Domestic Systemically Important Banks: Why are these banks too big to fail"?

• The Reserve Bank of India (RBI) has once again classified State Bank of India (SBI), HDFC Bank, and ICICI Bank as Domestic Systemically Important Banks (D-SIBs), reinforcing the view that these banks are “Too Big To Fail” (TBTF) and critical to the economy's financial stability.

Highlights:

• The Reserve Bank of India (RBI) has once again classified State Bank of India (SBI), HDFC Bank, and ICICI Bank as Domestic Systemically Important Banks (D-SIBs), reinforcing the view that these banks are “Too Big To Fail” (TBTF) and critical to the economy's financial stability.

What Are D-SIBs?

• Domestic Systemically Important Banks are large institutions whose failure could severely impact the economy due to their size, complexity, interconnectedness, and lack of easily available alternatives. D-SIBs are viewed as crucial for maintaining essential banking services. Since 2015, the RBI has annually disclosed these banks, categorizing them under a bucketing structure that reflects their systemic importance.

Historical Classification:

• The RBI identified SBI and ICICI Bank as D-SIBs in 2015 and 2016, respectively, while HDFC Bank was included in 2017. This recent classification is based on data up to March 31, 2024, and maintains the banks’ previous positions in the bucket structure established in the 2023 list.

Why D-SIBs Are Important:

• The designation of D-SIBs ensures continuity of essential services. However, the TBTF label implies an expectation of government support during financial distress, which can reduce market discipline, encourage risk-taking, and potentially distort competitive markets. To address these risks, D-SIBs are subject to additional regulatory measures, particularly in capital requirements.

The Bucket System for D-SIBs:

• RBI places D-SIBs into different buckets based on their systemic importance score:
• Bucket 4: SBI
• Bucket 3: HDFC Bank
• Bucket 1: ICICI Bank
• Each bucket has specific additional capital requirements, known as the Common Equity Tier 1 (CET1) requirement, to absorb potential losses.

Capital Requirements for D-SIBs

• The capital surcharge for each bank is based on the bucket they occupy:
• SBI: 0.80% of Risk-Weighted Assets (RWAs) by April 1, 2025 (0.60% until March 31, 2025)
• HDFC Bank: 0.40% of RWAs by April 1, 2025 (0.20% until March 31, 2025)
• ICICI Bank: 0.20% of RWAs
• In cases where foreign banks operating in India are classified as Global Systemically Important Banks (G-SIBs) by their home country, they are required to maintain additional CET1 capital in India proportionate to their global risk-weighted assets.

Selection Process for D-SIBs:

• The RBI’s two-step process for identifying D-SIBs begins with selecting a sample of banks for evaluation. The sample typically includes banks with assets exceeding 2% of GDP.
• The banks in this sample are then assessed based on indicators like size, cross-jurisdictional activity, and complexity to compute a composite systemic importance score. Only banks with scores above a specified threshold are classified as D-SIBs, with higher-scoring banks placed in higher buckets.

Global Systemically Important Banks (G-SIBs):

• The Financial Stability Board (FSB) identifies G-SIBs annually. As of 2023, 29 banks, including JP Morgan Chase, Bank of America, Citigroup, HSBC, and Bank of China, are recognized as G-SIBs. These banks adhere to higher capital requirements and are subject to regulatory oversight to manage the systemic risk they pose globally.

Prelims Takeaways:

• Domestically Systemically Important Banks (D-SIBs)
• Global Systemically Important Bank (G-SIB)
• Financial Stability Board (FSB)