There will be no ‘Lehman Moment’ (2008 GFC) now as major global central banks and governments will not allow such banking crisis to linger, which may threaten Financial Stability
India’s benchmark stock index made a 5-month low of around 16850.95 Thursday. Overall Nifty lost almost -10% since Dec’22 primarily due to the banking crisis on both sides of the Atlantic amid global macro headwinds, higher borrowing costs/bond yields, and sticky inflation. Further Indian market was also affected by the Adani saga and related banks & financials, having significantly high exposure in various Adani groups.
As Fed/ECB/BOE and other major global central banks are tightening rapidly for the last 1-year, bond yields are rising; i.e. bond prices are falling rapidly, causing huge MTM/unrealized losses in bond portfolio (HTM category) of banks. Although big banks have an adequate capital buffer to withstand such MTM/unrealized losses, many small/mid-size banks in the U.S. may be vulnerable in such situations.
There is a huge mismatch in assets & liabilities for regional/community/small/mid-size banks like SVB. If we only consider deposits, SVB used to lend around 57% of total deposits, while utilizing 52% on debt/bond (mainly TSYs) investments in 2018. But after COVID (2020) this ratio drastically changed; now SVB lends around 43% of the deposit while using 72% on investments/bonds in 2022, against 35% and 71% respectively in 2021. Now as Fed is hiking rates from March’21 and tightening from late 2020 (QE stopped), 2YUS bond prices tumbled from around 110 in Jan’21 to 100 today (13th Mar 23). This 10% fall in bond prices caused a huge notional MTM loss in SVB’s bond portfolio running into billions of dollars. But as most of it falls under HTM (Hold Till Maturity) category, the bank has not considered the MTM (unrealized) loss in its PL account.
But sensing possible loss in the future and liquidity issues, and higher return from investing in bonds directly, big depositors like VC, start-ups which earlier deposited their excess cash for a better return from SVB, are now worried about the return of capital rather than return on capital, causing a run on bank (deposit withdrawal). Thus SVB falls into a liquidity crisis and attempted to raise fresh capital by FPO/fresh bond issuance, but it failed-resulting in the crash. Now Fed is extending unlimited liquidity to such regional community/small banks (like SVB) so that they don’t have to sell bonds/TSYs/MBS in loss to meet withdrawal pressure.
Overall, it seems that these small banks are reluctant pro-actively to expand their lending business into the productive sector of the economy, which is the core function of any bank. Moreover, SVB lends mainly to the local industry like Vineyard; thus there was some limitation. In any way, NIM and NII are bound to suffer for such regional community banks, lending mainly to SMEs. It also seems that the investment arm of such banks is not smart enough to manage bond portfolios effectively. But these banks are also important systematically and politically. Thus White House has no option but to bail out.
Eventually, U.S. Treasury, Fed, and FDIC made a joint statement late Sunday, assuring all depositors irrespective of insured/uninsured will be safe and can access/withdraw their deposits/hard-earned money; i.e. U.S. government effectively treating SVB, Signature, and other regional banks as too big to fall and virtually issued Federal guarantee to ensure financial (Wall Street) stability.
Fed is effectively extending unlimited liquidity (by printing more & more) at a time when it’s itself suffering huge negative cash flow to the tune of almost -$1.1T; in his recent Congressional testimony, Fed Chair Powell admitted -$36B MTM loss (unrealized) due to higher reverse repo rate (overnight) to banks. Big U.S. banks are earning risk-free returns equivalent to $36B from Fed as Fed is absorbing excess banking/money market liquidity against the collateral of US TSYs. There was also a report of thin liquidity in the U.S. treasury market! But Fed’s latest liquidity guarantee may ensure at least $2T of liquidity for fragile banks.
Further, on Wednesday, global stock futures tumbled after Swiss Banking conglomerate Credit Suisse (SIX:) (CS) plunged as Saudi National Bank Chair ruled out more assistance/further investments into the fragile bank. CS was already trading at all-time lows after it said Tuesday that its financial reports had a material weakness. And CS further plunged, while its CDs jumped to record highs after the bank’s top shareholder, Saudi National Bank Chairman Ammar Al Khudairy, whose stake has lost more than one-third of its value in three months, ruled out investing any more in the troubled Swiss bank as a bigger holding would bring additional regulatory hurdles.
