Page 52 - Banking Finance May 2023

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Risk Management shouldn’t be limited to

regulatory minimums

oot causes of financial crises have similarities. holdings were not, even though their market value also
R Consider three of the past 15 years: the global crashed. When SVB was forced to sell HTM bonds, huge
financial crisis (GFC), Indian corporate-loan crisis
losses were booked which had to be adjusted against equity.
and Silicon Valley Bank (SVB) failure. Seeds for
between 2016 and 2019, a popular post-covid narrative
these were sowed by faulty assumptions, bolstered by As the Fed had raised its rate by 2 percentage points
narratives and selective data usage, that seemed reasonable expected the rate to rise similarly at most. So this was the
at one time. For the GFC, US house prices were assumed worst-case scenario for a stress test. On this, SVB was
never to fall. For the Indian banking crisis, it was assumed compliant with regulatory asks and peer practices. A 4.5
that Indian growth was decoupled from the world’s and 6- percentage point rate spike over 14 months was not seen
8% per year was up for grabs. For SVB, it was that US as plausible. But it happened.
interest rates would remain low for long; so borrowing short-
In India, since July 2020, the 10-year G-Sec yield rose from
term funds at ultra low rates and exposure to long-term
about 5.75% to 7.3%. It would have eroded bond prices by
assets with higher yield looked reasonable.
12% to 14% over a 33-month period. In its published stress
In response to the recent banking turmoil in the West, India’s test, RBI uses stress scenarios that are 1.25-2.5 standard
finance minister asked all public sector banks to take a deviations away from average values. If a bank does not
health check. As reported, it includes a detailed scenario model a scenario of, say, a 4% interest rate spike in 12
analysis of various risks and the ability of banks to handle months, it would still be compliant. This assumes such a
such contingencies. While this is prudent, major risk concerns steep rise cannot happen in India. In addition, the stress-
could still escape notice. There’s room for complacency. testing capability of most Indian banks may not be robust
Indian bank balance sheets are at their strongest since 2010, enough for the rigour required. So, overall, banks are unlikely
systemic non-performing asset (NPA) rates are reducing, and to give the finance minister much to worry about.
corporates borrowers are showing lower aggregate leverage
However, our banks still need to enhance their analytical
and better cash-flows. But our risk radars need to turn in
capabilities to cover potential but unprecedented events
another direction to spot future worries. Just focusing on
that could spring nasty surprises.
past causes of blow-ups may offer false comfort.
One, retail lending: There is only a limited view available on
Bankers are likely to focus on interest rate and liquidity risks
Indian household leverage. While credit disbursed has risen,
over and above credit risk. Between 2010 and 2015, the US
a look at coincidental NPA rates on an expanded lending
Fed’s interest rate was almost zero. However, between
base will fail to send a warning signal.
2016 and June 2019, its rate rose to 2.375%. This eroded
Two, climate risk: India will be significantly impacted. Most
almost one-fifth the value of bonds purchased when the Fed
banks appear unaware of how heat waves might impact
funds rate was near zero (0.125%), but as it rose over a
retail credit, not to mention a water crisis which may create
period of 30 months, the shock was not severe. After covid,
stalled assets in long-term asset financing deals.
the US Fed reduced that rate and then raised it sharply in
response to inflation; it spiked from 0.125% in January 2022 Three, cyber risk: Instances of customer data breaches at
to 4.8% in February 2023. Bond prices crashed by 30-35% major banks are becoming worrisomely regular. Since banks
in these 14 months. A portion of a bank’s securities portfolio are not meaningfully penalized for such breaches,
is marked-to-market (MTM); i.e., revalued daily by market investment in cyber security is often not a top priority for
prices. Another part is held-to-maturity (HTM), with its them. Careless banks, though, may lose more than customer
value logged at original purchase prices. While MTM bond data in a potential attack, which could impact their
prices were adjusted down as the Fed’s rate rose, HTM reputation and stock price. (Source: Mint)

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