Domestic Systemically Important Banks: Why are these banks ‘too big to fail’?

Which banks have been classified as D-SIBs by the RBI?

The RBI has continued to identify SBI, HDFC Bank and ICICI Bank as Domestic Systemically Important Banks under the same bucketing structure as in the 2023 list of D-SIBs. The regulator had issued the framework for dealing with D-SIBs in July 2014. Since 2015, the RBI has been disclosing the names of the banks classified as D-SIBs every year.

While the Reserve Bank had announced SBI and ICICI Bank as D-SIBs in 2015 and 2016, HDFC Bank was classified as D-SIB in 2017 along with SBI and ICICI Bank. The current update is based on the data collected from banks as on March 31, 2024.

Why have D-SIBs been created?

Some banks, due to their size, cross-jurisdictional activities, complexity, lack of substitutability and interconnectedness, become systemically important. The disorderly failure of these banks has the potential to cause significant disruption to the essential services they provide to the banking system, and in turn, to the overall economic activity. Therefore, the continued functioning of Systemically Important Banks (SIBs) is critical for the uninterrupted availability of essential banking services to the real economy.

SIBs are perceived as banks that are ‘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. However, the perceived expectation of government support amplifies risk-taking, reduces market discipline, creates competitive distortions, and increases the probability of distress in the future. These considerations require that SIBs should be subjected to additional policy measures to deal with the systemic risks and moral hazard issues posed by them, according to the RBI.

What are the different buckets under which D-SIBs are placed?

Banks are allocated different buckets based on their systemic importance score. The RBI has placed SBI in bucket 4, HDFC Bank in bucket 3 and ICICI Bank in bucket 1.

What are the capital requirements for D-SIBs?

Based on the bucket in which a D-SIB is placed, an additional common equity requirement has to be applied to it. The additional capital requirement ranges from 0.20 per cent to 0.80 per cent of risk weighted assets, depending upon the bucket D-SIBs are plotted into.

On Wednesday, the RBI said, the additional common equity tier 1 (CET1) requirement as a percentage of Risk Weighted Assets (RWAs) for SBI is 0.80 per cent. The additional fund requirement for HDFC Bank is 0.40 per cent, and that for ICICI Bank is 0.20 per cent.

The higher D-SIB surcharge for SBI and HDFC Bank will be applicable from April 1, 2025. Hence, up to March 31, 2025, the D-SIB surcharge applicable to SBI and HDFC Bank will be 0.60 per cent and 0.20 per cent, respectively.

In case a foreign bank having branch presence in India is a Global Systemically Important Bank (G-SIB), it has to maintain additional CET1 capital surcharge in India as applicable to it as a G-SIB, proportionate to its Risk Weighted Assets (RWAs) in India, i.e., additional CET1 buffer prescribed by the home regulator (amount) multiplied by India RWA as per consolidated global Group books divided by total consolidated global Group RWA.

How are D-SIBs selected?

The process of assessment of systemic importance of banks by the RBI is a two-step process.

In the first step, a sample of banks to be assessed for their systemic importance are decided. The systemic importance of all the banks need not be computed as many smaller banks would be of lower systemic importance and burdening these banks with onerous data requirements on a regular basis may not be prudent, as per the RBI.

Hence, the sample of banks for identification of D-SIBs excludes many smaller banks. Once the sample of banks is selected, detailed study to compute their systemic importance is initiated. Based on a range of indicators, a composite score of systemic importance for each bank in the sample is computed. The banks having systemic importance above a threshold are designated as D-SIBs. D-SIBs are 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 the lower bucket attracts lower capital charge and a D-SIB in higher bucket attracts a higher capital charge.

Banks are 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 per cent of GDP are selected in the sample.

Which are global SIBs?

The Financial Stability Board (FSB), in consultation with Basel Committee on Banking Supervision (BCBS) and national authorities, has identified the 2023 list of global systemically important banks (G-SIBs). The list is based on end-2022 data, based on a methodology agreed upon in July 2018 and implemented for the first time in the end-2021 G-SIB assessment. The list for 2023 includes 29 G-SIBs, one less than the 2022 list. The G-SIBs include JP Morgan Chase, Bank of America, Citigroup, HSBC, Agricultural Bank of China, Bank of China, Barclays and BNP Paribas.

A new list of G-SIBs will be published this month.