Saudi National Bank, which owns a $1.5B stake in CS following the group’s capital-raising effort last year, said it was pleased with the bank’s recent turnaround plans, which include the separation of its investment banking unit and noted that its equity capital ratios were consistent with Swiss regulations, but said it can’t go over its current 9.9% threshold due to a ‘regulatory issue’. As a recapitulation, CS has been suffering from a host of scandals and missteps over the past years that have triggered an exodus of client deposits from both its bank and wealth management divisions and said earlier this week that it found ‘material weaknesses’ in its financial reporting and internal controls –thus postponing annual report publication.
The market is now also concerned about the side effect of higher interest rate/bond yields and subsequent plunge in bond prices resulting in huge unrealized (MTM) loss in the HTM bond portfolio of not only small/mid-size banks but also big ones.
On Wednesday, after the CS fiasco and subsequent ‘dooms day’ scenario across global markets, reminding the 2008 GFC (Lehman moment), the U.S. and also some other G7 countries/central banks reportedly reached (pressurized) Swiss authority/SNB to bail out CS (as U.S./Fed bailed out SVB/other small banks) and stabilize the financial market.
Eventually, late Wednesday, SNB and the Swiss regulator FINMA bailed out CS and said Credit Suisse (CS) meets the capital and liquidity requirements imposed on systemically important banks (too big to fall) and that the SNB will provide the bank with liquidity if necessary. Subsequently, Wall Street Futures recovered and GOLD, USD, and US bond yields stumbled. In an early European session Thursday, CS said it would borrow up to CHF 50B from the SNB, while also buying back up to CHF 3B of OpCo senior debt securities to regain market confidence.
The risk trade got a boost as CS takes steps to improve liquidity; the CD (Credit Default) swap of CS also drops. Overall, Wall Street as-well-as India’s Dalal Street recovered from a multi-month low on the easing of the global banking crisis as Central Banks will not allow any big or small banks to fall/fail for the sake of financial stability and too big to fall strategy; i.e. the Lehman moment of 2008 GFC may not occur this time.
Late Thursday, in the U.S., a consortium of 11 big banks announced that it will rescue FRB (First Republic Bank) by infusing $30B.The Treasury Department, the Federal Reserve, the FDIC, and the OCC confirmed the decision describing the move as a sign of the sector’s resiliency in the country. Wells Fargo (NYSE:), Citigroup (NYSE:), JPMorgan Chase (NYSE:), and Bank of America (NYSE:) will each contribute $5 billion. Meanwhile, Morgan Stanley (NYSE:) and Goldman Sachs (NYSE:) will do it for $2.5 billion. PNC, US Bancorp (NYSE:), Trust, State Street (NYSE:), and Bank of New York Mellon (NYSE:) will deposit around $1 billion each. These banks said in a joint statement:
“America’s financial system is among the best in the world, and America’s banks – large, midsize, and community banks – do an extraordinary job serving the banking needs of their unique customers and communities. The banking system has strong credit, plenty of liquidity, strong capital, and strong profitability. Recent events did nothing to change this”.
The US Treasury Secretary Yellen, Fed’s Powell, and FDIC said:
- This demonstrates the resilience of the banking system
- We stand ready to provide liquidity to eligible institutions
- First Republic deposits show resilience
The model of big U.S. banks rescuing regional/small banks along with active support of the central bank/government is like India’s example of the Yes Bank (NS:) bailout, which will be eventually followed in Europe too directly/indirectly. The Swiss government/SNB may also request/force UBS to merge/buy out Credit Suisse, resulting in further consolidation of the banking sector in Europe/EU.
As a result, both Wall Street and Dalal Street Futures (SGX Nifty) jumped early Friday but stumbled briefly before closing higher. But Nifty slid almost -1.80% for the week after losing around -1.03% last week. On late Friday, Nifty got some boost as China/PBOC cut RRR/CRR by -0.25% (to be effective from 27th March) and as NCLT allowed the mega-merger between HDFC Bank (NS:) with HDFC. Chinese CRR cut may spur economic growth in the 2nd largest economy of the world, especially for commodity demand (steel, cement, metals, and oil).
On Friday, Nifty was boosted by HDFC duo (merger confirmation by NCLT), ICICI Bank (NS:), Kotak Bank, SBI (NS:), Axis Bank (NS:) INFY, Bharti Airtel (NS:) (5G optimism), L&T, Ultratech Cement (NS:), and Tata Steel (NS:). On a sectoral basis, Nifty was boosted by banks & financials(easing of global bank crisis tension), techs/IT (overnight recovery in Nasdaq/tech-related stocks) metals & mining, construction materials (Chinese growth optimism), while dragged by power, FMCG, automobiles, consumer durables, healthcare/pharma and oil & gas (energy).
