Why local banks are insulated from SVB ripples

Source: The post is based on the following articles

“Why local banks are insulated from SVB ripples” published in the Livemint on 14th March 2023.

“Bailout or not? – Ad hoc steps to stop banking contagion may have implications” published in the Business Standard on 14th March 2023.

Syllabus: GS – 3: Effects of liberalization on the economy.

Relevance: About SVB failure and its impact on India.

News: The fall of Silicon Valley Bank (SVB) has had effects around the world.

How did the Indian government respond to bank failures in the past?

The failure of Laxmi Bank and Palai Central Bank in 1960 prompted the government to introduce the Deposit Insurance Corporation (DIC) Bill in 1961 to protect depositors.

In 1968, the Act was amended to widen its ambit to cover cooperative banks.

Deposit insurance started with a sum of ₹1,500, way back in 1962. This was gradually increased to ₹100,000 in 1993 and most recently, to ₹500,000 in 2020. In dollar terms (as of end-December 2021), this comes to 3.01 times India’s per capita income. In the US, the deposit cover is 3.6 times of nation’s per capita income.

How did the US government respond to the SVB failure and other bank failures?

The US levying a new tax on the banking system to provide guarantees to depositors who were previously guaranteed. Using this, the US government would ensure the safety of depositors’ money. However, the equity holders in the bank will lose their shares.

The US Treasury Secretary has also said that no taxpayer funds will be used to bail out SVB. This means the bank and management will not be rescued.

What are the major questions associated with SVB Failure?

In 2018, SVB and other small banks were provided with exemptions from post-crisis banking regulations. To avoid the immediate problem of interest-rate risk, a new facility which lends against collateral valued at par has been introduced. This removed interest-rate risk from the equation for banks.

This new scheme raises the following concerns a) Covering all depositors on bank failure is not financially prudent, b) With rumours going viral in minutes on social media platforms, delinking interest-rate risk from the banks might create frequent bank runs.

Why India is less impacted by the SVB failure?

This is because of a) Tight regulation of banks in India by RBI, b) Indian banks largely do not fund startups and hence the impact on the startup world is manageable to a large extent, and c) In FY24, banks are at their best shape in decades. For instance, the recent RBI stress tests found that banks would be able to withstand severe stress. It found that even if customers withdraw 15% of uninsured deposits, liquid assets equivalent to 12.2% of total assets would be available.