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In this article, we would discuss Domestic Systemically Important Banks.

On August 31, the Reserve Bank of India (RBI) declared State
Bank of India (SBI) and Industrial Credit and Investment Corporation of India
(ICICI) as Domestic Systemically Important Banks (D-SIBs). This designation
means that the two banks-India’s largest public sector and private sector
lender respectively-would be considered one of the pillars of India’s economy
and every effort would be taken to prevent their downfall, which would be a catastrophic
blow to the economy.

This is the first time the RBI has identified any bank as
D-SIB and will disclose the names of such banks every August.

What is systemic
importance?

Banks assume systemic importance due to their size,
cross-jurisdictional activities, complexity, non-substitutability and
interconnectedness. Failure of such banks can significantly disrupt normal
functioning of the banking system, and consequently, the overall economic
activity. As they are critical for the uninterrupted availability of essential
banking services, these banks are considered Systemically Important Banks (SIBs).

There is one official list of
Global Systemically Important Banks (there are 30 G-SIBs as per the list
updated in November 2014) and several Domestic Systemically Important Banks
(D-SIBs) in each country.

Need for stricter
policy measures for SIBs

–
During the 2008 financial crisis, it was evident
that issues faced by a handful of large and highly interconnected financial
institutions hindered the orderly functioning of the financial system, thereby impacting
the real economy.

–
This necessitated government intervention to sustain
financial stability in many jurisdictions. To enhance resilience of banks and banking
systems after the crisis, a series of reforms called ‘Basel III norms’ were
developed.

–
However, the perception of SIBs being ‘Too Big
To Fail (TBTF)’ lends them greater government support in times of distress and
certain advantages in the funding markets.

–
As this increases risk-taking, reduces market
discipline, creates competitive distortions, and increases the likelihood of
distress in the future, SIBs need to be subjected to additional policy measures
beyond the Basel III norms.

–
Therefore, in 2010, the Financial Stability
Board (FSB) ordered that all member countries should have a framework in place
to reduce risks attributable to G-SIBs. In November 2011, the Basel Committee
on Banking Supervision (BCBS) developed an assessment methodology encompassing both
quantitative and qualitative indicators to evaluate systemic importance of banks.
The G20 leaders then requested that this framework be extended to D-SIBs as
well.

RBI’s methodology to
identify D-SIBs

RBI has outlined a two-step process to select banks of systemic
importance.

–Identification
of banks for assessment: The RBI will firstly decide on a sample of banks to be
assessed for their systemic importance.

– Computation of
their systemic importance: The RBI’s
methodology will be similar (with a few alterations) to the indicator-based
approach being used by the BCBS to identify G-SIBs. This includes the following
parameters:

1. Size: The RBI considers size as an important indicator as the downfall of a bank will
be more likely to damage the domestic economy and people’s trust in the banking
system if its activities constitute considerably large share of banking
activities. Size will be given a weight of 40% while other three indicators
will be given a weight of 20% each. Banks with assets exceeding 2% of the GDP
will be added in the sample. Both on-balance sheet and off-balance sheet size
will be considered.

2. Interconnectedness: Failure of one bank may increase the probability of failure of other banks if it
has a high degree of interconnectedness (contractual obligations) with the others.
This chain effect operates on the liability side as well as the asset side of
the balance sheet. The higher the number of linkages and size of individual
exposures, the greater is the systemic risk. Interconnectedness is further divided
into three-intra-financial system assets held by the bank, intra-financial
system liabilities of the bank and total marketable securities issued by the
bank.

3. Substitutability: The failure of a bank will have greater damage to the financial system and real
economy if certain critical services provided by the bank cannot be easily
substituted by other banks. Its failure would disrupt the availability and range
of services and infrastructure liquidity. Also, the costs to be shouldered by customers
of the failed bank to get the same service at another bank would be much higher
if the former had a greater market share in providing that particular service. Assets
under custody, Payments made in INR using RTGS and NEFT systems and total
amount of debt and equity instruments underwritten, are the three
sub-indicators of substitutability.

4. Complexity: The more complex a bank is, the greater are the resources and time required to revive
it. Three indicators of complexity of a bank are-(i) notional amount of
over-the-counter derivatives (unlisted stocks, debt securities and other
financial instruments traded through a dealer network and not a centralised
exchange); (ii) cross-jurisdictional liabilities (liabilities of all offices-including
headquarter, branches and subsidiaries in different jurisdictions-to entities
outside the home market are taken into account besides liabilities to NRI’s
within the country) and (iii) value of securities held for trading, available
for sale and designated as fair value.

SBI and ICICI – figures

–
As of June 30, SBI’s loan book carried a value
of Rs.12.8 trillion while ICICI’s loan book was close to Rs.4 trillion.

–
SBI constitutes 16.3% of the total market
capital of all listed banks whereas ICICI’s share is 14.08%.

–
As of June 30, SBI’s gross non-performing assets
(GNPAs) stood at Rs.56, 420.77 crore, constituting 18% of the total bad assets
in the banking system, which amount to Rs.3.2 trillion. On the other hand,
ICICI’s GNPAs constitute only 5% of the total bad loans.

–
SBI Tier I capital is at 9.62% as opposed to
7.00% required under the current guidelines. ICICI’s Tier I capital was 12.26% at
the end of June quarter.

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