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By Sanjay Sinha The tremors preceding the financial crisis in 2008 look similar to that in 2023 – run on deposits leading to banks’ failure (2008- IndyMac Bank, Washington Mutual Bank; 2023- Silicon Valley Bank, Signature Bank); government administered bank’s buy out in Europe (2008- HBOS Plc By Lloyds TSB; 2023 – Credit Suisse by UBS), banks’ shares plunging by 20-25% within a week.What followed we all know.massive bailouts by governments and a global economic recession.The problem in 2008, however, was essentially a credit risk crisis, caused by excessive lending (mortgages) by the US banks at low interest rates to unqualified borrowers creating a housing bubble.The shadow banks also joined in the credit creation binge by simultaneously buying and selling these loans as mortgage-backed securities (MBS).The bubble burst and the banks around the world found themselves exposed to sour investments that were difficult to value.This time, it is more of banks’ balance sheet crisis caused by duration risk (bond’s price sensitivity to interest rate changes) and liquidity risk (asset liability mismatches).The assets (US Treasuries and bonds) that are causing trouble for banks are easy to value and sell, and most analysts thus believe the impact of the current troubles may not be contagious like 2008.

Turmoil in the US Silicon Valley Bank (SVB) problems could be linked to its investment policy, believing that the Federal Reserve (Fed) easy money policy (near zero interest rates) would go on forever.The bank accepted billions in demand deposits, largely uninsured, and put them into US government bonds for their hold-to-maturity (HTM) portfolio.What seemed like a safe bet became a trap when the Fed started hiking interest rates aggressively from June 2022 to tame inflation.

Bonds prices being inversely related to interest rates, banks holding government bonds found their value depleting and exposed to losses.Federal Deposit Insurance Corporation (FDIC) has estimated America’s banks unrealised losses in bonds at $620 billion as at the end of 2022.Also Read: Which Govt investment scheme should you opt for your kids? The higher interest rate scenario also affected SVB’s clients, predominantly Venture Capital, who delayed their funding rounds and decided to burn their cash by drawing down their cash balances.As a result, SVB’s deposits started to fall towards the end of 2022.

Further, SVB’s profitability was also getting a knock-on effect of the prevailing higher interest rate due to the short -term rates (banks use for borrowing) becoming higher than longer-term rates (banks use for lending).SVB sold a bunch of securities at a loss to help pay customers’ deposit withdrawals and announced on 8 March 2023 to raise $2.25 billion in capital to plug the hole.

Their uninsured depositors got panicked and began withdrawing their money fearing they would hardly get their money back in the event of SVB going under.SVB had uninsured deposits of $151.5 billion as at the end of 2022.

FDIC would safeguard deposits up to $250,000 per depositor, per FDIC- insured bank.This triggered the run on SVB and its stock plummeted 60%, dragging shares of other banks down with it and stoking the fear of a repeat of 2008 global financial crisis.

Signature Bank (SB) also had high amount ($80 billion) of uninsured deposits constituting 90% of its total deposits.It was also overexposed to crypto currency sector.Besides being a big lender, it was providing a 24/7 payment network for crypto clients contributing 25% to its deposits.With the fall in the value of crypto currencies, there were reports that SEC and other US federal regulators were investigating SB’s crypto currency business, particularly potential money laundering by clients.

SB announced in December 2022 that it would reduce deposits from the crypto sector by $8 -$10 billion and reportedly shed $1.2 billion in the first two months of 2023.It was, however, not enough to soothe its depositors’ concerns as by the time the exodus of depositors from banks having crypto and tech ties already started.This also worried SB’s uninsured depositors from other sectors and they started withdrawing fearing their money would be gone forever if the bank collapsed.The sudden implosion of SVB on 9 March 2023 made the matter worse for SB, as it struggled to meet its customers’ withdrawal requests.

