Syllabus:GS 3/ Economy
In News
- RBI has retained State Bank of India (SBI), HDFC Bank, and ICICI Bank as Domestic Systemically Important Banks (D-SIBs) for 2024 under the same bucket structure as in 2023.
- SBI and ICICI were classified as D-SIBs in 2015 and 2016, respectively, while HDFC joined in 2017.
About Domestic Systemically Important Banks (D-SIBs)
- The Reserve Bank of India (RBI) designates D-SIB status to banks that are considered “Too Big to Fail” due to their size, complexity, and interconnectedness within the financial system.
- The D-SIB classification is updated annually based on the framework set by RBI in 2014.
- The Reserve Bank of India (RBI) has categorized banks into five buckets based on their risk profiles and capital requirements. This categorization is primarily based on their Additional Common Equity Tier 1 (CET1) ratio to Risk Weighted Assets (RWAs).
- Banks in Bucket 1 must maintain the lowest Common Equity Tier 1 (CET1) capital surcharge, while those in Bucket 5 have to maintain the highest CET1 buffer.
- RBI evaluates banks over 2% of GDP in size to determine systemic importance. Banks above a threshold are classified as D-SIBs and assigned a bucket, determining their CET1 requirements.
- Foreign Banks Operating in India: The Financial Stability Board, with other global regulators, identifies Global Systemically Important Banks (G-SIBs) annually.
- Foreign banks designated as (G-SIBs) must maintain CET1 capital in India proportional to their Risk Weighted Assets (RWAs) in the country.
| – Common Equity Tier 1 (CET1): It is a critical component of a bank’s capital and a key measure of its financial strength. CET1 capital includes the bank’s common shares, retained earnings, and other comprehensive income, excluding items like intangible assets and deferred tax assets that could reduce its ability to absorb losses. – Risk Weighted Assets (RWAs): It is used to determine the minimum amount of capital a bank needs to hold to cover potential losses, ensuring the bank remains stable in times of financial stress. Assets are assigned different risk weights (e.g., 0% for cash, higher percentages for loans) based on their likelihood of default. Riskier assets like loans or derivatives have higher weights, requiring more capital. |
Benefits of the D-SIB Classification
- Enhanced Stability: Large banks with complex operations are essential for providing continuous financial services.
- By requiring higher capital reserves, the RBI ensures that D-SIBs are better equipped to handle economic downturns, protecting depositors and maintaining confidence in the banking system.
- Systemic Safeguards: The classification encourages sound risk management practices among major banks, lowering the risk of disruptive bank failures.
- Preparedness for Future Shocks: The RBI’s D-SIB framework allows proactive adjustments to banks’ capital requirements, enabling the financial system to respond more effectively to future challenges.
Challenges
- Moral Hazard: The “Too Big to Fail” perception can create expectations of government support for D-SIBs in times of crisis, which may inadvertently encourage risk-taking and reduce market discipline.
- Competitive Distortions: Smaller banks, which are not classified as D-SIBs, may find it difficult to compete against these large institutions that benefit from investor confidence and market advantages tied to their perceived stability
- Increased Costs: Higher capital requirements may lead to increased operational costs for D-SIBs, potentially affecting their profitability and competitive positioning in the banking industry.
Conclusion and Way Forward
- The D-SIB classification remains a vital tool for safeguarding India’s financial stability, ensuring that essential banking services remain available even during economic challenges. As India’s economy grows and its financial landscape evolves, the RBI’s D-SIB framework may continue to expand, potentially adding more institutions to the list.
- With proactive regulation and risk management, D-SIBs will likely continue to play a pivotal role in supporting India’s economic growth and resilience.
Source: TH
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