Beyond the Big Bank Theory: SVB collapse shows need for regulatory scrutiny

A chain is only as strong as its weakest link. The message that comes across from the dramatic collapse of the Silicon Valley Bank (SVB), and Signature Bank, is that new risks are coming to the fore in an increasingly interconnected world; and the idea of systemically important institutions may have to be rethought. SVB now threatens the start-up ecosystem, which is already in the throes of a funding winter due to raising interest rates, the tightening of the regulatory framework and the resultant question marks on many of their business models.

In India’s rear-view mirror, the mess at YES Bank, Infrastructure Leasing & Financial Services, and the erstwhile Dewan Housing Finance Corporation led to a swift realignment of oversight by the Reserve Bank of India (RBI) by cutting down on regulatory arbitrage. But another aspect never came under the arc light: though not a Domestically Systemically Important Bank (D-SIB) even “Lilliput” Punjab and Maharashtra Co-operative Bank (PMC Bank) caused havoc for depositors. It had to be taken over by the Centrum-BharatPe combined with a little bit of forbearance (it now exists as Unity Bank).

So the question is: What should be the threshold for being classified as D-SIB?

A little under a decade ago, RBIs in its “Framework for dealing with DSIBs” (22 July, 2014) noted, “It is felt that systemic importance of all banks need not be computed as many smaller banks would be of lower systemic importance, and burdening these banks with onerous data requirements on a regular basis may not be prudent. Hence, the sample of banks for identification of D-SIBs may exclude many smaller banks.” The blowout at PMC Bank turned this approach on its head.

Now, let’s take the latest list of D-SIBs released by the central bank on January 2 this year.

It’s largely unchanged from previous years. State Bank of India (SBI), HDFC Bank and ICICI Bank still figure in it. But the pecking order of banks by asset size has shifted after the government merged four sets of state-run banks. SBI and HDFC Bank continue to occupy the top two slots in terms of asset size, but Bank of Baroda and Punjab National Bank come in next (in that order), having edged out ICICI Bank to number five.

Is it time for a relook into the D-SIBs rostrum? The matter is said to have figured in internal meetings of the RBI’s supervisory department after the merger of state-run banks.

In his foreword to the December 2022 Financial Stability Report (FSR: 2022), RBI Governor Shaktikanta Das was prescient. “This issue (financial stability) comes at a very critical juncture when the cumulative impact of the extraordinary shocks to the entire world over the last three years is still working its way through across countries,” he said. “That the international economic order stands challenged; financial markets are in turmoil due to monetary tightening in most parts of the world; food and energy supplies and prices are under strain; debt distress is staring at many emerging markets and developing economies; and every economy is grappling with multiple challenges.”

SVB was caught in the cross hairs of all the factors Das articulated above. That brings us back to what’s “systemically important”.

In its approach for assessing the systemic importance of global systemically important banks (G-SIBs), the Bank for International Settlements has assigned a weight of 6.67 per cent for payments; the RBI had done likewise for D-SIBs. Given the exponential growth in the payments business with fintechs playing a major part, and partnering with banks (across business verticals), perhaps this may warrant a relook. The supporting architecture — the National Payments Corporation of India (NPCI) and account aggregators — also warrants scrutiny. In what way are they any less “systemically important” compared to banks, or non-banking financial companies? Consider that the Niti Aayog has also put out “A Proposal for Digital Banks in India: Licensing & Regulatory Regime” in July 2022.

Will payment systems turn out to be a weak spot? Even back in FY2002, Madhavpura Mercantile Cooperative Bank (MMCB) (another “Lilliput”) had unsettled the authorities. The bank issued pay orders (POs) of Rs 1,200 crore to stock broker Ketan Parekh, which were discounted by Bank of India (BoI); the bank also gave loans to Mukesh Babu and Sirish Maniar of the Maniar Group (a brokerage) at a time when they were not allowed to receive more than Rs 15 crore. The MMCB-BoI transaction was a case of conflating POs with cheques.

To the credit of RBI, it’s been proactive when it comes to the intersection of the old and the new.

A particular arrangement under regulatory examination is the issuance of first-loss default guarantees (FLDG) — a back-up offered by digital platforms (or other unregulated entities) as guarantee to lenders (regulated) on whose behalf they source business. After SVB and its impact on start-ups (and the contagion it may trigger), the future of FLDGs may not be rosy. It has been learnt on good authority that the central bank has informally conveyed to regulated entities that it is not comfortable with these arrangements. The move to seek details on FLDG arrangements had come even as there is speculation in banking circles that RBI is working on a master circular on outsourcing.

Indeed, the RBI can offer a lot of experience in this emerging field. “India has assumed the presidency of G20 this year, and the same gives the country an opportunity to showcase its leadership in the field of fintech, particularly in digital payment systems. While India has made significant strides in developing its domestic payments systems, which are acknowledged globally, it can also contribute to innovations in cross-border payment systems,” deputy governor M K Jain said last week, speaking on the “Fintech Revolution in India: Innovation, Inclusion and Regulation”. But as SVB has shown, it may need to track the domestic business more closely before committing to such globalisation.

A few new fault lines

• May call for relook of what constitutes systemically important entities
• The intersection of legacy and newbies can lead to instability as there’s nothing by way of a past to glean from
• The payments business is to be watched out for with fintechs playing a major part
• The mess at SVB has the potential to stifle funding to fintechs in particular