This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.
The US banking crisis triggered by the collapse of Silicon Valley Bank (SVB) has its origins in the unprecedented monetary loosening by the Federal Reserve and other OECD central banks after the 2008 global financial meltdown, which intensified in 2020 after the COVID-19 outbreak.
The Fed’s balance sheet expanded from $800 billion to $4.5 trillion in the decade after the 2008 crisis. Post COVID, the Fed balance sheet expanded further from $4.5 trillion to $ 8.5 trillion. Have you ever wondered where this flood of freshly minted US dollars backed by the Federal Reserve might have gone? Large chunks, available at virtually zero interest, were going into financial assets like stocks, real estate, commodities and most importantly, safe US government securities of short and long tenures. It is well-known that large and mid-size US banks used the Fed’s big bailout in 2008 to buy US government securities, because the prospects of real lending for growth were always limited due to growth impulses generally weakening in the US and EU over the longer term.
This is also reflected in Silicon Valley Bank’s balance sheet profile. According to the Economist, “SVB’s deposits more than quadrupled – from $44 billion at the end of 2017 to $189 billion at the end of 2021 – while its loan book grew only from $23 billion to $66 billion.” Clearly, a very unusually large chunk (over $120 billion) of SVB deposits were invested in government securities.
So when the low interest rate cycle reversed dramatically over the last one year, with the Fed upping the benchmark rate from virtually zero to 5%, the banks found a gaping hole in their investment portfolio. The irony is they are suffering for investing in ‘safe’ government securities. A sudden rise in interest rates eroded the value of older US government securities on their books, which bore a very low interest coupon. When SVB found its balance sheet in tatters, it tried to repair the damage by raising additional capital. But the market had read the writing on the wall and there was a massive run on the bank, which ceased only after the Fed extended its guarantee to all depositors of SVB. Following SVB’s collapse, other mid-size banks in the US, like Signature and First Republic, also discovered big holes in their balance sheets. Big US banks like JP Morgan Chase, Morgan Stanley and others are proposing to infuse $30 billion to rescue First Republic Bank.
According to Forbes magazine, other banks worried about liquidity took out a combined $164.8 billion in loans from the Federal Reserve over the past week, topping a record set in 2008. The KBW stock index for US banks has fallen more than 25% in a week, which has happened only twice before in recent decades, after the 2008 global financial crisis and the COVID-19 outbreak. Today, the KBW bank index is where it was in March 1998! That’s how much US bank stocks have lost. No wonder bigger US banks are trying to rescue midsize banks to stop the contagion spreading!
Some macroeconomists say that the US Fed should not have reversed the benchmark interest rates so sharply, so soon, to attack high inflation. Many US analysts feel that the Fed may now go slow on its interest rate hike path. Next week, it will review monetary policy options.
In India, meanwhile, the business community is suggesting the RBI should go slow on hiking benchmark rates. So far, the banking crises in the US have had limited impact here. According to tech entrepreneur Sanjeev Bhikchandani, only about 14% of India-based VC funds had any deposits in SVB.
But bank stocks in India also saw downward pressure last week, on account of sentiment. If the US slows its interest rate hikes, there might be some breathing space for the financial system at large, which had gotten too complacent over a decade and a half with interest rates near zero.
But the deeper malaise represented by the multiple asset bubbles created over nearly 20 years with ultra-cheap money flowing from the US central bank will come back to haunt us from time to time. It is nearly impossible to predict which asset bubble will be pricked. Today, US government securities in bank balance sheets are falling. Tomorrow, it could be commodities, stocks or real estate, which are always vulnerable.
India was relatively insulated in 2008 but it did not escape the global fallout that followed. Any big crisis in the west is bound to reach India via a general decline in growth impulses. Remember the banking sector crisis after 2010 was caused partly by the excessive investment optimism of corporates, who assumed GDP growth over 8%. That never materialised, resulting in the well-documented “twin balance sheet” ( banks and corporates) problem. Socialisation of losses is a reflexive tendency seen during such periods of crises, whether in the developed or developing world. This, of course, continues unabated.
M.K. Venu is a founding editor of the The Wire.
