Banking turmoil in the West has placed India at a fork in the road

Lower growth and inflation are now more likely and this calls for Indian policy preparedness against emerging global risks

- SONAL VARMA

Recent events have shaken the global economic outlook. Three US mid-sized banks have failed, Credit Suisse has had to be taken over by UBS, and the spotlight is now on German banks. These have re-ignited memories of the 2008 Global Financial Crisis (GFC), but the turmoil so far is different from it in a few aspects.

During the GFC, the problem was one of credit risk, caused by a surge in banks' bad mortgage loans. The current crisis in US regional banks is one of liquidity risk, driven by deposit outflows, and Silicon Valley Bank's (SVB) issues emanated from large losses on its government bond holdings amid rising interest rates.

However, SVB's problems are more systemic than idiosyncratic. Many banks on both sides of the Atlantic have unrealized losses on their bond holdings (albeit this in itself is not reason for alarm). SVB's failure has also resulted in contagion via deposit outflows from other small and mid-sized US banks into larger banks and money market funds, which makes it more systemic.

How the banking turmoil may progress-good versus bad scenario: In the good scenario (our baseline case), the US Federal Reserve manages to address banks' liquidity needs via its new bank term-funding programme and its regular discount window. This prevents other smaller US banks from having to sell their assets at a loss. The existing backstop restores confidence, deposit outflows stabilize after some time and further bank runs are avoided.