Banks Too Big To Fail

Are Indian banks ‘too big to fail’?-Hindu Business Line By Radhika Merwin

 

 

Their size and business models suggest they may need to be seen from a different perspective

BL Research Bureau:  

Last week, the RBI said it will identify 4-6 Indian banks which are ‘too big to fail’ and require them to adhere to more stringent capital adequacy norms and other rules. But analysis of data shows that Indian banks are midgets compared to their global peers.

 

The Financial Stability Board (headquartered in Switzerland) has identified 29 banks as systemically important from a global perspective.

Size comparison

These banks are headquartered across 11 countries. The eight US banks in the list have combined assets of more than 60 per cent of the country’s GDP. The UK and France have four banks each featuring in the list, and their assets-to-GDP ratio is about 300 per cent.

 

Contrast this with the six likely big banks in India. Their combined assets are just over one-third of the country’s GDP. In Germany, one bank alone has assets-to-GDP of 60 per cent. Compare this to India’s largest bank SBI, whose assets are just 15 per cent of our GDP.

 

In absolute terms, too, the size of global banks are intimidating. JP Morgan Chase, the largest bank in the US, has an asset size of $2,415 billion, which is nearly eight times that of SBI’s. The lending operations of Indian banks are also much lower than that of their global peers. JP Morgan’s loan book is nearly three times that of our largest lender (SBI). Closer home, Industrial and Commercial Bank of China, which tops the list global big banks in terms of asset size, has a loan book that is nearly eight times that of SBI’s.

Risk factor

Indian banks also differ substantially from global banks in terms of risk of operations. Domestic banks now mainly resort to plain vanilla lending, to companies and retail clients. The risk for them thus emanates from the quality of borrowers.

 

In advanced economies, on the other hand, most banks have high exposure to inter-connected financial products. It was this inter-connectedness of global financial institutions, through credit guarantees and other financial contracts that led to the global crisis.

 

After the financial crisis, global banks have strengthened their operations by retaining more of their profits and relying more on retail sources for their funds.

The BIS (Bank for International Settlements), following a study of 92 banks from advanced and emerging economies, notes that one-third of the institutions that entered the crisis in 2007 as wholesale-funded or trading banks (engaged heavily in trading and investment banking), ended up with a retail model (vanilla lending through retail deposits) by 2012.

Thus, globally, banks have shifted their business models towards traditional banking to reduce risk.

 

With Indian banks already following a traditional banking structure, the risk is already lower. Most large private banks are also well capitalised with Tier-1 capital ratio of 11-12 per cent. This, according to BIS, is much higher than the capital ratio of 9.5 per cent for large, internationally active banks.

Selection process

The move to identify too-big-to-fail banks is in line with the mandate of the Basel Committee of Banking Supervision. So it is debatable whether Indian banks are really that systemically important.

 

The relative size and business models of Indian banks suggest that they may need to be looked at from a different perspective.

 

After the FSB started identifying Global Systemically Important Banks (GSIBs) in November 2011 — the failure of which can impact the entire global financial system — individual countries such as India are now embarking on this exercise.

 

While the RBI has laid down the framework for Domestic Systemically Important Banks (DSIBs), in line with the broad principles of the Basel Committee, the RBI has adapted it to local conditions in its method of selecting the big banks as well as assessing their additional capital requirement.

 

For instance, one of the criteria when selecting GSIBs is cross-jurisdictional activity (a bank’s activities outside its home turf). This has been omitted by the RBI when identifying DSIBs. Size (in terms of asset size) has been the main criteria for the RBI.

 

Similarly, the capital needs set out for Indian big banks are much lower than that prescribed for global banks.

 

Indian banks need to set aside 0.2-0.8 per cent extra capital based on the category under which they fall. Global biggies in contrast have to set aside 1-2.5 per cent extra capital.

RBI unveils tighter regulatory norms for ‘too-big-to-fail’ banks

Banks whose size equals 2% of GDP will be designated as systemically important

Mumbai, July 22:  

The RBI today set out a framework for identifying and dealing with large banks, termed domestic systemically important banks or D-SIBs.

 

A size beyond 2 per cent of GDP will be one of the criteria for designating a bank as a D-SIB and it will be subject to higher capital requirements, according to the Reserve Bank of India.

The other three criteria for designating a bank as a D-SIB are: interconnectedness; lack of readily available substitutes or financial institution infrastructure; and complexity.

The RBI framework comes as a solution to the problems faced during the global financial crisis of 2008, when such large institutions hampered the functioning of the financial system, negatively impacting the real economy.

 

D-SIBs are perceived as banks that are ‘Too Big To Fail’. This perception creates an expectation of government support for these banks at the time of distress, the RBI said in its framework for dealing with D-SIBs.

 

The expectation of government support leads to risk-taking, reduces market discipline, creates competitive distortions, and increases the probability of distress.

These considerations require that SIBs be subjected to additional policy measures to deal with the systemic risks and moral hazard issues posed by them.

 

The RBI said banks having systemic importance above a threshold will be designated as D-SIBs.

These banks will be segregated into five 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 a lower bucket (bucket 4) will attract a lower capital charge (of 0.20 per cent) and a D-SIB in a higher bucket (bucket 5 or empty bucket) will attract a higher capital charge (1 per cent).

 

An empty bucket with a higher common equity tier 1 requirement will incentivise D-SIBs with higher scores not to increase their systemic importance in future. In the event of the fifth bucket getting populated, an additional empty (sixth) bucket would be added with the same range and same differential additional capital.

 

The RBI said the higher capital requirements applicable to D-SIBs will be applicable from April 1, 2016, in a phased manner and would become fully effective from April 1, 2019.