It has been a routine activity for the Reserve Bank of India to identify certain banks as domestic systemically important banks (D-SIBs). Last week, on Thursday, the central bank published the list for FY25. The usual three — State Bank of India among public sector banks and HDFC Bank and ICICI Bank among private banks — found mention in the list.
Colloquially, such banks are reckoned as ‘too big to fail’ and certainly so because they represent over 50 per cent of the country’s total banking system. Banks classified so are required to hold addition common equity Tier-1 capital as a percentage of risk weighted assets so that they have the capital cushion to handle any crisis. In 2010, post the global financial crisis, the Financial Stability Board of the Basel Committee on Banking Supervision recommended that all member countries should have a framework to reduce risks attributable to Systemically Important Financial Institutions, and in the process identify and establish a regulatory framework to deal with D-SIBs. India adopted this concept in 2014, along with its global peers, and in 2015, named SBI and ICICI Bank as D-SIBs. A year later, HDFC Bank was added to the list.
While this classification is at one end, it’s equally important to acknowledge that the RBI has always handled any bank failure with such vigour that these events have barely dented the overall stability and balance of the country’s banking system. Whether it was the massive failure of Global Trust Bank two decades ago, or the more recent YES Bank crisis that could have severely jolted the country’s financial stability and image in the global arena, the central bank was quick to cautiously execute a rescue mechanism.
In short, for the RBI, irrespective of the size, every bank is reckoned as ‘too big to fail’, and this is the approach adopted every time the country faced a crisis.
In fact, including the largest urban cooperative bank, India has seen three bank failures in a span of two years (2019 and 2020). What’s extremely appreciable is that unlike the past instances, where failed banks were handed out to large PSU and private banks to rescue them, the RBI devised newer solutions to handle each crisis. Whether it was a consortium of financial institutions led by SBI, which bailed out YES Bank, or Lakshmi Vilas Bank’s buyout by DBS Bank India or Unity Small Finance Bank created to rescue PMC Bank, each of these are out-of-text book solutions devised by the RBI to ensure that no bank, big or small, is left to fail.
In a country where depositors’ money forms the bedrock for the banking system, truly the regulator cannot afford any bank to fail, irrespective of its positioning or scale in the system. Therefore, while the three banks – SBI, HDFC Bank and ICICI Bank are classified as D-SIBs — in reality, every bank is systemically important. The nomenclature of D-SIB is important from a global compliance perspective, but in practice almost every bank has been treated as too big to fail.
"Too big to fail" (TBTF) is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected that their failure would be disastrous to the greater economic system, and therefore should be supported by government when they face potential ...
Since large financial institutions are essential to the workings of an economy, it may require government to step in to prevent their failure. Thus, they are considered too big to fail. This creates a moral hazard problem.
- It is valuable to big banks rather than little banks. - Too-big-to-fail policy assists with overseeing risk efficiently. - Policy would offer security to depositors as well as creditors. The Too-big-to-fail policy upholds huge monetary foundations and offers advantages to depositors and creditors.
RBI continues to classify SBI, ICICI Bank and HDFC Bank in the category of D-SIBs. But, what are D-SIBs? These are the banks which are so important for the country's economy that the government cannot afford their collapse. Hence, D-SIBs are thought of as “Too Big to Fail” (TBTF) organisations.
In February 2009, under new President Barack Obama, Congress passed the $789 billion American Recovery and Reinvestment Act, which helped bring about an end to the economic recession. The stimulus package included $212 billion in tax cuts and $311 billion in infrastructure, education and health care initiatives.
Based on this array of flawed assumptions and mismanagement, each bank put billions of funds to work, some in loans and others in bonds. Most of these investments were made at lower interest rates. As inflation increased, by 2022, interest rates skyrocketed and these longer-term loans and bonds lost market value.
In most cases, the FDIC will try to find another banking institution to acquire the failed bank. If that happens, customers' accounts will simply transfer over to the new bank. You will get information about the transition, and you will likely get new debit cards and checks (if applicable).
One of the primary concerns is that large banks might be perceived as “too-big-to-fail” by regulators and creditors, allowing these banks to take excessive risks.
This is because the upside value goes to the shareholders if the risk pays off, while the downside is borne by others. This creates a clear incentive to take on risks that are imprudent. This incentive is often referred to as the "moral hazard" problem.
The collapses in March of Silicon Valley Bank (SVB) and Signature Bank – two of the largest U.S. banks to fail since the Great Depression of the 1930s – have led some to wonder if the nation may be headed for a new widespread banking crisis.
Amazon CEO Jeff Bezos told employees, in response to a question at an all-hands meeting last week, that the company is not “too big to fail.” Bezos was asked a similar question at an internal meeting in March about Amazon's size and the potential for government regulation.
Thus, the systemic importance of a particular bank is closely associated with the number of different risky banking activities in which the bank participates. This, in turn, may not be directly associated with the bank's size. In other words, “too big to fail” is not always valid.
Conclusion. The Bank of the Commonwealth bailout in 1972 was the first too-big-to-fail bailout of the modern era. It was then followed by a sequence of too-big-to-fail bailouts by the FDIC and the Federal Reserve that led to the Continental bailout of 1984 and, ultimately, those of the recent financial crisis.
If the failing bank cannot pay its depositors, a bank panic might ensue, causing depositors to withdraw their money from the bank (known as a bank run). This can make the situation worse for the failing bank by shrinking its liquid assets. When a bank's assets decrease, it has less money to lend to borrowers.
Banks can fail for a variety of reasons including undercapitalization, liquidity, safety and soundness, and fraud. The chartering agency has the authority to terminate the bank's charter and appoint the FDIC to resolve the failure.
Most significant, the nation learned over the weekend that Silicon Valley Bank, the 16th largest depository institution in the United States, was deemed by the government to be too big to fail — at least in the sense that the normal rules for allocating losses were set aside.
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