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Understanding Domestic Systemically Important Banks (DSIBs)
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In the complex world of finance, certain banks stand out due to their sheer size, cross-jurisdictional activities, complexity, lack of substitutability, and interconnectedness. These financial giants are known as Domestic Systemically Important Banks or DSIBs. Domestic systemically important banks in India are State Bank of India (SBI), ICICI Bank, and HDFC Bank.
In this comprehensive guide, we will explore what DSIBs are, their significance, and their role in the financial landscape.
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What are Domestic systemically important banks (DSIBs)?
DSIBs, short for Domestic Systemically Important Banks, are financial institutions that have reached a level of significance where their operations can significantly impact the entire financial system and, consequently, the broader economy. These banks are often referred to as "Too Big To Fail (TBTF)" because their failure could have catastrophic consequences for the financial system.
Key Points
Here are some key points to understand DSIBs better:
- Systemic Risk: DSIBs pose a significant systemic risk, meaning that their collapse or failure can lead to a widespread financial crisis. The interconnectedness and interdependence of these banks with other financial institutions create a domino effect.
- Moral Hazard: The concept of moral hazard is closely associated with DSIBs. It refers to a situation where one party engages in risky activities because they know they are protected from the consequences, with the cost being borne by another party. In the case of DSIBs, the expectation of government support can encourage risk-taking behavior.
- Essential Services: DSIBs provide essential services to the banking system and the broader economy. Their disorderly failure can disrupt these services, leading to economic turmoil.
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Background of DSIBs
To better understand DSIBs, it's essential to explore their evolution and how they are identified globally.
G-SIBs: Global Systemically Important Banks
The Financial Stability Board (FSB), in collaboration with the Basel Committee on Banking Supervision (BCBS) and national authorities, has been identifying Global Systemically Important Banks (G-SIBs) since 2011. G-SIBs are international banks whose failure could have severe global implications. These institutions are subject to specific regulatory measures to mitigate systemic risk.
G-SIIs: Global Systemically Important Insurers
In addition to banks, the FSB, along with the International Association of Insurance Supervisors (IAIS) and national authorities, has been identifying Global Systemically Important Insurers (G-SIIs) since 2013. G-SIIs are insurance companies whose distress or failure could disrupt the global financial system. These insurers are subject to stringent regulations.
List of DSIBs in India
- State Bank of India (SBI)
- ICICI Bank
- HDFC Bank
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RBI’s Selection Process for DSIBs
The RBI employs a two-step process to evaluate the systemic importance of banks. Initially, a sample of banks is chosen for assessment, avoiding the inclusion of all banks to prevent imposing extensive data requirements on smaller banks regularly. The selection is based on the size of banks, determined by the Basel-III Leverage Ratio Exposure Measure as a percentage of GDP. Banks exceeding 2% of GDP are included in the sample. A composite score of systemic importance is then calculated for each bank using various indicators. Subsequently, the identified Domestic Systemically Important Banks (D-SIBs) are categorized into buckets based on their systemic importance scores. D-SIBs in lower buckets face a lower capital charge, while those in higher buckets incur a higher capital charge.
Domestic Systemically Important Banks (D-SIBs)
While G-SIBs and G-SIIs have a global focus, countries also identify and regulate banks and insurers that are systemically important at the domestic level. These are known as Domestic Systemically Important Banks (D-SIBs).
The D-SIB Framework
The D-SIB framework focuses on assessing the impact of a bank's distress or failure on the domestic economy. Unlike the global frameworks, D-SIB identification is conducted by national authorities, such as the central bank or regulatory agency, that are best positioned to evaluate the local financial system's vulnerability.
In India, the Reserve Bank of India (RBI) issued the D-SIB framework in 2014. This framework involves the assessment of several indicators, including size, interconnectedness, substitutability, and complexity.
Classification of D-SIBs
Based on their systemic importance scores, D-SIBs are classified into different buckets. These buckets determine the additional capital requirements for these banks. The capital requirement ranges from 0.20% to 0.80% of risk-weighted assets (RWA) and is referred to as Common Equity Tier 1 Capital (CET1).
CET1 capital is the highest-quality regulatory capital, designed to absorb losses immediately when they occur. It plays a crucial role in maintaining financial stability.
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Requirements to be Followed by Domestic Systemically Important Banks
- Domestic Systemically Important Banks (D-SIBs) must adhere to specific requirements to ensure financial stability.
- D-SIBs are identified based on a two-step process, considering size and systemic importance scores.
- Once designated, D-SIBs are categorized into buckets that determine their capital charge.
- D-SIBs with lower systemic importance face a lower capital charge, while higher systemic importance incurs a higher charge.
- Compliance with these requirements is essential for maintaining financial resilience and stability.
- The requirements aim to address the potential impact of the failure of D-SIBs on the overall financial system.
- Systemic importance scores are determined through a comprehensive analysis of various indicators.
- Regular monitoring and assessment ensure that D-SIBs align with the established criteria.
- The regulatory framework helps mitigate risks associated with the systemic importance of certain banks.
- By following these requirements, D-SIBs contribute to a robust and secure financial environment.
Foreign Banks and D-SIBs
Foreign banks that operate branches in a country with a D-SIB framework may also be subject to additional capital requirements if they are identified as G-SIBs. These requirements are proportional to their Risk Weighted Assets (RWAs) within that country.
Domestic Systemically Important Insurers
While much attention is given to systemically important banks, insurance companies also play a vital role in the financial system. Domestic Systemically Important Insurers (D-SIIs) are insurers of such size, market importance, and domestic and global interconnectedness that their distress or failure could disrupt the domestic financial system.
In India, notable insurers like the Life Insurance Corporation of India (LIC), General Insurance Corporation of India, and The New India Assurance Co have been identified as D-SIIs.
Conclusion
Domestic Systemically Important Banks and Insurers are critical components of a country's financial stability framework. Their identification and regulation are essential to prevent systemic crises and protect the broader economy from the consequences of their distress or failure. Understanding the role of DSIBs and their regulatory measures is vital in maintaining a resilient and stable financial system.
We hope that all your doubts regarding the Domestic Systemically Important Banks will be cleared after going through this article. You can download the Testbook App now to check out various other topics relevant to the UPSC IAS Exam.
Domestic Systemically Important Banks FAQs
Are DSIBs only a concern for large countries with extensive financial systems?
No, DSIBs can exist in both large and small economies. Even in smaller financial systems, a single bank's failure can have a profound impact on the stability of the entire system.
How often are DSIBs assessed for their systemic importance?
The frequency of assessment may vary by country, but it is typically done annually or as needed to ensure that the classification remains up-to-date.
What is the role of the International Association of Insurance Supervisors (IAIS) in identifying D-SIIs?
IAIS provides guidelines and recommendations for identifying D-SIIs globally. Member countries, including India, use these guidelines to identify and regulate systemically important insurers.
Can D-SIBs avoid being classified as such?
D-SIB classification is based on specific criteria and indicators. While banks can take measures to reduce their systemic importance, the final classification is determined by the national authorities.
How does additional CET1 capital help mitigate systemic risk posed by D-SIBs?
Additional CET1 capital acts as a financial cushion. In the event of a crisis, this capital can absorb losses, reducing the likelihood of a bank's failure and its impact on the broader financial system.