Mumbai: The Reserve Bank on Monday included HDFC Bank in its list of ‘too big to fail’ lenders, also referred to as D-SIB or domestic systematically important banks.
With the inclusion of HDFC now, there are three D-SIBs in India, the other two being SBI and ICICI Bank.
The term to ‘too big to fail’ is every bit daunting as it sounds. Simply put, it refers to banks that are systematically so important that their failure would have a domino effect, leading to the disruption of the banking system. In the event of its failure, the govnernment would have to come to its rescue.
So how was this term coined?
The phrase ‘too big to fail’ came into existence in the aftermath of the global financial crisis of 2007-08 when big lenders collapsed, affecting several economies around the world.
How does RBI define ‘too big to fail’ banks?
In its framework to deal with D-SIBs, RBI defines them as: “banks [that] assume systemic importance due to their size, cross-jurisdictional activities, complexity, lack of substitutability and interconnectedness. The disorderly failure of these banks has the propensity to cause significant disruption to the essential services provided by the banking system, and in turn, to the overall economic activity. These 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.”
It goes on to say that “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”. Moreover, due to this perception of these banks as being TBTF, they enjoy certain advantages in the funding markets.
How does RBI identify these banks?
RBI follows a certain assessment methodology to identify D-SIBs that was prepared by the Basel Committee on Banking Supervision (BCBS) as part of the various measures that were taken to prevent global economic disruptions like the economic crisis of 2007-08.
In a two-step process, RBI first creates a sample of banks to be assessed for their systemic importance which mostly excludes smaller banks of low systematic importance.
Then the RBI, through a detailed study of various indicators, selects D-SIBS that have systemic importance “above a threshold”.