8 Sep 2014

Domestic Systematically Important Banks:An analysis of long -term benefits (PART II)

The main merit of following these frame works would be enhanced ability to withstand stress situations, a bank’s financial fighting strengths and competitiveness. However, it will lead to higher lending rates and lower deposit rates. Thus, loans would be available only for safe customers. Meeting capital requirements of public sector banks, which would be in tune of Rs. 2.4-2.8 trillion, will be a huge challenge for banking industry and government. However, private banks will benefit as they enjoy better current capitalization and internal accruals. The prime motto of this move is to reduce the frequency and severity of banking crisis.

Analysts and bank experts are in opinion that following banks would make it into the final list- State Bank of India, Punjab National Bank, Citi Bank, Standard Chartered Bank, ICICI Bank, HDFC Bank and Bank of Baroda.  

Feature of DSIBs Image Source: Economic Times

These guidelines should not prove to be a problem for banks profitability, as most of Indian banks have capital well above the proposed regulatory level. Banks would be in a better position to absorb severe losses, with more equity, thus ensuring financial stability in economy. These measures will act as a buffer for government, as banks will not depend on it to mitigate losses. Also, this would discourage banks from taking irrational risks.

Higher capital requirements are an essential instrument in strengthening the financial stability of the banking sector. They ensure that banks are in a better position to absorb risks and compel banks to improve their risk control, as they bear the costs of those risks themselves. The result will be that banks will reduce their risks and will control them more effectively. This will strengthen the banking sector. Banks with a healthy business model will be able to keep up their lending and remain competitive.

The Financial Stability Board has studied how banks practically respond to increased capital requirements in reality. And, it has found two key things. Firstly, they reduce their risk-adjusted balance sheets (lending less risky business) and secondly by raising equity. Both these measures make a bank, more efficient and safe in functioning.

Testimony of the benefits of increased capital adequacy is the two papers released by the Financial Stability Board and the Basel Committee on Banking Supervision. Both papers conclude that stronger capital and liquidity requirements bring significant benefits for banks- and doesn’t affect much adversely, as perceived. These researches emphasize that such measures will help to insulate efficient banks from problems faced by weaker ones. These measures would result in reduced frequency, severity, and public costs of financial crises.

The significance of Domestic Systematically Important Banks can also be understood by the fact that all G 20 leaders have committed to increase the levels of capital and liquidity in their national banking system.

Image Source: http://www.shrinews.com

So, the decision of Reserve Bank of India (RBI) to categorise important banks as Domestic Systematically Important Banks (DSIBs) would help Indian banking industry in the long run and ensure a robust financial system. It is a justified reform to make Indian banks more competitive and safe.

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