The recent global banking debacles have highlighted the robustness of India’s Rs 216-lakh crore banking industry. But there are important lessons there for India’s banking sector as well. The crisis has brought to the fore factors such as portfolio concentration, liquidity risk, the superiority of equity over additional tier-1 (AT1) bonds—a kind of debt issued by a bank that can be converted into equity if its capital levels fall below requirements—as well as market risks.
The emergency credit lines opened by regulators also raise questions about the role of governments and regulators in rescuing stressed banks. “Every crisis gives us a new regulatory blueprint,” says a private sector banker who wishes to remain anonymous. Banks have a lot to deal with—from risk management to credit to liquidity to market risks by moderating the expectations of equity shareholders. “They [banks] should address portfolio diversification, growth in the intrinsic net worth of their assets, quality of credit, market risk in terms of measurement of assets’ sensitivity to interest rate movements and funding risks, especially depositors leaving as quickly or quicker than when they came in,” says Monish G. Chatrath, Managing Partner of MGC Global, a risk advisory firm.
Let’s talk about fault lines. If the 2008 financial crisis highlighted the concept of ‘too big to fail’ entities, the run on Silicon Valley Bank (SVB) has shown that even a relatively smaller bank going belly up has the potential to massively impact the banking sector and the economy. What could be the equivalent of an SVB in India? Small finance banks (SFBs), for one. SFBs serve risky poor borrowers who don’t have much credit history. Like SVB that catered to start-ups and venture capitalists, SFBs have a chunk of their credit locked up in unsecured loans. SFBs also enjoy a net interest margin of close to 7 per cent as opposed to the 2.5–3.5 per cent enjoyed by commercial banks. In fact, public deposits are also shifting to these riskier assets as they offer higher savings and fixed deposit rates. In an economic slowdown, SFBs’ customers are usually more impacted than the salaried class. This was evident after Covid-19, when SFBs’ gross non-performing assets (NPA) jumped to around 5 per cent. “It could have been better if universal banks held stakes in SFBs and payments banks to make them resilient,” says Moses Harding John, President & CEO of IndusInd International Holdings, the promoter company of IndusInd Bank.
There are also conflicting signals on the treatment of AT1 bonds that are used by banks to raise capital. Usually perpetual, these bonds offer higher returns compared to other bonds. Three years ago, the RBI stunned the markets by writing down Rs 8,400 crore worth of AT1 bonds to zero (but not the equity) as part of the restructuring of YES Bank. Now, the Swiss Financial Market Supervisory Authority has followed the RBI’s template to rescue Credit Suisse, by writing down its entire AT1 bonds worth $17.3 billion. The Monetary Authority of Singapore, however, has taken an opposite view. “Equity holders will absorb losses before holders of AT1,” it has said. A consultant, who declined to be named, says, “Our banks are much more in need of such bonds than global banks, where corporates have access to the debt markets to raise funds.” S&P Global Ratings said recently that the decision to write off Credit Suisse’s AT1 bonds may contribute to higher cost of capital for banks. “It could further accentuate a state of reluctance and inadequate levels of confidence of investors,” says MGC’s Chatrath.
A banking crisis such as the current one also raises financial stability concerns in the non-bank sector, which is largely funded by banks. Some NBFCs may be vulnerable to liquidity shocks, according to stress tests in the RBI’s financial stability report released in December 2022. India’s NBFC sector has weathered some heavy storms like the collapses of infrastructure financing institution IL&FS, housing major DHFL, Anil Ambani’s Reliance Capital and Kolkata-based SREI Infrastructure. The entire outstanding loan portfolio of NBFCs is currently around Rs 38.40 lakh crore in terms of assets, which is 18 per cent of the entire banking system. According to the RBI, the gross NPAs of NBFCs eased from a peak of 7.2 per cent recorded during the second wave of the pandemic to 5.9 per cent in September 2022, which is close to pre-pandemic levels.
Clearly, there are longer-term risks that could threaten the stability of the banking sector. Chief Economic Advisor V. Anantha Nageswaran recently said that the impact of the current global financial crisis will be ‘low or negligible’ for India. The RBI Governor, Shaktikanta Das, has also talked about the importance of ensuring prudent asset liability management, robust risk management and sustainable growth in liabilities and assets, undertaking periodic stress tests and building up capital buffers for any unanticipated future stress.
Amidst the present crisis, it is also critical to address cyber risk and its impact on financial stability. A recent paper by the Bank for International Settlements —an international financial institution owned by central banks—has highlighted phishing and social engineering as the most common forms of cyberattacks related to central banks. “The growing adoption of cloud-based services as well as the shift to remote work have key implications for cybersecurity strategies,” it warns. That’s a big known unknown banks need to be wary of.
@anandadhikari