Another ‘Lehman moment’? : Learnings for global banking system | March 31st Financial Deadlines to meet & more | Debt Mutual funds lose Tax Advantage

The collapse of Silicon Valley Bank (SVB) over the weekend has brought back memories of the 2008 Global Financial Crisis (GFC) and highlighted the instability of global markets. While it is unclear whether this event marks a “second Lehman moment” for the financial industry. The former was much worse and led by multiple factors.

SVB’s Fallout: The Federal Reserve began raising interest rates a year ago, which had an impact on SVB Bank’s tech stocks. Additionally, the rise in interest rates resulted in the devaluation of long-term bonds acquired by SVB and other banks. As venture capital dried up, start-ups were forced to draw down funds from SVB, which led to unrealized losses in bonds. To mitigate this issue, SVB sold securities at a loss and announced a plan to sell $2.25 billion in new shares to stabilize their balance sheet. This move caused key venture capital firms to advise companies to withdraw their money from the bank. SVB’s stock began to plummet, and other bank shares followed suit, leading to regulators shutting down the bank and placing it in receivership under the Federal Deposit Insurance Corporation. Although SVB’s collapse is not likely to cause a financial crisis, all insured depositors will have access to their deposits, and uninsured depositors will receive an “advance dividend” within a week, as stated by the FDIC.

While it is natural to compare current fallout of small sized US banks to the fall out of banks and financial institutions during the Great Financial Crisis 2008, the actual comparison indicates a much more difference in the two situations:

Here are some of the stark differences between the two independent events:

The Global Financial Crisis (GFC) was a period of severe economic instability that had a significant impact on the banking and financial services sector. The GFC was primarily caused by a housing market bubble in the United States, which eventually burst, leading to a significant decline in the value of housing and mortgage-backed securities. This led to many financial institutions experiencing significant losses, and a crisis of confidence in the global financial system.

The impact of the GFC on the banking and financial services sector was significant. Many banks and financial institutions experienced significant losses, and some institutions were forced to close their doors or be bailed out by governments. As per Wikipedia a total of 85 banking and financial institutions were impacted post the GFC some were majority of them were acquired and rest files for bankruptcy. (Source:?https://bit.ly/3LKg3R9 )

Like for example if one wants to compare the current banking crisis, following are some of the metrics which one can look at:

1. GFC Credit Crisis and Today’s Bond Market:

• During the Great Financial Crisis, banks took on risky investments in products such as low-quality mortgages, collateralized debt obligations, and CDO-squared.
• These investments lost value as the housing bubble burst, leaving banks with minimal equity capital. However, the current bond market offers a stark contrast to the credit crisis.
• Long-dated bonds held-to-maturity have relatively minimal losses today.
• Even a 10-year US Treasury bond purchased at historically low yields in 2021 retains a value of over 80 cents on the dollar.
• This marks a significant difference from the credit crisis when investments became worthless, and banks’ balance sheets were severely affected.
• Although the bond market is not without risks, the current stability and resilience of long-dated bonds suggest a less volatile and more secure investment landscape than the one that led to the credit crisis.

2. Resilience in US economy.

• Despite the overall strength in employment within the US economy, small and mid-sized banks are currently facing stress attributable to the asset-liability mismatch witnessed in the affected banks.
• While the employment rate is a crucial factor in preventing a recession, weakness in certain sectors and signs of stress indicate potential risks.
• It is important to monitor job losses in the construction industry, which is known for its cyclical nature and can serve as a leading indicator for future economic activity. Despite recent layoff announcements in the tech and ecommerce sectors, the employment rate in the US construction industry remains strong compared to the Great Financial Crisis (GFC), as illustrated in the chart below.
• The construction industry often serves as a lead indicator for the future of the US economy, and it is important to keep an eye on its performance to anticipate any potential challenges or opportunities.

3. Post GFC Reforms

• Central banks responded to the economic decline of 2007 by reducing interest rates to stimulate growth. However, the policy response intensified after the collapse of Lehman Brothers and the resulting hit to global growth.
• Central banks employed “quantitative easing” by lowering interest rates to near zero, lending large sums of money to institutions unable to borrow in financial markets, and purchasing a substantial amount of bonds to support struggling markets and revive economic activity.
• Governments increased spending to stimulate demand, guaranteed deposits and bank bonds to shore up confidence in financial firms, and purchased ownership stakes in some banks and other financial firms to prevent bankruptcies that could worsen panic in financial markets.
• While the policy response prevented a global depression, millions of people lost their jobs, homes, and wealth, and some economies took years to recover.
• Regulators strengthened their oversight of banks and other financial institutions by launching a slew of regulations requiring banks to assess loan risk, use resilient funding sources, operate with lower leverage, and restrict using short-term loans to fund customer loans. The increased vigilance of regulators in monitoring risk propagation across the financial system is essential to prevent future financial crises and safeguard people’s livelihoods.
• To prevent potential banking crises and protect customers, the Treasury Department, Federal Reserve, and FDIC announced that all Silicon Valley Bank clients would be able to access their money, even those exceeding the $250,000 insurance limit.
• The Fed announced an emergency lending program allowing banks to borrow from the Fed to pay depositors instead of selling securities.
• The Treasury set aside $25 billion to offset any losses incurred under the Fed’s emergency lending facility, though it is not expected to be needed.

