International Financial System Shakes as US Banks Rush to Boost Capital.

Viral Acharya

By Viral Acharya

In many emerging markets, public sector banks receive deposits merely by the status of being backed by their governments and usually regardless of their true underlying efficiency. In fact, the banks might be even undercapitalized and yet depositors seek the safety and security offered by the government backing. Such, possibly undeserving, influx of deposits leads to “lazy banking”, a term coined by Dr Rakesh Mohan, the former Deputy Governor of the Reserve Bank of India.

The model of lazy banking is to be passive recipients of deposits and simply invest them in government securities, hoping to earn “carry” and mark-to-market gains on “available-for-sale” portfolio if interest rates decline, and then seeking accounting dispensations or capital forbearance from the regulator when rates rise so as to hide losses by moving securities into the “hold-to-maturity” portfolio. This way, lazy banks ride up and down with the interest rate cycle, becoming undercapitalized when rates rise, and choking credit to the real economy, precisely when it is tough-going for the borrowers. Worse, lazy undercapitalized banks, once granted regulatory or accounting forbearances, evergreen their distressed borrowers, resulting in a zombification of the real economy and sclerosis of its healthier parts.

The failures of Silvergate, Silicon Valley Bank (SVB), Signature Bank and First Republic Bank in the United States (US) over the past three months has many shades of lazy banking. There are parallels as well as differences, as when it comes to financial fragility, history usually rhymes rather than repeats itself.

Read the full Nikkei article.
Viral Acharya is the C.V. Starr Professor of Economics