Systemically Important BanksBY: MAHIMA MADAN

PIYUSH ZAMBANI

Relevance •SIB are those entities whose failure might trigger a financial crisis.

•Post 2008 crisis the Financial Stability Board has published a list of global systemically important financial institutions.

•The banks are considered Systemically Important Banks (SIBs) as their continued functioning is critical for the uninterrupted availability of essential banking services to the real economy.

Need for SIB’S•As a response to the recent crisis, a series of reform measures were unveiled, broadly known as Basel III, to improve the resilience of banks and banking systems.

•Basel III reform measures include increase in the quality and quantity of regulatory capital of the banks, improving risk coverage, global standard for liquidity risk management.

• However, these policy measures are not adequate to deal with risks posed by systemically important banks. Therefore, additional policy measures for SIBs are necessary to counter the systemic risks and moral hazard issues posed by these banks, which other policy reforms do not address adequately.

•SIBs are perceived as ones 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.

•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.

•In October 2010, the Financial Stability Board (FSB) recommended that all member countries needed to have in place a framework to reduce risks attributable to Systemically Important Banks

• BCBS came out with a framework in November 2011 for identifying the Global Systemically Important Banks (G-SIBs).

• The BCBS has developed a methodology for assessing the systemic importance of G-SIBs. The methodology is based on an indicator-based measurement approach.

•The indicators capture different aspect that make a bank systemically important and its survival critical for the stability of the financial system.

•The selected indicators are –size, global (cross-jurisdictional) activity, interconnectedness, lack of substitutability or financial institution infrastructure, and complexity of the G-SIBs.

Assessment Process•The process of assessment of systemic importance of banks is a two-step process.

•In the first step, sample of banks to be assessed for their systemic importance will be decided.

•Once the sample of banks is selected,Based on a range of indicators, a composite score of systemic importance for each bank in the sample will be computed.

•The banks having systemic importance above a threshold will be designated as D-SIBs. D-SIBs would be segregated into different buckets based on their systemic importance scores.

s.no Indicator Sub-indicator Indicator weight1. Size ---- 40%

2. Interconectedness

Intra financial system assets

Intra financial system liabilities

Securities outstanding

6.67%

6.67%

6.67%

3. Substitutability Assets Under Custody

Payments made in INR using RTGS and NEFT systems

6.67%

6.67%

Underwritten transactions in debt and equity markets

6.67%

4 Complexity Notional amount of OTC Derivatives

Cross Jurisdictional Liabilities

securities in Held For Trading and Available for Sale categories

6.67%

6.67%

6.67%

Size•The impairment or failure of a bank will be more likely to damage the domestic economy if its activities constitute significantly large share of domestic banking activities.

•There is a greater chance that impairment or failure of a larger bank would cause greater damage to the financial system and domestic real economy.

• The impairment or failure of a bank with large size is also more likely to damage confidence in the banking system as a whole. Size is a more important measure of systemic importance than any other indicators and therefore, size indicator will be assigned more weight than the other indicators.

Interconnectedness Indicator•Impairment or failure of one bank may have the potential to increase the probability of impairment or failure of other banks if there is a high degree of interconnectedness (contractual obligations) with other banks.

•Interconnectedness indicator is divided into three sub-indicators: intra-financial system assets held by the bank, intra-financial system liabilities of the bank and total marketable securities issued by the bank.

Interconnectedness•INTRA FINANCIAL ASSETS :it includes lending to financial institutions and holding of securities issued by other financial institutions.

•INTRA FINANCIAL LIABILITIIES:All marketable securities issued by banks, deposits by financial institutions.

Substitutability•The greater the role of a bank as a service provider in underlying market infrastructure, eg payment systems, the larger the disruption it is likely to cause in terms of availability and range of services and infrastructure liquidity following its failure.

•Also, the costs to be borne by the customers of a failed bank to seek the same service at another bank would be much higher if the failed bank had a greater market share in providing that particular service

•The failure of a bank with a large share of underwriting of debt and equity instruments in the global market may prevent new securities issuance with negative consequences for the economy. .

Complexity Indicator The more complex a bank is, the greater are the costs and time needed to resolve it.

Three indicators of complexity have been considered to measure complexity of a bank:

(i) notional amount of over-the-counter (OTC) derivatives

(ii) cross jurisdictional liabilities

(iii) trading and available-for-sale securities.

OTC Derivatives•Nominal or notional amounts outstanding are the gross nominal or notional value of all deals concluded and not yet settled at the reporting date.

•The greater the number of non-centrally cleared OTC derivatives a bank enters into, the more complex a bank’s activities. This is especially so in the context of resolution as highlighted in the failure of Lehman Brothers.

•Banks are asked to report the figure for total notional amount for all types of risk categories and instruments (ie sum of foreign exchange, interest rate, equity)

•The indicator for each bank is calculated as the ratio of the notional amount outstanding for the bank and the sum total of the amounts reported by all banks in the sample.

Cross Jurisdictional Claims•Claims include deposits and balances placed with other banks, loans and advances to banks and non-banks, and holdings of securities and participations.

•cross-jurisdictional liabilities cover the liabilities of all offices of the same banking organisation (headquarters as well as branches and subsidiaries in different jurisdictions) to entities outside the home market. The sum includes all liabilities to non-residents of the country

Trade and sale of securities•Holding of financial securities for trading and available for sale securities could also generate spillovers through mark to market loss and subsequent fire sale of these securities in case an institution experiences severe stress.

•The indicator for each bank is calculated as the ratio of the total value of the bank’s holding of securities for trading and available for sale category and the sum total of the figures reported by the banks in the sample.

Bucket Additional CET 1 requirement (as a percentage of risk weighted assets)

5 (Empty) 1.00%

4 0.80%

3 0.60%

2 0.40%

1 0.20%

ADDITIONAL COMMON EQUITY TIER CAPITAL REQUIREMENT

Thank you!!