Banks That Are Too Big To Fail
Present circumstances:
- The fall of the investment bank Lehman Brothers in 2008 precipitated the global financial crisis, but India remained a safe haven thanks to its strong domestic institutions and sound regulatory framework.
- Notwithstanding the banking industry’s global interconnectivity, Indian banks were unaffected by Silicon Valley Bank’s (SVB) and Signature Bank’s bankruptcy in the US last week.
- How secure are Indian banks, especially the domestic systemically important banks (D-SIBs) with international operations in the age of startups and digitization?
What is the basis for the public’s confidence in the resilience of Indian banks?
- An SVB-like calamity is improbable because of the unique balance sheet structure of India’s local banks. Because “no system in India allows for the withdrawal of deposits in such enormous amounts,”
- In contrast to the US, where corporate deposits make up a major share of bank deposits, household savings make up a significant portion of bank deposits in India.
- Although a sizable number of them are held by public sector banks, the vast bulk of the remaining deposits in India are owned by extremely powerful private sector lenders like HDFC Bank, ICICI Bank, and Axis Bank.
- Customers were reassured by the banker that they should not be concerned about their investments, and it was stated that the government has always stepped in when banks have had issues.
- In India, the regulatory body has generally taken the position that depositors’ money must be protected at all costs. The best example is the Yes Bank bailout, which received significant liquidity support.
Which banks are classified as D-SIBs?
- The RBI has designated SBI, ICICI Bank, and HDFC Bank as D-SIBs.
- The additional Common Equity Tier 1 (CET1) requirement for D-SIBs increased gradually starting on April 1, 2016, until it was fully applied on April 1, 2019.
- In addition to the raised CET1 requirement, there was a capital conservation buffer. That suggests that in order to protect their commercial operations, these banks will need to set aside more capital and purchase insurance.
- The central bank was obligated, starting in 2015, to disclose the names of banks that had been classified as D-SIBs and to classify them according to their Systemic Importance Scores, per the D-SIB framework that the RBI announced on July 22, 2014. (SISs). Depending on the bucket to which it is assigned, a D-SIB may be subject to an additional common equity requirement.
- According to data obtained from banks as of March 31, 2017, HDFC Bank was categorised as a D-SIB with SBI and ICICI Bank. The most recent version was made using data obtained from banks as of March 31, 2022.
- The Basel, Switzerland-based Financial Stability Board (FSB), working with the Basel Committee on Banking Supervision (BCBS) and Swiss national authorities, has compiled a list of internationally significant institutions as part of a G20 initiative (G-SIBs).
- Among the 30 G-SIBs that are currently in operation are JP Morgan, Citibank, HSBC, Bank of America, Bank of China, Barclays, BNP Paribas, Deutsche Bank, and Goldman Sachs. There are no Indian banks listed.
How do the D-SIBs get picked by the RBI?
- The RBI employs a two-step process to assess banks’ systemic relevance.
- A sample of banks whose systemic importance will be assessed is first picked. Not all banks are created equal, and many smaller banks would be less relevant to the system as a whole if they were frequently subjected to onerous data requirements.
- It is decided whether a bank is of systemic importance by looking at its size (based on Basel-III Leverage Ratio Exposure Measure) as a percentage of GDP.
- Banks with a size greater than 2% of GDP will be included in the sample.
- An extensive examination to identify the banks’ systemic relevance has begun after a sample of banks has been selected. Based on a variety of factors, each bank is given a composite score of systemic relevance. D-SIBs are banks whose systemic relevance is greater than a specific threshold.
- In accordance with the groups to which the D-SIBs are designated based on their systemic importance scores, they may be assessed a graded loss absorbency capital surcharge.
- A D-SIB in the lower bucket will have a smaller capital charge, while a D-SIB in the upper bucket will have a greater capital charge.
Why did it seem necessary to create SIBs?
- Problems with a select number of important and closely related financial institutions contributed to the 2008 financial crisis, which negatively impacted the actual economy and the efficient operation of the global financial system.
- Government engagement was seen as necessary in many nations to ensure financial stability.
- All of the member countries should create a framework to reduce risks related to Systemically Important Financial Institutions (SIFIs) within their borders, according to a proposal made by the Financial Stability Board (FSB) in October 2010.
- The perception of SIBs being “Too Big To Fail (TBTF)” banks gives them an advantage in the funding markets.
- However, this mindset encourages risk-taking, impairs market discipline, distorts the competitive market, and increases the possibility of future difficult times. It also creates the expectation that the government will step in to aid when things become rough.
- Further regulatory measures are thought to be necessary to guard against systemic risks and moral hazard problems, according to the RBI report on D-SIBs.
- Although the Basel-III Norms call for a capital adequacy ratio (CAR) of 8% for the bank’s ratio of capital to risk, the RBI has been more conservative and required a capital adequacy ratio (CAR) of 9% for scheduled commercial banks and 12% for public sector banks.
Why are these precautions required?
- Everywhere in the world, the collapse of a big bank could lead to similar developments elsewhere.
- The impairment or failure of a big bank is also likely to reduce public trust in the banking sector as a whole. For determining systemic importance, size is more important than any other signal, and size indicators are given more weight.
- The impairment or failure of one bank could potentially increase the possibility of impairment or failure of other banks if there is a high degree of interconnectivity (contractual commitments) between them.
- Since that this chain effect has an impact on both the funding side and the asset side of the balance sheet, there might be links between them.
- As a result, the degree of individual exposures and the number of links both enhance the possibility that the systemic risk would be exacerbated, which could raise concerns in the financial sector.
- D-SIB provides the financial sustainability in the economy and also receives assistance from the government during tough times because it is essential for the financial viability of the economy.
