CONTEXT

Three major banks in the US have collapsed since 10 March - Silicon Valley Bank (SVB), Silvergate and Signature Bank - the biggest bank failures since 2008. Similarly Credit Suisse Bank of Switzerland is about to collapse without the support of the European Central Bank. 

The question is why do banks collapse, especially such big and old ones? Banks are susceptible to many types of risks.

1. One of them is the credit risk where loans they have given turn bad or do not return.
2. The other is the liquidity risk when depositors withdrawals exceed the available funds with the banks.  
3. The third is the loss of their investment, either in equity or the debt. In this banks’ investments lose their value which adds to the crisis. This loss can be due to many factors such as due to a collapse in real estate prices or the fall in the bond prices in which they have invested.  

Banks invest heavily in government bonds to keep their money safe. But if their investment value declines, banks are at risk. 

Why do bond prices fall? When interest rate increases, cost of borrowing increases or interest one earns in lending also increases. If a lender can get more interest rate elsewhere, then why would they buy bonds? Hence the prices of bonds decrease. And if bond prices decrease, It leads to the Bank's losses on their investment. 

If this happens, banks’ asset values decrease substantially and liabilities become bigger than assets, hence the bank is at risk or about to collapse.  When this news comes in the market, many depositors want to withdraw deposits at the same time. This leads to the scenario that the bank does not have enough cash on hand. The bank can become illiquid, deepening the bank’s troubles. 

This as a whole lowers the share prices of the banks. It also closes the option to raise money by selling the shares which are already trading at the lowest price.   Adding to this, If Banks’ regulations are not strong like liquidity ratios and others, banks facing these situations are bound to collapse. All of the above events occurred with the American banks which have led to their collapse. But they had something more to their problem. 

US Banks catered to companies dealing in IT and technology industry which has been struggling with lower demand and due to sharp falls in crypto currencies. 

This is not the case with Indian Banks. How is the situation with Indian Banks? 

RBI, the regulator of Indian Banks, has been stringent with banking liquidity through many ratios which the banks had to follow. So the liquidity problem is not there.  NPAs have come down significantly so the issue of bad loans is also not concerning.  

Investment risk in government bonds is also minimal because the tax revenues of the government have been significantly high and fiscal deficits are being lowered. 

But precaution is a must and lessons must be taken from these events. Indians can't afford any bank collapse as they already face many shocks in their daily life.