Credit Suisse Collapse: An RBI lesson for European central banks

Why in News?

• Recently, Credit Suisse, Switzerland’s second largest bank, was sold to state-backed Union Bank of Switzerland (UBS), which is Switzerland’s largest bank and a long-time rival.
• The article put emphasis for European central banks to draw a lesson from India in terms of coordinating monetary and fiscal policy.
• A decade and a half after the global financial crisis 2008, Indian banks, backed by sound regulatory practices, have remained unaffected by recent bank failures in the US, showing strength and resilience in a financially interconnected world.

 

What is Credit Suisse-UBS Deal?

• UBS agreed to buy rival bank Credit Suisse for 3 billion Swiss francs ($3.23 billion) and assume up to $5.4 billion in losses, in a merger engineered by Swiss authorities.
• Under the deal, 16 billion Swiss francs ($17 billion) of Credit Suisse’s Additional Tier 1 debt (used for bolstering the bank’s capital) will be written down to zero on the orders of the Swiss regulator.
• The move came to not just contain the crisis of confidence in Credit Suisse, but also to stop the contagion to other banks.
• This collapse for the 166-year-old and one of the world’s 30 systemically important bank is even more concerning as it is the third major bank that has collapsed in past 10 days after the Silicon Valley Bank (SVB) and Signature Bank.
  • Credit Suisse bank suffered a revolving door of senior management, with each leadership change putting more pressure on performance to generate returns.

 

A Flurry of Banking Collapses

• Recently, SVB, U.S. 16th-largest bank, collapsed after just a single day of stress following a bank run in which depositors demanded $42 billion in one go.
  • This was the second-biggest collapse after the iconic Lehman Brothers crises of 2008.
• Following this, another bank called Signature Bank had to be seized after depositors demanded 20% of all its deposits.
  • This made Signature Bank the third largest bank to collapse in the US.
• This led to the share prices of First Republic Bank (FRB) nosediving within hours until when 12 big U.S. banks like JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs Group etc., came in to rescue it with $30 billion.
• However, this borrowing by the FRB for a very short period of 90 days to prevent fleeing depositors appears short-sighted compared to similar packages in India in 2008 and 2020 by the RBI when a consortium of banks hand-held ailing banks for multi-year periods.

 

The Emergency Arrangement

• Following the sale of Credit Suisse, key central banks like Bank of Canada, England, Japan, the European Central Bank, Federal Reserve, announced a coordinated action to enhance the provision of liquidity via the standing S. dollar liquidity swap line arrangements.
• This emergency arrangement aimed to calm down the jittery consumers and also bolster the confidence of nervous policymakers and bankers.

 

What are the likely effects of Credit Suisse Collapse?

• The wipeout of the entire portfolio of contingent convertible/AT1 bonds will erode confidence for new issuers, and raise the risk premium disproportionately in the $250 billion bond market.
• The high level of CDS (credit default swap) of Credit Suisse for protection against near-term default, may result in rating changes for financial markets and even sovereign banks.
• The demands for payment from diverse protection buyers can be daunting for UBS and the entire banking system wanting refuge in the crises.
• It also casts a shadow over the credibility of these central banks, their ability to provide regulatory forbearance, steer markets through turmoil and ensure well-orchestrated, coordinated monetary and fiscal policies.
• These sudden bank runs and collapses point to the possibility of people losing confidence in the banking and financial system which may take much longer to reestablish.
• The bank will have to grapple with a tougher business environment in a world of higher interest rates and depositors suddenly aware of the pitfalls of large uninsured balances.

 

Learnings from India’s Robust Fiscal Policy

• The following findings signal that India’s banking and financial system is very disciplined, and that no fear of an international balance sheet contagion can originate from here.
• The upward revision in the deposit insurance limit by the Indian government in 2020 needs to be seen in comparison to the U.S.
• For example, as per independent research estimates, smaller bank deposits in the U.S. are insured in the range of 30-45 per cent only.
• In contrast, smaller bank deposits in India such as regional rural banks, cooperative banks and local area banks are better protected at 82.9 per cent, 66.5 per cent, and 76.4 per cent respectively.
  • Also, while public sector banks, which have a large proportion of customers from rural, urban and semi-urban areas have better customer deposits protection in comparison to private banks.
• Further, India’s deposit insurance coverage to per capita income ratio at 2.53 is one of the highest across the world.
  • Brazil, which has the highest insurance coverage ratio, has a far more expansive definition, which raises questions of serviceability if any crises arise there.
• Indian banks are also in sound financial health as compared to other major countries, it has the least foreign claims, both on counterparty basis, and on a guarantor basis.
• Additionally, India’s ratio of foreign claims to domestic claims is also the least among countries.

 

Why SVB-like Failure is Unlikely in India?

• The domestic banks in India have a different balance sheet structure, and depositors cannot withdraw their deposits in such bulk quantities.
• The household savings constitute a major part of bank deposits in India unlike the US, where a large portion of bank deposits are from corporates.
• Also, a large chunk of Indian deposits is with public sector banks, and most of the rest is with very strong private sector lenders such as HDFC Bank, ICICI Bank, and Axis Bank.
• In India, the approach of the regulator has generally been that depositors’ money should be protected at any cost. The best example is the rescue of Yes Bank where a lot of liquidity support was provided.
• The RBI has also put domestic systemically important banks (D-SIBs) classification to assess risks in the banking sector.
  • The banks are selected for computation of systemic importance based on an analysis of their size (based on Basel-III Leverage Ratio) as a percentage of GDP.
  • Banks having a size beyond 2% of GDP will be selected as ‘Too-Big-To-Fail’ banks (TBTF)’ and these banks need to earmark additional capital and provisions to safeguard their operations.
  • Thus, RBI has classified SBI, ICICI Bank, and HDFC Bank as D-SIBs.

 

Way Forward

• While India may appear relatively insulated from these events, the channels through which such a crisis can permeate into the domestic financial system and the broader economy need to be carefully monitored.
• As policy makers across the world navigate this tumultuous period, the policy framework must be guided by the objective of maintaining macroeconomic stability.
• The regulators need to plan their moves with clarity, in consultation with broader market participants to continue to remain in the driving seat.

 

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Q1) What are global systemically important banks (G-SIBs)? 

Ans)G-SIBs are banks whose systemic risk profile is so important that the bank’s failure would trigger a wider financial crisis and threaten the global economy. 

 

Q2) What is credit default swap (CDS)? 

Ans) It  is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor.

 

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Source: The Indian Express