By Ruma Dubey

In Sept 2008, there were long serpentine queues across the country at almost each and every ATM of ICICI Bank.  Panic stricken account holders were scurrying from one ATM to the other and there was a sense of palpable fear across the country.

This was when the worldwide financial meltdown happened and rumors started floating around that ICICI Bank was going down as it was caught in a big financial mess. We had friends and relatives calling us up, asking whether this news was true. Even at that time, very nonchalantly, we refuted these rumours and our answer was simple and straight, “ICICI Bank is the second largest bank and the largest private sector bank of India. It is simply too big to go down; if it goes down, our country will go down. So don’t worry, nothing will happen.”

The key word then was – too big to go down. There was so much at stake; even if there had been a financial trouble, there would have been no option but to bail out the bank.

And that is precisely what came into the mind today when we read the news - RBI unveils tighter regulatory norms for ‘too-big-to-fail’ banks.  Calling these as ‘Domestic Systematically Important Banks’ or D-SIBs, it set out four criteria – its size should be beyond 2% of India’s GDP,  interconnectedness; lack of readily available substitutes or financial institution infrastructure; and complexity. RBI is expected to list out the names of 4-5 such banks by August’15 but rough guess would be SBI, Punjab National Bank, Bank of India and ICICI Bank.

Ever since the 2008 crisis, there has been a debate raging about the need to have such big banks as there is fear that stress in these banks could put the entire country into a jeopardy. There have been economists worldwide who have advocated breaking down of these too-big-to-fail banks. The most famous amongst them was Robert Fisher, President of Federeal Reserve of Dallas who said that banks should be “too small to save”.  He proposed that the existing too-big-to-fail banks should be downsized to such an extent that if and when the banks fail, it could be closed on Friday and open on Monday under a new ownership and management.  Paul Volcker, former Federal Reserve Chairman  was also not in favor of these big banks and has stated that reform can be brought along only by limiting the size and the scope of the big banks. 

What one has to remember from the 2008 crisis is that it were the smaller banks which failed and led to a dominos effect; it was not the big banks – call it shadow banking or whatever, that was the main reason. And the grouse is that tax payers money was used to rescue the big banks, who had taken unnecessary risks and squandered away money, knowing that they were too-big-to-fail.  As per the list released by Financial Stability Board (mandated by G20 to oversee the regulatory response to the financial crisis), JP Morgan Chase is the biggest bank in the world, followed by HSBC, Citigroup, Barclays, BNP Paribas, Deutsche bank. There are a total of 29 banks on that list. The big question is – how can you break up such big banks, spread across the world into smaller banks? That world of small banks simply does not exist anymore with the world getting more and more connected.

But at the same time there is no doubt that too-big-to-fail banks enjoy major advantages – lower funding, higher scales of economy, lower costs than smaller banks and took risks because they knew they would be bailed out by the Govt.

That does not mean that we should not have big banks. These banks can exist as long as they are strictly regulated and as Paul Krugman right said – it is what these banks do which needs to be monitored and not how big they get.

And that is precisely what RBI is planning to do – a set of additional policy measures to deal with the systemic risks and moral hazard issues posed by big banks. It is planning to follow the system of – Banking Bucket List which was compiled by the Financial Stability Board. Under this system, these big banks are forced to hold more capital than other banks, not only to mitigate the risk pose to tax payers for a bailout but to also neutralize the advantage which these banks enjoy.

As banks try to maximize returns by operating with the lowest level of capital that they consider safe, the surcharges penalize a bank for being too large, too complex or too interconnected to be resolved easily in the event of a failure. Thus there are five buckets and the consequent surcharge it attracts – 1% surcharge is lowest and bank has to hold capital equivalent to 8% of its risk-adjusted assets, rather than the 7% dictated by new global standards. Over half of the 29 banks on the list are in this bucket. The other 14 are in buckets that carry surcharges of 1.5%, 2% and 2.5%. At the top of the scale is an empty bucket of 3.5%, created to deter SIFIs from getting any bigger than they already are.

Based on this, RBI’s ‘Bucket List’ for India’s too-big-to-fail banks is – lowest Bucket with surcharge of 0.20%  and the highest will have a surcharge f 1%. It too has kept an empty bucket, which will be like a warning, dissuading banks from increasing their systemic importance in the future.

Let big banks exist but what we need to ask is whether they create value for the world or do they need to be so big to complete their role? Remember, RBI regulates our banks with a tight noose, which is what protected us from a collapse in 2008. Thus that faith in RBI remains intact….