Lessons For Uncle S(c)am: US Regulators Can Learn Something Useful From RBI

The third major US banking collapse in just over two months shatters the myth that Uncle Sam somehow has an emulatable regulatory regime compatible with free markets.

If anything, it is time its regulators learnt a few things from India’s own experiences, which were learnt the hard way by having to deal with our own scams and market issues.

Last week, the regulator seized First Republic Bank and handed it over to JP Morgan after its shares started tanking.

This happens to be the second largest banking collapse in US history, the worst being that of Washington Mutual in 2008.

Including First Republic, the second, third and fourth biggest bank collapses are all from this year, including Silicon Valley Bank and Signature Bank at No 3 and No 4 (see the laundry list of big US bank failures here), which makes 2023 one of the worst years of regulatory failure.

If, 15 years after the Lehman crisis, US regulators can still preside over three of the biggest financial failures in its history, we can conclude two things:

One, the US regulatory system is simply incapable of handling its problems, and this could be because there is little or no real coordination between its fiscal and monetary authorities.

The collapses this year are the direct result of fiscal profligacy, which forced the Fed to keep raising rates to extortionate levels in order to tame inflation. But while inflation isn’t sailing off into the sunset anytime soon, it is clear that the financial system is under stress.

The first priority will thus be to save the system, not bring down inflation.

In India, where the fiscal and monetary authorities often talk to one another, there is far better coordination and understanding of their mutual problems.

The Western model of the fiscal and monetary sides behaving as though they are on separate planets, which liberals call independence of institutions, is simply not working.

Every institution needs independence to function effectively, but this independence is subordinate to the overall stability of the system. 

Two, the US system has learnt little from the scams of 2000 (the dotcom bubble), the 2008 crisis, the eurozone crisis, the Bernie Madoff Ponzi scheme, and the Covid fiscal freebies.

Now, the entire economy looks like it is in the midst of another macroe-Ponzi scheme, where everybody, banks included, will get large cheques from Uncle Sam to keep the system afloat. 

In contrast, all of India’s scams, from the 1992 Harshad Mehta securities scam to Ketan Parekh’s stock market scam nine years later (in 2001), and the more recent bank collapses resulting from public sector overindulgence and lack of adequate Reserve Bank of India (RBI) oversight over weak cooperative banks, has improved the regulatory environment in India.

In most cases, whether it is Yes Bank or some of the weaker public sector banks, the RBI has acted before public confidence in a bank started falling.

Its prompt corrective action (PCA) framework has helped put public sector banks back on the rails, both by curtailing their lending activities and focusing on the recovery of loans.

The RBI also forced many public sector banks to send their biggest bad loans to the insolvency courts, making recoveries faster than ever before. 

In the Silicon Valley Bank case, the US federal regulators failed on the most elementary aspect of asset-liability mismatch monitoring.

Silicon Valley held some of the safest assets known to mankind (US treasury stock), but these were losing value as interest rates were rising sharply (when rates rise, bond prices fall as they adjust to new yields).

In India, the RBI allows banks to segregate vulnerable bonds into a “held for maturity” category, where there is no need to adjust for market rates.

So, asset-liability mismatches are handled better in India, though the problem of interest rate volatility remains.

Belatedly, the US Fed has now realised that it is directly responsible for the recent banking collapses.

A new report, authored by the Fed’s vice-chair for supervision, Michael Barr, notes that the Fed was slow to recognise the problems at Silicon Valley Bank, and even when its supervisors saw the problems, they were slow to act.

The report suggests that the 2019 Fed decision to closely scrutinise only the biggest banks resulted in weak supervision elsewhere, and the culture of less assertive policing of banks was partly responsible for Silicon Valley’s collapse. 

Isn’t it time we gave our own steady and cautious regulator a pat on the back for sparing us the blushes on bank failures?

The constant refrain from economic liberals, that the RBI is too much of a nanny, is plain and simple wrong.

It is the cautionary role played by the RBI that saved us in 2008, and now again in the post-Covid world.

The RBI should take a silent bow; the US Fed needs a kick in the butt. Only one letter separates Uncle Sam from being called Uncle Scam.