BackDe-jargoned: Systemically Important Financial Institutions
Such banks will attract a higher degree of supervision to ensure stability in the financial system
Premium
The Reserve Bank of India (RBI), on 22 July, released the framework to deal with “Domestic Systemically Important Banks" (D-SIBs). In the framework, RBI highlighted the methodology that it will adopt to identify such banks. These banks will be subjected to additional regulatory and supervisory requirements. The apex bank also said that based on the March 2013 data, 4-6 banks may be classified as D-SIBs. The framework released by RBI is in line with the recommendation of the Financial Stability Board that all member countries need to have a framework in order to reduce risks from “Systemically Important Financial Institutions".
What are Systemically Important Financial Institutions?
A number of financial institutions in the developed world, during the recent financial crisis, faced survival risk and became a threat to the financial system. As a result, governments had to step in to save these institutions to avoid the collateral damage, both in the financial market and in the real economy. Systemically Important Financial Institutions are those entities whose failure can threaten the survival of other institutions which in turn can possibly lead to a financial crisis. These institutions are also termed as “too big to fail".
The modern financial system is highly interconnected and interdependent where failure of a large financial institution can have a domino effect that can impact the stability of the entire financial system in that country. In fact, failure of a large financial institution with presence or connections in different parts of the world can threaten the stability of the global financial system. State intervention, which was seen necessary during the financial crisis, leads to what economists call the problem of moral hazard. Differently put, if banks and financial institutions are aware that governments will always bail them out, they may get encouraged to take higher risks.
Therefore, the Financial Stability Board, which has been established to facilitate coordination between financial authorities at the international level, in October 2010 recommended that its members should put in place a framework to contain the risk emanating from important financial institutions. In November 2011, the Basel Committee on Banking Supervision released a framework to identify systemically important banks at the global level. All members are required to have a framework for D-SIBs.
The framework
With some changes, RBI has adopted the methodology put forward by the Basel Committee. After assessing banks on indicators such as size and interconnectedness, the central bank will give a score for relative systemic importance. Banks with scores above the cut off, which is to be decided, will be termed as D-SIBs. Such banks will attract a higher degree of supervision to ensure stability in the financial system. RBI will declare names of such banks every August, starting 2015.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