For the week, the Indian market was dragged by banks & financials (same global concern of higher bond yield and HTM portfolio MTM loss coupled with elevated NPA); techs (possible slowdown/recession in U.S./Europe; various startups may still have around $1B deposit in SVB; significant exposure of TCS (NS:) and INFY to U.S. regional banks); automobiles (subdued sales figure for January and deficient monsoon this year-may affect rural demand).
The Indian market is now also concerned about elevated interest rate/borrowing costs on the overall economy; especially banks & financials, which hold government bonds (GSECs) in HTM portfolios that may be now in deep MTM/unrealized loss. Thus RBI may also focus more on higher regulatory capital voluntarily by banks, especially which fall under too big to fall (SBI, PNB (NS:), HDFC, ICICI, Axis, Kotak, IndusInd (NS:), and also Yes Bank).
As the immediate concern of global financial stability eases, both Fed and ECB may go for their planned rate hikes in a calibrated manner to ensure price stability. Although Fed is providing liquidity support to some regional banks directly and expanding its balance sheet (back door QE), this is a temporary emergency measure for the sake of Financial stability and thus may continue to hike rates for price stability. As per Fed’s latest data, its B/S expanded by almost $300B in one week (to bail out regional banks), which is equivalent to 4-months of QT or almost 50% of the total QT done so far; i.e. Fed will ensure Financial Stability at any cost, but also have to ensure Price stability by further calibrated hiking. The same is also true for ECB as well as RBI.
India’s RBI may also hike +0.25% on 6th April and further +0.25% in June for a terminal rate of 7.00% against the Fed’s expected 5.50%. India’s core CPI continues to be sticky around +6.00% and thus RBI wants to ensure a real positive rate, by around +100 bps (restrictive levels) wrt at least average core inflation.
Thus RBI will continue to tighten to keep interest rate/bond yield differential and also under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand; i.e. slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.
As per Taylor’s rule, for India:
Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0+4+1.5*2=0.50+4+3=7.50%
Here for RBI/India:
A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6
On 22nd February, RBI released the minutes of the Feb’23 MPC meeting, which shows RBI may continue to hike at 25 bps at least until June’23 in line with the Fed. RBI is quite concerned about elevated core CPI around +6% substantially higher than the target of +4%. As India’s economic growth and outlook are still robust, RBI has no problem hiking further to control demand and inflation. RBI now thinks price stability is the bedrock of the economy and sustainable inclusive growth. As India’s banking system is now quite robust and there is little concern about any financial stability issue (contagion effect), RBI has no problem in hiking for ensuring price stability. But RBI may also call for higher regulatory/buffer capital, at least voluntarily in the wake of the growing global banking crisis.
In the U.S./Europe/Japan, as interest rates were low for the last 10 years, NIM/NII were also on the lower side, negative for higher regulatory capital/sufficient buffer requirement to avert such banking crisis from small regional/community banks. Now banking is a deep-pocket business requiring huge buffer capital and may not be suitable for small players. Thus banking consolidation in U.S./Europe is the only way and along with that governments may also start their public sector banks with a management controlling stake. These PSU Banks may serve the requirements of small community banks as well as large banks by serving both MSMEs and large corporates.
This will ensure also fair competition and balance between private and public sector banks like in India, where the banking system is now very strong after a series of consolidations. Now there are various public as well as private banks that have physical presence all over the country to serve every section of society. For a big country like India, having a 1.40B population and 80% of them are in BPL (below poverty line) category, financial and digital inclusion is now almost complete. India now has two big PSUs and four big private banks along with some other small private/PSU and cooperative banks. As the banking sector is strategic for any country including India, the government may never convert these PSU banks into private anymore, but will try to improve service and efficiency further; naturally private banks will also follow and improve themselves.
Indian banking system/sector is now quite resilient after years of consolidation, various regulatory reforms, and also elevated NIM/NII regime; banks are now flush with excess capital buffer to avoid any U.S. types of small bank failure even in extreme stress conditions, be it for NPA or HTM/MTM bond portfolio loss.
Bottom line: SGX Nifty Future: 17050 as of 17/03/23-Pre-U.S. session
Looking ahead, whatever may be the narrative, technically SGX Nifty Future now has to sustain over 17000 for a rebound to 17300/350-500/700-775/900-18100/375 in the coming days; otherwise sustaining below 16950, Nifty Future may further fall towards 16850/650-15795/525* and further 15000/14450-13500/12950 in the worst case scenario (another 2008 type GFC; but that’s highly unlikely now as global central banks/government will now not allow that to happen in the first place).
Note: Such global banking/financial crisis is generally negative for equities, but positive for , USD/US bonds (safe-haven flow), and vice-versa