The government’s actions were limited compared to the 2008 financial crisis, with no failed banks rescued and no taxpayer money provided to them.

In conclusion:?The collapse of Silicon Valley Bank (SVB) has raised concerns about the instability of global markets, but it is unclear whether this event marks a “second Lehman moment” for the financial industry. Unlike the Global Financial Crisis (GFC) of 2008, which was primarily caused by a housing market bubble in the United States that led to many financial institutions experiencing significant losses and a crisis of confidence in the global financial system, the current banking crisis in the US is primarily attributable to the asset-liability mismatch witnessed in the affected banks.

While there are signs of stress in certain sectors and potential risks, the US economy remains resilient, and the bond market offers a more stable investment landscape than during the credit crisis. The US housing market is also showing positive signs of stabilizing at low levels, and post-GFC reforms have left a lasting impact on the world’s economy.

Up your finance quotient: What else needs your attention?

1) Top 5 mid-cap stocks with low debt but high returns?

Secure your portfolio from inflation now! In the below video, we present you with the top 5 mid-cap stocks that can withstand rising prices and have a low debt-to-equity ratio. We also consider the 5-Year Historical EPS (earnings per share) - an essential metric for gauging a company's profitability.?

Why does the debt-to-equity ratio matter? The lower the debt-to-equity ratio means the greater ownership shareholders have in the company, and it lowers the need for borrowing money for growth. In simpler terms, a company with less borrowing will have a low debt-to-equity ratio and more of its own funds.?

EPS is another useful measure to estimate a company's value and profitability. It indicates the amount of profit a company generates for each share of its stock.?

| Watch the below video to get a fundamental analysis of these select top 5 stocks

2) Financial Deadlines You Should meet by March 31st and more: Mutual Fund & Demat Nomination, PAN-Aadhar linking & EPS-pension?

Don't miss out on savings and be on time! The new financial year is around the corner, with many investment opportunities. But, make sure to mark your calendar for some important dates that are getting closer as the current financial year comes to an end.?

Taxpayers and investors must meet these deadlines to avoid penalties, losses & inactive accounts.?

A fast approaching deadline is the PAN-Aadhar linking announced by the government.?The central government has instructed that PAN must be linked to Aadhaar before March 31st, and if you fail to do so, a penalty of ?1,000 is applicable, along with the PAN becoming 'inoperative' from April 1st.

The last date for updating nominations for trading and demat accounts is March 31, and trading accounts of investors not meeting the deadline will become inactive, as per SEBI.

Even Mutual Fund investors cannot redeem their units from April 1st, 2023, if they do not comply with the nomination process.

Another significant one being taxpayers having until March 31st to file a revised income tax return for the fiscal year 2019-2020.

| For more on important financial deadlines for 2023, click here

3) FDs are making a comeback: But can they beat inflation?

Equity markets have been on a rollercoaster ride off late, throwing retail investors on the sidelines. Meanwhile banks are busy wooing investors with higher interest rates on their fixed deposits. A slew of major banks including SBI, HDFC Bank, ICICI Bank and Axis Bank have raised their fixed deposit (FD) rates in recent times.?

Banks have been increasing fixed deposit or FD rates after a series of rate hikes by the RBI. Now, the central bank has signaled that deposit rates could go up further amid competition between banks for share of deposits.

What's in it for the banks? They are looking to raise funds to meet the growing demand for loans despite the higher lending rates. Banks also find it cheaper to raise funds from deposits than from the market.?

This comes after the RBI's slew of hikes in the repo rate .Since May last year, the Reserve Bank has increased the short-term lending rate by 225 basis points to contain inflation.

Here are some banks that recently hiked their fixed deposit interest rates:

To get more such quick takes on brands, stocks and money, follow us?here .

But can fixed deposits (FDs) stomach inflation? will FDs ever prove to be a good long-term investment option??

