What is systemically important financial institutions?

After the global financial crisis of 2007, financial regulators like central banks and governments have taken a firm pledge that the mistakes of the past should not be repeated. They made several arrangements to correct the excessive risk taking mentality of the big banks which is described as the’ too big to fail’ (TBTF) problem.

The TBTF is a psychic mentality of a big bank where it believes that it is too big and when some bad thing happens to it, the government will take care of it and public money will be utilized for the rehabilitation of the bank.

Now after the financial crisis, the central banks have done some extraordinary smart work with the political energy injected by the G 20 and created some global and national arrangements to arrest future bank failures. The G 20 has created an institution called Financial Stability Board to design sophisticated regulation measures for banks. Besides, the BIS (Bank for International Settlement) has also supported the G20 initiatives. These institutions have collectively brought out several measures including identification of systemically important banks (and also systemically important financial institutions, which include institutions like insurance companies) and asking them to keep more capital.

Big banks are systemically important because of their size, network, and their ability to provide complex financial products on their own. Hence, when they fall, effects will be disastrous for the global economy. if such banks are controlled or well regulated, the occurrence of a crisis and its adverse effects etc. can be minimized. Hence, the Basel Committee on Banking Supervision (BCBS) started to identify such big banks which are named as Global Systemically Important Banks (G-SIBs) who are spread across the world. The BCBS has developed sound criteria for identifying the G -SIBs. These criteria are:

1. Size (business volume or asset size) – higher the size, higher will be systemic importance

2. Interconnectedness: Interconnectedness refers to networking and intra financial market dealings by the bank. Higher the interconnectedness, higher will be systemic importance.

3. Substitutability: whether there are adequate substitutes for major businesses of the bank. Lack of substitutability enhances systemic importance of a bank.

4. Complexity – higher volume of complex financial products like derivatives traded by the institution

As per the 2015 (November) of the FSB, there are 30 banks across the world as G-SIBs. There is no Indian bank in the list.

If a bank is identified as G-SIB, it has to undergo much stricter regulations and has to keep more capital to survive any risk. The BCBS has prescribed additional capital requirements for GSIBs under the Basel III norms. They have to keep additional capital of 3.5% to 1 % of their assets.

In the same fashion, central banks of each country should identify Domestic Systemically Important Banks (D-SIBs). The criteria for selecting D-SIBs are similar to that of G-SIFIs. In India, the RBI has identified SBI and ICICI as D-SIBs.

The RBI has adopted the scale of systemic importance to impose higher level of regulation on a particular institution. For example, there is Systemically important NBFCs and Core Investment Companies- Systemically Important besides the D-SIBs.