By Anjan Roy
US policy-makers quick move to rescue the beleaguered Silicon Valley Bank is an object lesson in what can be described as “real economics” in parallel to real-politic.
Real-politic is the art of playing politics in realistic manner. Real economics is similarly handling of economic issue realistically. We have of course seen some examples of these in the aftermath of the 2007-2009 global financial meltdown. But after fourteen years, all that has dimmed in memory.
In simple terms this is handling an economic emergency from a practical point of view rather than stick to the so-called free market principles.
In the Mecca of free market economics, the United States, these high saluting principles have most frequently been flouted whereas the adherents of this line of thinking had practised what came to be known as the “Washington Consensus” on developing countries in the latter’s hours of crises.
The Washington Consensus had imposed austere conditions for giving loans to countries facing economic crises. Just now, for example, countries humbled into bankruptcy after swallowing large Chinese loans, are being insisted to introduce wide-ranging austerity measures.
However, when the Silicon Valley Bank faced a run on it Thursday before last, the central bank of USA and the US government did not dispassionately watch it go under. But they quickly extended a robust life line by extending some of the most widest accommodation. IT was a quick rescue act prevent the bank from failing.
What did they do? The US government stepped in to assure that all depositors of the troubled bank will have full access to their funds from the following Monday. This is by overriding the limits on deposit insurance covers that the Federal Deposit Insurance Corporation (FDIC). Until then, the corporation would extend insurance covers to deposits upto $250,000.
This limit was extended by a quick executive order and all deposits were to be repaid. In a situation of government assurance to depositors funds, there would be little logic for depositors to scurry for withdrawal of their funds.
This is enough. The US central bank thereafter announced a measure which would have even further wide-ranging implications.
The second measure announced was that the US Fed would act as the ultimate lender of last resort and provide funds to the beleaguered bank against all US treasuries upto their face value. This is tackling the basic reason for banks’ vulnerability and its systemic risk.
There is a context to it. In the period after the global financial meltdown, central banks had provided funds at extremely cheap rates with which the banks had loaded up the government treasuries instead of lending these funds onward to borrowers at an interest margin. The banks had accumulated huge portfolio of long dated government securities against shorter maturity deposits.
The moment the monetary policies began to be normalised and interest rates began rising, the market value of these treasuries had plummeted. That is, they have to sold at a discount in case you need to and thus book a loss. The losses could wipe out their capital base. In such a situation banks market capitalisation erodes and thus further squeezes their financial viability. This is an ideal condition for a run and bank failure.
Failure of a very large bank could trigger off a chain reaction and spread the contagion to other banks and the entire financial system. But then, SVB was not such a large systemically important “Too Large to Fail” bank. Why was it rescued?
This is because SVB is a niche bank and had exposure to a critical sector of the US economy. It had in a way nurtured the US technology industry in Silicon Valley and many of them dealt with the SVB and had their funds there. Failure of SVB and funds locked in there could even have impacted their pay-rolls to their staff.
The rescue was necessary to preserve the Silicon Valley eco-system, as Larry Summers described in a conversation with the Economist magazine. Secondly, as he sensed, it was to stop what could be a “21st Century contagion”. A failure would have consequences for a large group of players.
Following the SVB debacle, another US bank had also faced similar threats. But it was averted by a takeover by another operator.
In a trans-Atlantic spread, one of the hallowed names in European banking, Credit Suisse, had also faced a run and a quick rescue by the Swiss Central Bank. Subsequently, Credit Suisse has been acquired by another giant of International banking, UBS. All these developments hold object lessons for Indian policy-makers and strategic thinkers in these areas.
Adhering to economic orthodoxy of fiscal prudence and consolidation, one finance minister had kicked in serious fiscal compression to achieve the objectives of the Fiscal Prudence Act. The fiscal brake was so severe that the economy had almost screeched to a halt.
In another sphere, the finance ministry had stipulated that in case of a bank facing closures the depositors would be compensated only upto the limits of insurance under our deposit insurance provisions. Needless to say, out deposit insurance norms are measly and sends a shiver down the depositors’ spine in case there is any fear of a bank closure or even a merger. It is the depositors which have to face the hair-cut.
These are punitive propositions for the ordinary public and savers. Even ir life-tie savings could vanish for no fault of theirs than trusting a public sector bank with their money.
The credibility of the financial sector is the key stone for a country and its economy. In a country where there is no social security network for the ordinary public bank deposits are the last resort for survival. In this country, the government should provide a blanket security to depositors in at least the government owned banks. This will do wonders to at least saver’s confidence. (IPA Service)