Sunday 5 July 2009

Bank Failures in the US

Bank Failures in the US
And their implications to all of us

Take a look at this graph:

Some points to note:

  • The above does not include banks that have been bailed out because they are "too big to fail"
  • Nor does it include investment banks like Lehman
  • And still, there are folks who are already talking about green shoots and a quick recovery
  • And expect us to believe the same!

I was just thinking about the implications of bank failures:

When a loss-making private company from Mumbai fails (or a PSU like Air India or HMT Watches unit or a textile mill from Tirupur),

  1. A few people lose jobs (say, 10000 folks)
  2. A few suppliers lose business (at least partially)
  3. The government loses some revenues
  4. A few investors (only those shareholders who've bought the failed company's shares) lose some money
  5. A couple of days / weeks / months of strikes, bandhs, etc. follow in places like Kolkata or Mumbai or wherever the unit might be located 
  6. And life goes on ... ... ... ... ...

However, when an Indian Bank goes bust or a Global Trust bank goes bankrupt,

  • All the above things (Points 1-5 above) happen; And, in addition,
  • All the thousands / lakhs of depositors
    • Lose lots of money
    • Get part of the money from Deposit Insurance Corporation, Government, etc. after remaining stuck for at least a year or two
    • Salvage some of their money - which they promptly take out and re-deploy in even safer avenues (like NSCs, postal deposits, etc.), which in turn contribute the least for economic growth of the country as well as to the financial well-being of the depositors
  • All the hundreds / thousands of creditors are stuck between a rock and a hard place:
    • They need to repay all their loans to the re-constituted entity, if any or to the liquidator - perhaps ahead of schedule
    • In any case, they will no more get the additional instalments of loans that were originally promised by the bank - for instance, their OD facilities will suddenly get frozen
    • They will get into an extremely severe liquidity crunch - because they need money immediately
    • All of them will simultaneously try to get over their liquidity crunch by approaching (often) the same set of other banks / lenders - and their sense of desparation will be widely known in the market.
    • For obvious reasons, they will be very poor risks, compared to their situation that prevailed prior to the failure of the bank
    • This, in turn, will result in
      • Their not getting any fresh credit limits
      • If at all they get any money, it will be at obnoxious terms, at much higher rates of interest, with tough conditionalities
      • Their cost structure will shoot up
      • Their management focus will shift from business issues to liquidity issues
      • Their margins will go for a toss
      • There will be a live danger of their going bankrupt themselves!
    • And life goes often comes to a standstill for them ... ... ... ... ...
  • Depositors in other banks become equally wary - If Bank A can fail, so can Bank B - "So, let me be safe now than sorry later" - resulting in risk averse behaviour, which is pehaps good at the individual level, but certainly not good for the economy as a whole
  • Likewise, bankers in general will become much more risk-averse than usual while giving loans - resulting in lesser loans being sanctioned AND at higher rates of interest

Considering all the above, the bank failure data in US is scary, to say the least! We should remember that when US sneezes, the rest of the world develops Swine Flu!

I will not pay much credence to stories of Green Shoots - I'll certainly be quick to book profits in shares and slow to pick up any risky investments.

Regards,

N


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