More dominos waiting to fall in the US banking business: Aswath Damodaran

Valuation guru Aswath Damodaran believes there are more dominos waiting to fall in the US banking business, with banks that have grown the most in the last few years at the most risk.

“Unlike 2008, when you could point to risk-seeking behavior on the part of banks as the prime reason for banking failures, this one was triggered by the search for high growth and a failure to adhere to first principles when it comes to duration mismatches,” Damodaran said in his blog.

The fall of the Silicon Valley Bank had a domino effect, with Signature Bank falling soon after, followed by Credit Suisse in April 2023 and First Republic in the last week.

The banks that have fallen so far collectively controlled more deposits than all of the banks that failed in 2008, but unlike that period, equity markets in the US have stayed resilient, and even within banking, the damage has varied across different segments, with regional banks seeing significant draw downs in deposits and market capitalization.

But Damodaran believes that unlike 2008, the crisis this time will more likely result in redistribution of wealth across banks rather than creating costs for the general public.

The collapse in the financial sector this time got triggered because banks were chasing high growth, ignoring basic principles, which resulted in major asset-liability mismatch.

Damodaran has listed out four major changes that he expects in the banking structure in the world’s largest economy.

Damodaran believes the bank failures will accelerate consolidation, especially as small regional banks, with concentrated deposit bases and loan portfolios are assimilated into larger banks, with more diverse structure.

However, in the process of consolidation, banks will find it difficult to maintain profitability, and perhaps, see profits drop. So, while bigger banks will get bigger, they may not get more profitable.

Thirdly, regulators could bring changes into the accounting rules for banks in order to avert another Silicon Valley Bank-like crisis.

“While I don’t foresee a requirement that every investment security be marked to market, a rule change that will create its own dangers, I expect the rules on when securities get marked to market to be tightened,” Damodaran said.

Lastly, the bank crisis this year urges the need for some key changes to the banking regulations that will be less harmful for both banks and its investors.

Duration mismatches at banks and high concentration of deposits were two major problems that emerged, resulting in the collapse of SVB and the banks thereafter.

Damodaran expects that there will be regulatory changes that will try to incorporate both of these issues, but he remains unsure about the form that these changes will take.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)