Like SVB, SB was also shut down by the federal regulators and placed under the receivership of FDIC.Moody’s in its report (March 14, 2023) says that America’s banking system is generally healthy.It has enough cash and liquid assets to withstand an economic downturn.However, it expects pressure on the banking sector to persist as the Fed continues to hike interest rates to combat inflation.Banking blow-up in Europe Credit Suisse (CS), the second largest in Switzerland and a Global Systemically Important Bank (G-SIB), had problems entirely of its own.Ranging from missteps with regard to its risk management practices and compliance failures going back years, the improprieties it was caught up in, including money laundering, dented its reputation.CS reported a heavy loss in 2022 ($7.9 billion)—worst annual performance since the global financial crisis—and delayed publication of 2022 financial results following questions by the Securities and Exchange Commission (SEC) on 8 March 2023 over the revisions previously made to its cash-flow statements for 2019 and 2020.

A week later, CS acknowledged “material weakness” in its financial reporting and scrapped bonuses for top executives.The refusal by Saudi National Bank (biggest shareholder with 9.8% stake) on 15 March to pump in extra capital, citing regulatory and statutory reasons, shocked CS, its investors and depositors.The $54 billion emergency lifeline from the Swiss National Bank (Central Bank) on 16 March 2023 failed to convince investors, who continued dumping its shares; and its customers, who began shifting their funds to other banks.To contain the spill over to the European banking sector, the SWISS government and regulators arranged CS buy out by rival UBS for $3.25 billion, less than half its market value, and in the process completely writing down $17 billion worth of additional tier one (AT1) bonds.One might have thought that this emergency takeover would cause some relief to the European banking sector as this would resolve the uncertainty.

Unfortunately, this did not look like happening.The market was interpreting even positive signals differently.Deutsche Bank (DB), another G-SIB, announced on 24 March that it would pay back its $1.5 billion Subordinated Tier 2 bonds five years ahead of its maturity date.This was taken as DB getting under the impact of rising interest rates on its balance sheet and it was trying to overcompensate its creditors.

Resultantly, DB’s five -year credit default swaps (CDS) zoomed up to 208 bps (highest since early 2019) prompting German Chancellor “It is a very profitable bank”, and there is “no reason to be concerned” about DB.Incidentally, DB reported profits of $5.5 billion in 2022, highest in 15 years.Common factor The US and European banks feeling the heat have faced different challenges.But there is a common factor affecting them and the banking sector more broadly, sharply rising interest rates, following a decade or more of low or even negative rates.

The banks taking excessive duration and liquidity risks are most exposed, with the markets remaining on edge, and depositors and investors nervous.However, the Central Banks in these geographies do not think the failures threaten widespread financial stability and this would distract them in their efforts to bring inflation under control.Contagion risk to Indian Banking Sector RBI’s Financial Stability Report (FSR), December 2022, underlines the improved asset quality, return to profitability, strong capital and liquidity buffers of scheduled commercial banks (SCBs).The stress tests in FSR reveal that SCBs are capable of absorbing shocks under adverse scenarios.SBI’s economic research report “Ecowrap” (19 March 2023) emphasises Indian banks have least foreign claims as compared with other major G-20 countries, limiting the country’s exposure to the global uncertainties.The S&P Global Rating report (21 March 2023) highlights strong funding profiles, high saving rate and government support as among the factors that underscore Indian banks’ strength to endure any potential contagion effects emanating from the crisis.Thus, the Indian banking sector is in a relatively better position to withstand any potential financial shocks amid the stress in the banking sector in the US and Europe.Conclusion Henry Ford once remarked: “It is well enough that people do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” The world of banking is still extremely complicated.

It can be difficult to find new fragilities lurking under the system until these come to the fore like what happened in 2008 or the recent turmoil.One thing stands out that payment treatment of AT1 bonds, created in the wake of 2008 financial crisis, as capital instruments to absorb losses, requires a relook by the regulators in a non-bankruptcy situation.The holders of CS AT1 bonds have lost out completely unlike its shareholders, a situation similar to that of Yes Bank, where bondholders lost Rs 8,415 crore and sought legal recourse; the matter is sub-judice.Further, the regulators/banks will also need to examine the extent of flexibility to be allowed on premature payment of interest bearing deposits.SBI has just introduced a two-year non-callable fixed deposit.Fear around the health of banks is often contagious.If depositors start to worry about their deposits, they can move them at the click of a mouse, leading to runs on banks, affecting thefinancial stability.(The author is Independent Director, Beacon Trusteeship Ltd.

Views are personal.).