When the fixed deposit interest rates rise, it is across all tenures. Long-term FDs see a greater increase in interest rates as compared to short-term FDs. The interest rates are quite high at this time. Considering rising inflations, it is better to open a short-term fixed deposit account now. Once the inflation settles, long-term FDs will help you benefit better.

One thing’s for sure: overexposure to FDs is not good, and you need to assess your asset allocation and financial goals to decide how much money you park in them.?

For example, saving for your child’s marriage or higher education that is 15 years away through FDs might not be a judicious choice.?That’s because the post tax interest rate of an FD may not give you a real return (return that’s above the rate of inflation).?

But in case you wanna plan an international trip 1-2 years down the line, an FD can help. Or for anything that you plan for the near future such as buying a vehicle.

Question in Focus

How will the removal of LTCG tax & indexation benefits impact you?

With the 2023 Finance Bill being passed in Lok Sabha, the government announced some major changes with debt mutual funds.

Let’s first understand the changes before we head to its impact.

No benefit of indexation for long term capital gains on debt mutual funds will be available for investments made on or after April 1, 2023.?

This applies to those debt mutual funds whose investments in equities do not exceed 35%. Along with the debt mutual funds, gold mutual funds and ETFs, international funds of funds (FoFs), and some hybrid funds like Conservative hybrid funds will also lose their indexation benefits.

Thus, from April 1, 2023, these debt mutual fund schemes will be taxed at income tax rates which are applicable to your income.?

Why this move? In a nutshell, this brings taxation parity between 100% debt mutual fund schemes and bank fixed deposits, in a bid to boost deposit intake at banks.

How will debt mutual funds be taxed until March 31, 2023?

Debt mutual funds are taxed based on how long you hold them. If you redeem before three years, they are subject to short-term capital gains tax which is taxed at your slab rate. After three years, they are subject to a long-term capital gains tax of 20% with indexation benefit.?

Indexation is a feature that allows you to adjust the cost of acquisition of an investment to inflation. This is calculated on the basis of a Cost of Inflation Index (CII) which is notified by the Ministry of Finance for each financial year.From the year in which you purchase your debt mutual funds, the purchase cost is indexed for each financial year till you remain invested. The capital gains, for taxation purposes, are computed as sale price or redemption price minus the indexed cost of acquisition.

What should you do as an investor?

If an individual investor wants to avail the tax benefit of indexation, then they should do so on or before March 31, 2023. The investments made in debt mutual funds till March 31, 2023,? will continue to get the indexation benefit till the investments are redeemed from mutual funds.?

Experts claim that due to recent changes, people may start choosing safer investment instruments such as fixed deposits instead of debt mutual funds. This is because fixed deposits offer guaranteed returns, whereas mutual funds are affected by market conditions.?

While indexation benefits lost on debt mutual funds will primarily hurt those in the higher tax brackets, debt funds might still score some brownie points in comparison to fixed deposits.

Interest earned on fixed deposits are taxed on accrual basis, which means you pay tax every year that your FD is running. But you will pay tax only at the time of redemption in case of a debt mutual fund.? Also, FD interest of over Rs 40k is subject to TDS which isn't the case for debt mutual funds.?

Experts suggest that people nearing retirement may choose to invest more in fixed deposits and other debt instruments instead of debt mutual funds. But, for those willing to take some risk, investing in equity mutual funds might become more attractive, as they offer higher returns and better tax benefits after the new amendment.?

The proposal in the Finance Bill though still needs to be passed by the Rajya Sabha, and also includes plans to tax market-linked debentures as short-term capital gains.

Week Ahead for Markets: What to expect?

1. Banking Crisis: Any developments in the global banking system, particularly in the United States and Europe will be watched. In the previous week, the markets were volatile as Deutsche Bank experienced a significant drop of over 14% on March 24 as a result of a surge in credit default swaps (CDS). Despite closing down 6.5%, the bank saw a total loss of more than 25% for the month of March.
2. US Q4CY22 GDP growth:?

• March 30: Final US growth numbers for the final quarter of the previous calendar year

1. Other Global Economic Data:?

• Consumer Inflation Expectations (March): Euro Area
• Unemployment Rate (Feb): Euro Area
• UK Q4CY22 Current Account, GDP growth: UK

1. Domestic Economic Data:?

• March 31: Fiscal deficit and infrastructure output data (Feb); Current account and external debt numbers for the quarter ended December FY23

1. Oil Prices: ?Oil prices continue to benefit net importers such as India. This positive trend acts as a significant support not only for equity markets, but also for the overall economy. This is because any increase in fuel prices results in heightened pressure on the country's fiscal deficit.?

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