'If State Bank of India goes down...': Aswath Damodaran explains why big public sector banks matter the most

Amid the banking crisis in the US, valuation guru and a professor of finance Aswath Damodaran on Saturday explained what can happen in India if the country's largest public sector lender goes down. He said the problem with banks is that their risks and losses are not separable. "If State Bank of India goes down, guess what, it's not just State Bank of India going down, it's going to bring down the banking system," he said while speaking to India Today Group's Global Business Editor Udayan Mukherjee. 

Also read: 'Banks, Indian family businesses linked at the hip': Aswath Damodaran flags 'dangerous mechanism' at play

Damodaran, who teaches finance at the Stern School of Business at New York University, referred to the collapse of Silicon Valley Bank, which was the 16th largest bank in the US. He suggested that even the meltdown of the 16th largest bank in America had shaken the trust of investors, who scrambled to withdraw their money leading to a liquidity crisis in some other regional banks. 

Within 24 hours of SVB's collapse, another regional lender - Signature Bank - had collapsed and share prices of First Republic plunged nearly 90 per cent, prompting authorities to facilitate a rescue deal by a group of large peers.

Referring to this domino effect of SVB, Damodaran said in the larger scheme of things, one can say - who cares if the 16th largest bank in America goes down? "You won't even have noticed the 16th largest bank goes down...(but) look (it is) threatening to bring down the entire system. So, unfortunately, in banking, there's no such thing as separability. So, the big public sector banks have troubles, guess what? It's everybody's problem," the professor said, adding that if SBI goes down, it will bring down the entire banking system.

The warning comes against the backdrop of an ongoing banking crisis in the US, which recently spread into Europe and brought down Switzerland's second-largest bank Credit Suisse. Last week, reports emerged that there was trouble brewing in Deutsche Bank as the cost of insuring the bank's debt against the risk of default shot to more than four-year highs. 

When asked about the ripple effect of SVB and Credit Suisse, and how it was going to end, Damodaran said the banks are built on trust and it is very difficult to figure out when the trust comes back. "As an example, if we all decided to withdraw money from JPMorgan Chase, the largest bank in the world today, tomorrow, there would be no bank left.  Because of that, it's very difficult to figure out when the trust comes back," he said. 

"So, you can almost see the game play out - you get a weak bank, it gets knocked over, and the next target gets lined up almost immediately. So, I think it will end, let's hope it ends because otherwise, the end result is a catastrophe. It will end, but it's almost unpredictable when it ends. It is going to play itself out, and eventually, trust will come back, but there's going to be a lot of pain along the way," the professor said.