Banks That Are Too Big To Fail [UPSC Notes]

The recent failure of Silicon Valley Bank and Signature Bank in the US raises questions on the safety of depositors’ wealth all over the world including India. In this context, ‘banks that are too big to fail’ is a concept frequently seen in the news. In this article, we explain the term and its implications from the perspective of the IAS exam.

Too Big To Fail Banks

“Banks that are too big to fail” is a term used to describe financial institutions that are considered so important to the economy that their failure could lead to catastrophic effects on the economic system of the country. 

• These institutions are large, interconnected and pivotal in that their failure could trigger a chain reaction that could collapse the entire financial system.

Context of India: 

• In India, there are a few banks under the category, these are the State Bank of India (SBI), ICICI Bank and HDFC. 
• These banks are considered important because of their size and the significant role they play in the Indian financial system. For example, SBI is the largest bank in India, accounting for nearly a quarter of the country’s total banking assets.

Classification of Systemically Important Banks

• RBI has classified SBI, ICICI Bank, and HDFC Bank as Domestic Systemically Important Banks (D-SIBs) .
• Through a two-step process:

1. A sample of banks to be assessed for this categorization is decided. Banks are chosen based on their size (based on Basel-III Leverage Ratio Exposure Measure) as a percentage of GDP. 

           a) Banks having a size beyond 2% of GDP are chosen in the sample.

      2. After the selection of a sample, the ranking of systemic importance is done based on a range of                     indicators. 

            a) Based on their systemic importance scores various measures and provisions need to be                                 followed. 

            b) A D-SIB in the lower bucket will attract a lower capital charge, and a D-SIB in the higher                               bucket  will attract a higher capital charge.

• These measures of RBI are designed to ensure that the risks associated with large, complex financial institutions are minimized and that the stability of the financial system is maintained.

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