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Two-step process to pick big & key banks

Mumbai, Dec. 2: The Reserve Bank of India plans to start an exercise to identify banks that are systemically important in India.

The evaluation of the systemically important banks (SIBs) will be done through a two-step process. In the first step, a sample of the banks will be drawn up based on size, cross-jurisdictional activities, complexity, lack of substitutability and inter-connectedness.

The idea is to head off the sort of moral hazard that hove into view when the 2008 financial crisis erupted, prompting the US administration to bail out the big banks in the US that were popularly classified as being “too big to fail” (or simply, TBTF).

No one wants to be trapped in a similar ethical debate once again because TBTF “creates an expectation of government support for these banks at the time of distress,” says an RBI note on the subject circulated today.

“The perceived expectation of government support amplifies risk-taking, reduces market discipline, creates competitive distortions, and increases the probability of distress in the future. These considerations require that SIBs should be subjected to additional policy measures to deal with the systemic risks and moral hazard issues posed by them,” the RBI note said.

The RBI has distilled its own evaluation parameters to identify SIBs in India based on the methodology that was developed by the Basel Committee on Banking Supervision in 2010 in response to the Financial Stability Board (FSB) recommendations “that all member countries needed to have in place a framework to reduce risks attributable to systemically important financial institutions (SIFIs) in their jurisdictions”.

Banks designated as SIBs will be subjected to more onerous capital requirements.

The RBI said the exercise to draw up its sample of banks based on their systemic importance would not cover all the lenders and it would exclude the smaller banks.

The note said once the sample of banks was created, a detailed study would be done to compute their systemic importance. Based on a range of indicators, a composite score of systemic importance for each bank in the sample would be computed.

The banks having systemic importance above a threshold will be designated as D-SIBs. D-SIBs would be segregated into different buckets based on their systemic importance scores. The central bank is proposing that a D-SIB in lower bucket will attract lower capital charge and a D-SIB in higher bucket will attract higher capital charge.

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