The global financial landscape is deeply interconnected, and the consensus is that the stability of the American banking industry plays a crucial role in the global financial market. But is it true in case of financial well-being of India? In this article, we delve into the potential consequences of a failing American banking industry on India, examining the various channels through which the effects may be transmitted.
Over the past century, there have been numerous economic crises that have impacted countries all over the world. While the causes of these crises are varied and complex, it is interesting to note that the last four major economic crises have all been triggered by events that originated in the United States.
The first of these crises was the Great Depression, which began with the stock market crash of 1929. While there were many factors that contributed to the Great Depression, including overproduction and a decrease in consumer spending, the stock market crash was the immediate trigger that led to widespread bank failures and a significant decrease in economic activity.
The second major crisis was the oil crisis of the 1970s, which was triggered by a combination of events including the Arab-Israeli War and the decision by the Organization of the Petroleum Exporting Countries (OPEC) to restrict oil production. This led to a significant increase in oil prices, which in turn led to inflation and a decrease in economic growth.
The third crisis was the dot-com bubble of the late 1990s and early 2000s. This crisis was caused by a speculative bubble in the technology sector, which was fueled by easy access to capital and a belief that the internet would change the world. When the bubble burst, it led to a significant decrease in stock prices and a number of high-profile bankruptcies.
The most recent crisis was the 2008 global financial crisis, which was triggered by a number of factors including the subprime mortgage crisis, the failure of major financial institutions, and a decrease in consumer spending. This crisis had far-reaching effects and led to a significant decrease in economic activity around the world.
Banks can face financial difficulties for a variety of reasons, such as poor risk management practices, exposure to volatile markets or industries, and a high level of bad debt. It is important to note that First Republic Bank and Signature Bank have faced financial difficulties in the past whereas Silvergate Bank and Silicon Valley Bank collapsed recently. And there has been enough discussion on what led to it.
In case of First Republic Bank, it faced difficulties in the past due to concerns about its mortgage lending practices, which led to its acquisition by Merrill Lynch in 2007 – however eventually bought back by its founders in 2010, whereas Signature Bank faced difficulties after the 2008 financial crisis due to its heavy exposure to the real estate market.
On the other hand, the recent incident of Silicon Valley Bank (SVB) is something new to its management as well as a lesson for others as well. Most of the people have not experienced an interest rate scenario as high as 5% in the US in the last two decades. A poor forecasting of interest rates and poor risk management practice triggered the collapse of SVB overnight.
Apart from the American banks, we are witnessing a contagion effect of post-covid financial crisis across the globe. Credit Suisseis currently facing a crisis due to its involvement in the collapse of Archegos Capital Management, a hedge fund that had borrowed heavily from several banks whereas Deutsche Bank is in the news and currently facing a crisis due to a combination of financial and legal issues. Additionally, the bank has been the subject of multiple investigations and lawsuits related to money laundering, market manipulation, and other financial crimes.
It just emphasizes the importance for banks to have well-experienced management, sound risk management practices and to diversify their portfolios to reduce the impact of any kind of adverse situation. We have always emphasized on Diversification and Asset allocation. Banks that can maintain strong financials and manage risks effectively are more likely to weather economic downturns and remain stable over the long-term.
As the largest economy in the world, the United States has a significant influence on global finance. The consensus is that the failure of the American banking industry could lead to the collapse of several Indian banks that have business relationships with American banks. However, it is unlikely as the Indian banks have a low exposure to the American banks.
Furthermore, Indian banking system has become robust overtime due to the regulatory frameworks and constant oversight by the RBI. Risk management measures such as Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR) play crucial role during a liquidity crunch situation like Silicon Valley Bank.
Over the years, cleaning up of the balance sheet, timely recognition of bad debt and the Insolvency & Bankruptcy Code have helped banks to drastically reduce the risk of potential bad debts / frauds and as a result Indian banks have gained more faith amongst depositors and investors.
The American banking industry's failure will lead to a widespread panic and turmoil in global financial markets. As foreign institutional investors (FIIs) play a significant role in the Indian equity market, a sell-off by these investors could trigger a sharp decline in Indian equities.
While the Sovereign wealth funds and pension funds are relatively sticky among other FIIs, ETFs, FoFs, PE & VC Funds are more aggressive and sell Indian equities during any adverse market condition. For e.g. Blackstone Inc. sold many Indian equities like Sona Comstar, REITs etc. to meet the default of $500+ mn by Sponda Oy, a Finnish subsidiary of Blackstone Inc. – although it had nothing to do in India.
Further, FIIs are overweight on Indian IT & Banks and any action by them move the market either way. Indian IT companies like TCS, Infosys, LTI, Coforge etc. have direct business interest with the American banks and a collapse of any of these banks would impact the Indian IT sector. This would negatively affect investor sentiment and overall market stability in the country as the IT sector holds 14% weightage in Nifty.
1. Exchange rate volatility - A failure in the American banking industry could lead to a loss of confidence in the US dollar, causing its value to plummet. This would result in increased exchange rate volatility, affecting the Indian rupee as well. A depreciating dollar could make Indian exports more expensive in the international market, hurting the competitiveness of Indian goods and services. Again, Indian IT & Pharma exports to US may pay the price for it.
2. A Worst-Case Scenario - The worst-case scenario is a DEEP DEPRESSION in the US economy lead by the failure of American banking system. A depression in the US economy would lead to a shrink in consumption, high interest rates, and tightened liquidity. As the US economy is the global consumer, a collapse would definitely be global, and India cannot remain insulated from it.The recent spike in the US balance sheet is seen as “printing of fresh liquidity to safeguard the investors’ interest of the Silicon Valley Bank”. This action may revert all the efforts that FED has put in to suck-out the liquidity in last 12-18 months and may bring back a high inflationary scenario in the US - What we had also experienced during the post-covid pumping of liquidity.
While the failure of few American banks may have a limited direct impact on selected Indian companies, a full-blown banking crisis would lead to a deep recession in the US, and this will have a ripple effect on Indian economy indirectly. It is important to monitor the situation closely and assess any potential indirect effects on the Indian economy and banking sector.
On a closing note, we are witnessing a contagion effect on global banks post-covid, be it Silicon Valley Bank, Credit Suisse, or Deutsche Bank, but who will give a vaccine shot for this?😉