America is sneezing again

Failure of banks in the US has once again ignited debate on the safety of depositors' money in banks
America is sneezing again
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 It’s once again a time to reproduce a well-known phrase as I have quoted it in a few of my previous columns. “ When America sneezes, the world catches a cold.” This phrase means that as a global leader, other nations tend to follow America. In other words, what happens in America affects the rest of the world, be it for good or bad.

Usually, America’s sneezing shakes the geographies across the globe like a jelly. Be it stock market crash, financial crisis or bank failures in America, the world turns heads on the events as they feel the ripples of a doomsday. This time the successive failure of two private banks in the US, California-based Silicon Valley Bank and a New York based Signature Bank, has unleashed a wave of fear among the depositors, not only there but also in the rest of the world. Approximately 175 billion dollars of deposits are reported to be at stake in Silicon Valley Bank alone! It’s considered the largest bank failure since the 2008 financial crisis.

The collapse of both banks based in a country which has the reputation of being the most developed nation in the world and having highest benchmarks almost in every sphere, be it socio-economic, political, bureaucratic or corporate domain, is genuinely worrisome for the general public located in other parts of the world. The failure of these once reputed financial institutions directly reflects the fragile banking regulations existing in the US. The US regulators may cope up with such failures in the financial system of their country, but the question remains how come the most developed nation in the world affords such collapses that too happening in a jiffy.

It’s also pertinent to mention that the bank failure in the US cannot be claimed to have a local impact. In fact, it has a global impact. Even as depositors and businesses in other countries are not linked to the failed banks, there is every reason for them to fear for their money. The question on the safety of their money in banks in their respective countries holds ground.

The fall of the Silicon Valley Bank (SVB) and the Signature Bank has once again ignited debate on the safety of depositors' money in banks across the world. Let’s discuss the situation in the context of our country. In other words, in a given situation, it merits to be explained how depositors would be handled in case of a bank failure in India. Notably, in order to protect the depositors’ money during any such fallout, governments and central banks worldwide offer deposit insurance cover to deposit holders in a bank. Remarkably, India was the second country after the US to launch its Deposit Insurance Corporation in 1962. In the US it was launched in 1933.

It’s to be understood that we have different kinds of banks having varied ownership structures, and they together play a major role in the lives of the people. The banks perform a duo task that is to collect deposits and to provide loans in various forms. The banking sector houses government-owned banks, popularly known as public sector banks, private sector banks, cooperative banks, regional rural banks and other financial institutions. And the best part is that all these banks are regulated by a single entity - the Reserve Bank of India (RBI).

The role of the Reserve Bank of India, which commenced operations on April 1, 1935, has been hailed time and again for keeping the banking system afloat during rough times through its series of regulatory measures. Our banking regulatory system got world attention when the global recession in 2008 saw many well established banks disappearing from the banking scene. During Covid-19 pandemic, The RBI played a yeoman’s role to keep the engine of the country's banking system running so that the bruised economy remained afloat. Precisely, the measures taken by the apex bank during the peak of Covid-19 crisis kept the common household budgets afloat and helped different segments of populations to negotiate the pandemic-induced economic crisis. However, there have been some instances of bank failures in the country. A bank failure is a huge risk for a country's economy. 

Even as regulations are in place to protect depositors’ interests, some banks were unable to pay back the money to their depositors. The instances of crisis faced by Punjab and Maharashtra Co-Operative Bank Limited (PMC Bank), Yes Bank and Lakshmi Vilas Bank shook the confidence of the depositors.

Generally speaking, the story of a bank failure is a scary situation for depositors. 

Needless to mention that depositors are key to the existence of the banking sector and safeguarding their money is vital to ensuring a bank’s prosperity.

As already mentioned, there is a bank deposit insurance scheme in place where all deposit accounts in banks are automatically insured. If a bank suffers problems and cannot meet its obligations to repay their depositors, the account holders are paid from the deposit insurance up to the maximum limit of the deposit insurance per account.

Notably, each depositor in a bank is insured upto a maximum of Rs. five lakh for both principal and interest amount held by him/her in the same right and same capacity as on the date of liquidation/cancellation of bank's licence or the date on which the scheme of amalgamation/merger/reconstruction comes into force.

Deposit Insurance and Credit Guarantee Corporation (DICGC) administer deposit insurance scheme. Under this scheme, deposits of all commercial banks, local area banks and regional rural banks are insured by the DICGC. The deposits such as savings, fixed, current, recurring, etc. fall within the ambit of this scheme. However, there are certain types of deposits which are not covered in the scheme, which include deposits of governments, Inter-bank deposits, etc.

The best part of the Deposit Insurance scheme is that the premium is paid by the bank and not the depositor. It’s noteworthy that the deposit insurance scheme is compulsory for the banks and there is no scope for any bank to withdraw from it.

Meanwhile, the occasion also makes sense to alert the depositors about fraudsters who dupe people of their hard money by offering them higher returns. While chasing higher returns on their deposits offered by institutions, they should bear in mind that higher interest rates also bear higher risk. They should ensure that they are depositing their money with a financial institution that falls under the regulatory framework of the Reserve Bank of India. Financial institutions falling outside the ambit of the RBI framework are risky. And deposits parked with such institutions don’t fall under the deposit insurance scheme.

To conclude, the fiascos surfacing in the banking industry point to a fit case for depositors to adopt ‘Know Your Bank’ policy for choosing a bank. If banks have ‘Know Your Customer’ policy in place to measure the risk profile of their customers, ‘Know Your Bank’ policy can prove an effective tool in the hands of depositors to evaluate the risk profile of a bank.

What I mean to say is that the times have changed and so has financial architecture. If technology has revolutionized the banking system and facilitated ease of doing business, it has at the same time put the financial system in a whirlpool of new risks. The ability of banks to mitigate these risks needs to be measured by the customers now to stay safe. It makes sense for the customers now to have a look at the fundamentals of their banks carefully. Here measuring the asset quality of a bank is an important parameter. If you observe stress on assets with a tendency to impact the capital of the bank, then take it as an alarm of a fiasco on cards. There are other certain parameters such as provisioning coverage ratio, capital adequacy ratio (CAR), currents and savings account (CASA) ratio, which a common customer can check to evaluate the safety of the bank.

Who owns the bank? Today, you need to know the answer to this question. The ownership structure of a bank is a crucial indicator as far as safety of the bank is concerned. It’s actually the spine of the bank. Banks having frequent changes in ownership structure are always prone to survival challenges. Here, a government ownership does provide a strong spine to the bank.

(The views are of the author & not the institution he works for)

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