What is Systemically Important Bank?
Systemically important banks or a bank is one whose failure will have nationwide or worldwide repercussions, they are ‘too big to fail’. A bank failure is a scenario in which the bank or financial institution is unable to pay its depositors or fulfil its financial obligations.
'Too Big To Fail (TBTF)', this perception of TBTF creates an expectation of government support for these banks at the time of distress. Due to this perception, these banks enjoy certain advantages in the funding markets.
The Reserve Bank of India announced State Bank of India and ICICI Bank Ltd as Domestic Systemically Important Banks (D-SIBs) & subjected them to higher levels of supervision to prevent disruption to financial services in event of any failure. To understand this better, lets discuss this in detail.
Why RBI chose these banks as DSIBs?
The RBI uses a methodology to determine whether a bank is systemically important or not on the basis of its size, inter-connectedness, substitutability and complexity. Such banks have been termed as domestic-systemically important banks (D-SIB).
- Size: takes into account all exposures (Loans, savings deposits, commissions from mutual fund businesses) of a bank.
- Inter-connectedness: A bank is deemed more interconnected if it has borrowed or lent more money from other banks or financial institutions.
- Sustainability: it is a financial infrastructure indicator which determines whether the services provided by the bank are easily replaceable.
- Complexity: If a bank has higher complexity the cost and time taken to resolve its issues is more.
Based on these factors, RBI have chosen these banks as D-SIBs.
Framework for DSIBs
The Reserve Bank had issued the Framework for dealing with Domestic Systemically Important Banks (D-SIBs) in 2014. The Framework also requires that D-SIBs may be placed in four buckets depending upon their Systemic Importance Scores (SISs). The D-SIB Framework specifies a two-step process of identification of D-SIBs. In the first step, the sample of banks to be assessed for systemic importance has to be decided. The selection of banks in the sample for computation of SIS is based on analysis of their size as a percentage of annual GDP.