What are domestic systemically important banks (D-SIBs)? What is RBI’s framework to identify them?

economy D-sibs and rbi

Answer by Jai Parimi:

Tl;dr Systemically Important Banks (SIBs) are perceived as banks that are ‘Too Big To Fail'. Domestic SIBs are critical for the uninterrupted availability of essential banking services to the country's real economy even during crisis. RBI based on Basel committee's recommendations created a framework to safeguard the interests of public.

  • Recent global financial crisis proved that problems faced by certain large and highly interconnected financial institutions hampered the orderly functioning of the financial system, which in turn, negatively impacted the real economy.
  • Government intervention was considered necessary to ensure financial stability in many jurisdictions. Cost of public sector intervention and consequential increase in moral hazard required that future regulatory policies should aim at reducing the probability of failure of SIBs and the impact of the failure of these banks.

Timeline of events:

  • Oct'10: Financial Stability Board (FSB) recommended G20 nations to have a framework to reduce risks for Systemically Important Financial Institutions (SIFIs).
  • Nov'11 (updated in Jul'13): The Basel Committee on Banking Supervision (BCBS) came out with a framework to identify the Global Systemically Important Banks (G-SIBs) and the magnitude of additional loss absorbency capital requirements applicable to G-SIBs. The BCBS further required all member countries to have a regulatory framework to deal with Domestic Systemically Important Banks (D-SIBs).
  • Jul'13: RBI released a framework that discusses the methodology to be adopted by RBI for identifying the D-SIBs and additional regulatory/supervisory policies which D-SIBs would be subjected to.

The RBI's Framework:

  • RBI is primarily based on the BCBS methodology for identifying the G-SIBs with suitable modifications to capture domestic importance of a bank.

The methodology to be adopted by RBI to identify D-SIBs:
The process of assessment of systemic importance of banks will be a two-step process.

  1. Sample of banks to be assessed for their systemic importance will be decided. The sample of banks for identification of D-SIBs may exclude many smaller banks as their impact on the system would be less.
  2. Once the sample of banks is selected, Detailed study to compute their systemic importance could be initiated. Based on a range of indicators, a composite score of systemic importance for each bank in the sample will be computed. The banks having systemic importance above a threshold will be designated as D-SIBs.
  3. D-SIBs would be segregated into different buckets based on their systemic importance scores, and subject to loss absorbency capital surcharge in a graded manner depending on the buckets, in which they are placed. A D-SIB in lower bucket will attract lower capital charge and a D-SIB in higher bucket will attract higher capital charge.

The computation of systemic importance scores of all the banks in the sample will be performed annually based on the end-March data in the months of June-July every year using the following process.
Step 1: Sampling

  • The banks will be selected for computation of systemic importance based on the 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. For this purpose, latest GDP figure at market prices, released by Central Statistical Office, Government of India will be used.
  • As foreign banks in India have smaller balance sheet size, none of them would automatically get selected in the sample. few large foreign banks also in the sample because of their activity in the derivatives market and the specialized services provided by these banks which might not be easily substituted by domestic banks.

Step 2: Assessment methodology
The methodology used to assess the systemic importance is largely based on the indicator based approach being used by BCBS to identify G-SIBs. The indicators & sub-indicators to be used to assess D-SIBs & their weightages are given in table below:

Step 3: The role of regulatory/supervisory judgements
The multiple indicator based approach discussed above provides a general structure for assessment of systemic significance of banks. However, it is not a precise quantitative instrument and the final decision for designating a bank as D-SIB will also factor qualitative regulatory and supervisory judgements.

Step 4: Allocation of banks into buckets

  • Based on the data received from banks in the sample on the above indicators, systemic importance score will be calculated.
  • For each bank, the score for a particular indicator will be calculated by dividing the individual bank amount by the aggregate amount for the indicator summed across all banks in the sample.
  • The score for each category will be multiplied by 1000 in order to express the indicator scores in basis points.
  • Overall systemic importance of a bank will be computed as weighted average scores of all indicators. Thus, the systemic importance score of a bank would represent banks relative importance with respect to the other banks in the sample.
  • Banks that have scores above a threshold score will be classified as D-SIBs. However, the process of classification of a bank as D-SIB will also be guided by qualitative analysis and regulatory/supervisory insights about different banks. Banks will be allocated to different buckets based on their systemic importance score.
  • Banks that fall under a bucket pay extra Common Equity Tier 1
  • The systemic importance score will be calibrated in such a manner that the bucket 5 does not have any banks initially. An empty bucket with higher CET1 requirement will incentivize D-SIBs with higher scores not to increase their systemic importance in future. In the event of the fifth bucket getting populated, an additional empty (sixth) bucket would be added with same range and same differential additional CET1.
  • For foreign banks, different rules apply…..

Difference between Basel and RBI Framework:

Source: Reserve Bank of India

What are domestic systemically important banks (D-SIBs)? What is RBI's framework to identify them?

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