funds failed on account of their exposure to the sub-prime market.

These were the early tremors. Then came the earthquake.

In January 2008, Countrywide (the biggest issuer of sub-prime securities) avoided bankruptcy only by being taken over by Bank of America.

Two months later, the investment bank Bear Stearns teetered on the edge of bankruptcy and was gobbled up for a song by JP Morgan Chase.

In September finally came the Lehman moment when the entire western financial system came close to collapse.

It had taken two years from start to finish.

 

In every systemic crisis, whether on the scale of 2008 or smaller (like the 'Tequila crisis', which started in Mexico and swept through Latin America in the early 1980s), there are the initial soothing noises from regulators and commentators: There won't be contagion.

This or that company or country is safe or immune. Except that eventually there is contagion more often than not.

In the initial phase of the Asian financial crisis of 1997-1998, for instance, Thailand and Malaysia went into convulsions, but Indonesia was said to be safe because it had low inflation, a trade surplus, and lots of dollar reserves.

In the end, though, Southeast Asia's biggest economy was the worst hit as the rupiah crashed from 2,400 to the dollar in June 1997 to 14,900 a year later -- a drop to one-sixth of its earlier value.

There were ethnic riots in the streets and the government fell.

What is happening in the US just now is playing true to Nash's description of ketchup.

It began slowly, with the central bank jacking up interest rates to battle inflation -- itself the result of extremely lax monetary policy earlier to help the economy battle the Covid fallout.

Lenders initially papered over their losses on the securities they held (the prices of existing bonds fall when interest rates climb).

Now, as in 2007, the weakest links in the chain have snapped: Silvergate, Silicon Valley Bank, and Signature, all three in little over a week.

Yet there are the inevitable soothing noises about contagion.

But another bank failure has just been averted by the big boys stepping in to provide liquidity to First Republic, and the Swiss authorities are trying to bail out scandal-ridden Credit Suisse, even as other regional banks in the US see their share prices nosedive.

Depositors have rushed to withdraw their money.

If, like Silicon Valley Bank, any bank is forced to meet depositor demands by selling securities held at cost price, they will have to book losses on sales done at the prevailing lower prices -- and also book similar losses on all securities so far held at cost price.

That could lead to a large-scale wiping out of bank capital.

As Robert Armstrong wrote in the Financial Times, 'We are in a general, if so far mild, banking panic...; More weird things seem likely to happen.'

The tremors so far may not lead to an earthquake -- if, say, Credit Suisse avoids a messy bankruptcy.

Besides, the Reserve Bank of India has been conservative and requires more than three-quarters of bank-held securities be marked to market.

That means losses get booked, not hidden, thereby avoiding a sudden wiping out of capital.

But the broader economy risks a potential flight of foreign portfolio capital, therefore pressure on the rupee and more bad news on the stock market.

A lower rupee would raise risks for companies with unhedged foreign borrowings.

The RBI may be forced therefore to shore up the currency by selling dollars from its reserves, and avoid further rate hikes.

We may end up with smaller reserves, higher inflation, and lower share prices.

Beyond that, India seems safe. But remember Indonesia and stay alert.

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T N Ninan
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