Clipped from: https://www.thehindubusinessline.com/opinion/us-bank-runs-could-hurt-indian-it/article66827980.ece
The Indian IT industry could face disruption, thanks to its overarching reliance on Europe and US markets
The recent collapse of Silicon Valley Bank (SVB) closely accompanied by the fall of Signature Bank has raised alarm bells across the world amongst policymakers and common people alike. There has been a sharp deterioration in the value of bank stocks since these two events happened. While the reasons for the collapse of SVB are by now well known, its lessons are instructive.
Banks are required to have a robust risk-management framework that includes policies, procedures, and limits for risk management, contingency plans, and stress testing. The Asset-Liability Committee (ALCO) is responsible for implementing the ALM policy and monitoring a bank’s liquidity, interest rate risk, and market risk. The ALCO meets regularly to review the bank’s asset and liability position and take corrective actions, if required.
Banks in India must maintain sufficient liquidity to meet their obligations as they fall due. They are required to maintain a minimum liquidity-coverage ratio of 80 per cent, and they should have a contingency plan to deal with liquidity crunches.
To recap, California-based SVB attracted a lot of high profile clients, particularly start-ups, and put its assets in long-dated government bonds. Its liabilities were demand deposits that start-ups could withdraw any time. As the central bank in the US aggressively raised rates to fight inflation, the bonds held by SVB lost significant value whereas the liabilities hardly budged. Customers, including the venture capital investors, started to withdraw money in waves. Corporate and VC deposits, unlike retail deposits, are less sticky and liable to be withdrawn in bulk. SVB had a disproportionately large share of the former.
Liquidity issues also arise when loans and deposits have different maturities. Depositors have to be repaid when their funds mature, but banks cannot recall their loans. They will have to find new deposits or roll over those maturing, else they will not be able to service their depositors. This may also lead banks to pay prohibitively high rates.
Impact on IT sector, start-ups
With the crisis in the financial sector in the US and Europe there have been concerns about the consequences on the IT industry in India. The banking and financial services segment contributes over 30 per cent of the revenue of Indian IT companies. A recent report by Wedbush Securities stressed that deals from the Banking, Financial Services, and Insurance (BFSI) and high-tech sectors might slowdown in light of the crisis.
The Indian IT industry has recorded exceptional growth rate in the past few decades. However, the IT industry’s overarching reliance on Europe and US markets could up end creating disruption (see table).
Firms in the US and Europe are expected to defer their IT spending and also resort to cost-cutting measures. This would have a direct impact on the outsourcing business of Indian IT companies, and the uncertain economic environment could affect the project pipeline as well.
This would also have an impact on the recruitment in Indian IT firms at least in the shorter term.
Risk management at SVB
So far, the spillover effects on the Indian banking system seems to be minimal. SVB had a large pool of institutional depositors/VCs with typically low exposure to Indian financial system. Though as per TracXN data there were 21 start-ups based in India which had seen some investment from SVB, the total amount has still not come to light.
The SVB management did not have a chief risk officer (CRO) for a long period in 2022. The CRO, as part of the governing board, is responsible for managing the overall risk profile of the bank, identifying and assessing risks, and developing strategies to mitigate them.
Banks are advised to lay down a board-approved policy clearly defining the role and responsibilities of the CRO as per the current rules set by the RBI. Though currently we do not have banks violating such norms, NBFCs were recently asked to appoint CROs and the risk supervision framework was tightened.
Learnings from the crises
The crises in the US financial sector bring forth the importance of diversification from the point of view of depositors.
While depositing money in a bank it is imperative to scrutinise the balance sheet and also have a look at their operating numbers.
Investors looking to include banking stocks in their portfolio must not only take in account the market conditions but also the asset quality of the banks and their risk-management practices.
This situation causes a lot of consternation for depositors whose hard earned savings comes under threat due to the run on the bank. The Indian IT industry, too, needs to take steps to diversify its client base, thus thwarting any major negative repercussions from financial sector crises there.
Also, further tightening of norms relating to liquidity coverage, asset-liability committee deliberations and supervision of risk at both portfolio and bank levels would do a lot to assuage the concerns of all the stakeholders alike.
The writer is Assistant Professor, School for Securities Education (SSE), National Institute of Securities Markets