The collapse of two American banks — Silicon Valley Bank (SVB) and Signature Bank — highlights the danger of depending solely on market forces to run financial institutions. The villain of the piece is the sudden increase in the interest rates, which made less valuable the mortgage securities in the banks’ possession. And when there is a sudden demand for withdrawal of money, the banks are unable to honour their promises resulting in their collapse.
The SVB was known as the bank of the startups, where many tech companies, including those run by Indians, had invested heavily. What facilitated the collapse was the Trump law, enacted in 2018, under which banks with less than $250 billion assets were exempted from the severe operational conditions the banks had to follow. They no longer had to undergo periodic “stress tests” to ensure that they were properly insulated against conditions of collapse.
They were also exempted from the Basel convention concerning capital risk, market risk, and operational risk. Of course, they enjoyed the laissez-faire situation as underscored by the phenomenal growth achieved by the SVB. Started in 1983, it became the 16th largest bank in the US. The American system is in sharp contrast to the Indian system where the banking rules are the same for a mega bank like the State Bank of India or a small bank like the RBL Bank. The customers of these banks enjoy the same protection with regard to their deposits, subject of course to certain conditions. Also, the government is the great guarantor for all the banks that function within the purview of the Reserve Bank. In short, the Indian banking system is built on a safer and stronger foundation than in the US, considered the Mecca of capitalism.
Few fear that the collapse would have a cascading effect on the entire banking sector in the US, as the big banks have been following the Federal Reserve norms. It is not that all the depositors in the two banks would lose all their deposits as the insurance system under which investments up to $2.5 lakh are insured will come into play. Those to whom the banks owe more will have to wait for the liquidation process to be over. The incident is a reminder that it is better to be slow and steady as in India than to be quick and rushing as in the US.
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