What is a systemically important bank?
Systemically important bank or a bank that is ‘too big to fail’ is one whose failure will have nationwide or worldwide repercussions. A bank failure is a scenario in which the bank or financial institution is unable to pay its depositors or fulfil its financial obligations.
So why were SBI and ICICI Bank declared systemically important?
Primarily because of their size. The Reserve Bank of India (RBI) uses a methodology to determine whether a bank is systemically important or not on the basis of its size, interconnectedness, substitutability and complexity. Such banks are called domestic-systemically important banks (D-SIB)
Wait a second, what do these factors take into account?
Size takes into account all exposures (Loans, savings deposits, commissions from mutual fund businesses) of a bank. According to RBI, “The impairment or failure of a bank of large size is more likely to damage the confidence in the banking systems as a whole.”
SBI and ICICI Bank’s total credit risk exposure was over Rs 30 lakh crore or around 30% of India’s GDP. Secondly, a bank is deemed more interconnected if it has borrowed or lent more money from other banks or financial institutions.
Sustainability is a financial infrastructure indicator which determines if the services provided by the bank are easily replaceable or not. For instance, if a bank that fulfilled the highest number RTGS transactions was to fail its effect on the financial system would be relatively higher. SBI (along with its subsidiaries) and ICICI Bank complete 23% of all RTGS transactions.
Lastly, if a bank has higher complexity the cost and time taken to resolve its issues will higher. Among other things complexity takes into account the size of international liabilities. The two banks have a collective overseas exposure of Rs 5 lakh crore as of June 30.
And this makes them ‘too big to fail’ (TBTF), as the US puts it?
Yes it does. RBI noted in its framework for dealing with D-SIBs: “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”.
Does this mean that SBI and ICICI Bank will be treated similar to Citigroup and Bank of America in case of a crisis?
Not exactly. Citigroup and Bank of America were among the many banks – which gave rise to the term TBTF – that had assumed too much risk in the absence of regulations.
Also, these risky assets were spread all over the world. Therefore, if these banks were not bailed out — at a cost of $700 billion — the global financial system would have faced an even graver crisis.
However, after the crisis central banks and governments, globally, adopted a stronger regulatory stance that could prevent and foresee any such crises.
Does India have such regulations?
Yes it does. Primarily these are stipulated reserve requirements such as the cash reserve ratio. Also, there are norms such as the globally-accepted Basel III that require banks to have a certain amount of capital adequacy ratio, which determine how much shock a bank can absorb.
While these apply for all banks, SBI and ICICI Bank, which have been identified as D-SIB, will have to maintain additional capital as a percentage of its risk weighted assets.
This additional percentage is 0.6% for SBI and 0.2% for ICICI Bank. The two banks will have to implement this in a phased manner by April 1, 2019 or face further restrictions. All of the above are however, preemptive measures.
But, what if these banks do fail?
RBI’s wholly-owned subsidiary Deposit Insurance and Credit Guarantee Corporation (DICGC) insures savings, fixed, current and recurring deposits with all commercial up to a maximum of Rs 1,00,000, which means you will lose all your savings above that amount.
So much for the personal impact, a bank failure will imply all other deposits with the bank will be liquidated and RBI will take over the bank’s operation till it is acquired by someone else. However, this is a very rare case and since the early nineties no bank has failed in India as RBI has stepped in and effected a merger.