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What are ‘Too-Big-To-Fail’ banks, and what makes Indian banks safe?

GS Paper 3

Syllabus: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development

 

Source: IE

Context: Recent banking crisis in the US has raised the question of how secure Indian banks are in the age of start-ups and digitisation.

 

Background:

  • Despite the recent bank failures in the US (SVB), which occurred more than a decade and a half after the 2008 global financial crisis, Indian banks remained unaffected.
  • India has established Domestic Systemically Important Banks (D-SIBs)/Too-Big-To-Fail banks to protect itself from 2008/SVB-like episodes.

 

Too-Big-To-Fail banks:

What are D-SIBs?How are they selected?Significance
●       A bank that might substantially disrupt the financial system (because of its size, lack of substitutability, and interconnectedness) in the event of its failure.

●       In 2010, the Switzerland-based Financial Stability Board (FSB) recommended that all member countries should put in place a framework to reduce risks attributable to Systemically Important Financial Institutions (SIFIs) in their jurisdictions.

●       The D-SIB framework was announced by the Reserve Bank of India (RBI) in 2014.

●       RBI has classified SBI, ICICI Bank and HDFC Bank as D-SIBs.

●       These banks have to earmark additional capital and provisions to safeguard their operations.

●       This avoids moral hazard due to the perception that government support at times of distress encourages risk-taking, reduces market discipline, etc.

●       The RBI follows a two-step process.

●       First, a sample of banks to be assessed for their systemic importance is decided.

○        Banks (based on Basel-III Leverage Ratio Exposure Measure) having a size beyond 2% of GDP will be selected in the sample.

●       Next, the D-SIBs are segregated into buckets based on their systemic importance scores.

 

G-SIBs:

●       The Basel accord, in consultation with the Basel Committee on Banking Supervision (BCBS), has identified a list of G-SIBs.

●       There are 30 G-SIBs currently (none from India).

●       Including JP Morgan, Citibank, HSBC, Bank of America, Bank of China, Barclays, etc.

 

●       The failure of a large bank anywhere can have a contagion effect around the world.

●       The failure of a bank → damages confidence in the banking system → affects the domestic/global economy due to the interconnected financial systems.

●       As a result, government action was seen as being necessary for many jurisdictions to guarantee financial stability.

 

How is Indian banking unique?

  • Sound regulatory practices and government interventions when banks have faced difficulties (Yes Bank).
  • Different balance sheet structures – household savings constitute a major part of bank deposits in India, which can’t be withdrawn in bulk quantities.
  • A large chunk of Indian deposits is with public sector banks, and with very strong private sectors lenders such as HDFC Bank, ICICI Bank and Axis Bank.

 

Way ahead:

  • The RBI’s guidelines of 2018 advising banks to create an Investment Fluctuation Reserve is just the kind of countercyclical tool that has relatively insulated Indian lenders from interest rate risks.
  • Still, the RBI must remain on guard to ensure neither global contagion nor management missteps threaten any local lender.