Domestic Systemically Significant Banks (D-SIBs)

What’s in today’s article?

• Why in News?
• How Indian Banking Differs from Others?
• What are D-SIBs?
• How does RBI Select D-SIBs?
• Why is an Additional Common Equity Requirement Applicable to D-SIBs?
• Why was it Considered Essential to Establish SIBs?

 

Why in News?

• A decade and a half after the global financial crisis 2008, Indian banks remained unaffected by the other bank failures (SVB, Signature Bank) in the US recently, despite the global interconnectedness in the financial sector.

• The article emphasises how secure Indian banks are in the age of startups and digitisation, particularly the domestic systemically significant banks (D-SIBs)/Too-Big-To-Fail banks that have operations abroad.

 

How Indian Banking Differs from Others?

• In banking, confidence is important and no amount of capital will save a bank if the trust is lost.
• During the 2008 crisis triggered by the collapse of investment bank Lehman Brothers, domestic banks in India backed by sound regulatory practices showed strength and resilience.
• A reason why an SVB-like failure is unlikely in India is that domestic banks have a different balance sheet structure.
• Unlike the US, where a large portion of bank deposits are from corporates, household savings constitute a major part of bank deposits in India, which cannot be withdrawn in bulk quantities.
• A large chunk of Indian deposits is with public sector banks, and most of the rest is with very strong private sector lenders such as HDFC Bank, ICICI Bank and Axis Bank.
• Customers need not worry about their savings, as the government and the regulators (SEBI, RBI) have always stepped in when banks have faced difficulties. For example, the rescue of Yes Bank where a lot of liquidity support was provided.

 

What are D-SIBs?

• A bank is considered a D-SIB if its failure might seriously disrupt the financial system due to the bank’s size, cross-jurisdictional activities, complexity, lack of substitutability and interconnectedness.
• Under the D-SIB framework announced by the Reserve Bank of India (RBI) in 2014, the central bank was required to -
  • Disclose the names of banks designated as D-SIBs, and
  • Place them in appropriate buckets depending upon their Systemic Importance Scores (SISs).
• Depending on the bucket in which a D-SIB is placed, an additional common equity requirement [Common Equity Tier 1 (CET1)] is applicable to it.
  • Tier 1 capital (measured by the capital adequacy ratio (CAR)) is the core measure of a bank's financial strength from a regulator's point of view.
• It means that these banks have to earmark additional capital and provisions to safeguard their operations.
• RBI has classified SBI, ICICI Bank and HDFC Bank as D-SIBs.
• Similarly, the Basel - Switzerland-based Financial Stability Board (FSB), an initiative of G20 nations, has identified, in consultation with the Basel Committee on Banking Supervision (BCBS), a list of G-SIBs.
  • There are 30 G-SIBs currently (no Indian bank), including JP Morgan, Citibank, HSBC, Bank of America, Bank of China, Barclays, BNP Paribas, Deutsche Bank, and Goldman Sachs.

 

Image caption: Too big to fail banks

 

How does RBI Select D-SIBs?

• The RBI follows a two-step process to assess the systemic importance of banks.
• First, a sample of banks to be assessed for their systemic importance is decided. All banks are not considered, as burdening smaller banks with onerous data requirements on a regular basis may not be prudent.
  • Banks are selected based on an analysis of their size (based on Basel-III Leverage Ratio Exposure Measure) as a percentage of GDP.
  • Banks having a size beyond 2% of GDP will be selected in the sample.
  • Based on a range of indicators, a composite score of systemic importance is computed for each bank.
• Next, the D-SIBs are segregated into buckets based on their systemic importance scores.
  • A D-SIB in the lower bucket will attract a lower capital charge, and a D-SIB in the higher bucket will attract a higher capital charge.

 

 

Why is an Additional Common Equity Requirement Applicable to D-SIBs?

• The cost of public sector intervention, and the consequential increase in moral hazard, required that future regulatory policies should aim at reducing the probability of the failure of SIBs.
• SIBs are perceived as banks that are ‘Too Big To Fail (TBTF)’, due to which these banks enjoy certain advantages in the funding markets.
• However, this perception creates an expectation of government support at times of distress, which encourages risk-taking, reduces market discipline, and increases the probability of distress in the future.
• It is therefore felt that SIBs should be subjected to additional policy measures to guard against systemic risks and moral hazard issues.

 

Why was it Considered Essential to Establish SIBs?

• During the 2008 crisis, problems faced by certain large and highly interconnected financial institutions hampered the orderly functioning of the global financial system.
  • The failure of a large bank anywhere can have a contagion effect around the world.
  • The impairment or failure of a bank will likely cause damage to the confidence in the banking system as a whole (chain effect) → affecting the domestic real economy → interconnectedness/globalisation → affect global economy.
• Therefore, government intervention was considered necessary to ensure financial stability in many jurisdictions.
• In 2010, the FSB recommended that all member countries should put in place a framework to reduce risks attributable to Systemically Important Financial Institutions (SIFIs) in their jurisdictions.

 

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Q1) What is an Investment Fluctuation Reserve?

The RBI’s guidelines of 2018 advising banks to create an Investment Fluctuation Reserve is a kind of countercyclical tool that has relatively insulated Indian lenders from interest rate risks. It is created as a provision for any change in the market value of investments.

 

Q2) What is the Financial Stability Board (FSB)?

It is an international body that monitors and makes recommendations about the global financial system. It was established after the G20 London summit in April 2009 as a successor to the Financial Stability Forum (FSF).

 

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Source: What are ‘Too-Big-To-Fail’ banks, and what makes Indian banks safe