FINANCIAL SCENE
World’s leading banks under severe financial stress
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The expectation that India and other emerging markets would remain ‘decoupled’ from the West has been proved wrong
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The sudden downward lurch of major global banks suggests that recovery will be painful and further delayed.
— FILE PHOTOS
A man walks into the London headquarters of the Royal Bank of Scotland (RBS).
Over the past two weeks the world’s leading banks have been reporting huge losses in their last quarter results. That reinforces the view that the worst is far from over for the troubled financial sector in advanced countries. Policy makers, who had already lent considerable support to the banking system, are at their wits’ end to devise even more innovative ways to keep those banks afloat.
One of the principal causes for the crisis — the sizable presence of large ‘toxic’ assets in the balance sheets of the banks — still remains a potent factor.
In many respects the problems created by reckless lending by banks in an era of plentiful credit will get magnified as the economic outlook of the developed economies worsens, as anticipated.
Staggering losses
Despite such awareness, policy makers have been taken by surprise at the staggering losses disclosed by some of the leading banks for the latest reporting period.
A few of them are entering the loss making category for the first time.
For instance, Bank of America’s fourth quarter loss of $1.8 billion may not by itself appear worrisome but it is for the first time since 1991 that it has gone into the red.
In fact, in the early days of the crisis, BOA seemed to be a survivor when Citigroup and several others needed massive state support.
BOA actually rescued a famous investment bank Merrill Lynch. But the takeover has been costly. The erstwhile investment bank, in the process of being amalgamated with BOA, has reported a loss of $15.3 billion in the same quarter, caused primarily by its holdings of mortgaged assets, leveraged loans and so on.
Even if BOA had managed to minimise its exposure to these ‘toxic assets.’ it will now have plenty of them after its accounts are consolidated with those of Merrill. The bank has received $20 billion by way of capital injection in addition to the $25 billion it received in October.
The government is also guaranteeing $118 billion of its loan assets in a structured way.
A Bank of America branch in Charlotte.
Despite two previous bailouts, Citigroup has disclosed an $8.3 billion loss during the fourth quarter. It lost $18.8 billion in all in 2008.
After spinning off its brokerage Smith Barney into a joint venture with Morgan Stanley, Citigroup has decided to split itself into two.
Citicorp — its old iconic name — will house its core entity, global retail and commercial banking, its advising investment banking and transactions processing business.
The other part, to be called Citi Holdings, will have its non-core assets including its minority stake in the recently formed Morgan Stanley Smith Barney.
Across the Atlantic too, banks have been reporting unprecedented losses. On January 19, Royal Bank of Scotland (RBS) reported the biggest corporate loss in U.K. history after which its shares plunged by 65 per cent.
The government already owns 70 per cent of its stocks. World leader Deutsche Bank has reported unprecedented fourth quarter losses.
The list of loss making banks of the developed world is expanding by the day.
Clearly policy makers have underestimated the magnitude of the crisis; Federal Reserve chairman Ben Bernanke has said that economic recovery will not begin until the financial sector recovers its health. But then the latter depends on how soon the economy revives. No wonder policy makers of those countries are at their wits’ end.
According to the RBI (Trends and Progress of Banking), Indian banks do not have any direct exposure to the U.S. sub-prime market. Even their indirect exposure through their foreign offices and subsidiaries is not significant and in any case has been provided for.
The Indian economy is however susceptible to the sharp downturn in the U.S. and other developed economies.
The expectation that India and other emerging markets would remain ‘decoupled’ from the West has been proved wrong. Both through trade and financial channels, India remains vulnerable to the shocks emanating from abroad even though (a) it is not an export driven economy and (b) its mainline banks — nearly all of them in the public sector — are in a much better financial position than their counterparts in the West.
There are many policy lessons for us in India from the most recent stress that the financial sector in the West has been subjected to. Most of these banks — Citi, BOA and Deutsche Bank and others — are familiar names in India. It is not clear whether the income streams from their well established Indian business operations have aided their global performance. According to reports, most of them are reportedly not doing well in India in areas such as consumer finance in which they have had a head start over most Indian banks.
A casualty
One casualty will be the universal banking model that Indian banks led by ICICI Bank were betting on. Transforming a prosaic bank branch into a financial supermarket dispensing a variety of financial products seems a good idea. In practice, however, it has meant using a common brand name.
For the foreseeable future that is how banks will remain in India.
C. R. L. NARASIMHAN
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