Identification of systemically important banks in India using SRISK
| DOI | https://doi.org/10.1108/JFRC-07-2020-0067 |
| Published date | 07 August 2021 |
| Date | 07 August 2021 |
| Pages | 387-408 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Juhi Gupta,Smita Kashiramka |
Identification of systemically
important banks in India
using SRISK
Juhi Gupta and Smita Kashiramka
Department of Management Studies, Indian Institute of Technology Delhi,
New Delhi, India
Abstract
Purpose –Systemic risk has been a cause ofconcern for the bank regulatory authorities worldwide since
the global financial crisis. This study aims to identifysystemically important banks (SIBs) in India by using
SRISK to measure the expected capital shortfall of banks in a systemicevent. The sample size comprises a
balanceddata set of 31 listed Indian commercialbanks from 2006 to 2019.
Design/methodology/approach –In this study, the authors have used SRISK to identify banks that have a
maximum contribution to the systemic risk of the Indian banking sector. Leverage, size and long-run marginal
expected shortfall (LRMES) are used to compute SRISK. Forward-looking LRMES is computed using the GJR-
GARCH-dynamic conditional correlation methodology for early prediction of a bank’s contribution to systemic risk.
Findings –This study finds that publicsector banks are more vulnerable to macroeconomicshocks owing
to their capital inadequacyvis-à-vis the private sector banks. This studyalso emphasizes that size should not
be used as a standalonefactor to assess the systemic importance of a bank.
Originality/value –Systemic risk has attracted a lot of research interest; however, it is largely limitedto the
developed nations. Thispaper fills an important research gap in banking literature about the identification of SIBs
in an emerging economy, India. As SRISK uses both balance sheet and market-based information, it can be used to
complement the existingmethodology used by the Reserve Bank of India to identify SIBs.
Keywords India, Basel III, Banking, Bank regulation, Systemic risk, Risk-taking, SRISK,
Systemically important banks, GJR-GARCH-DCC
Paper type Research paper
1. Introduction
The global financial crisis (GFC) demonstratedthe magnitude and the speed with which the
financial losses of one institution or market can transmit throughout the financial system,
having severe negative consequences for the economic and financial stability. However,
financial institutions that engage in risk-taking activities may not internalize the cost of
negative externalities (Schwerter,2011;Varotto and Zhao, 2018). Their motive is to manage
their risk/return trade-off, thereby ignoring their risk-taking implications on the financial
system. If unmanaged, a breakdown of even one institution’sfinancial services can lead to
JEL classification –B41, D81, E58, G01, G21
The authors would like to thank the Editor-in-Chief, Prof. Ashton, and the anonymous reviewers for
their time and extremely valuable suggestions which helped in improving the quality of this paper.
The authors are solely responsible for any errors that might yet remain.
Funding: Juhi Gupta receives Senior Research Fellowship from the University Grants Commission
(UGC) India as part of her Ph.D. program. However, UGC has no involvement in the study design; in
the collection, analysis and interpretation of data; in the writing of the article; and in the decision to
submit the article for publication.
Identification
of systemically
important
banks
387
Received30 July 2020
Revised19 December 2020
13March 2021
Accepted30 March 2021
Journalof Financial Regulation
andCompliance
Vol.29 No. 4, 2021
pp. 387-408
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-07-2020-0067
The current issue and full text archive of this journal is available on Emerald Insight at:
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systemic risk in the economy. The Financial Stability Board (2009) defines systemic risk as
“a risk of disruption to financialservices that is:
caused by an impairment of all or parts of the financial system; and
has the potential to have serious negative consequences for the real economy.”
Systemic risk has two components: cross-sectional component, which deals with the spillovers
amplifying initial adverse losses, and time-series component, which deals with the build-up of
risk during periods of low volatility and theirmaterialization during a crisis (“volatility paradox”)
(Schwerter, 2011). Policies to reduce systemic risk in the cross-sectional capacity focus on
interconnectedness and common exposures. In the time-dimension, policies address procyclicality
by building up capital and liquidity margins of safety during periods of rapid growth to be drawn
upon in low growth periods (Caruana, 2010).
Certain banks presume systemic importance because their failure can cause significant
disruption not only in thebanking system but in the overall economic activities; thesebanks
are referred to as systemically important banks (SIBs) [Reserve Bank of India (RBI), 2014].
SIBs are perceived to be “Too big to fail”(hereinafter, TBTF). As theseinstitutions’failure
will have alarming consequences for the stability of the economy, they are generally not
allowed to fail and are expected to be bailed out by the government. While TBTF may
reduce the risk of economic instability,it creates costs of public intervention and encourages
moral hazard driven by excessive risk-taking by the large-sized banks. Thus, it promotes
taking more than optimal risk, the benefits of which go to the bank; however, the costs are
borne by the government (Atle Berg, 2011;Farhi and Tirole, 2012). This moral hazard
associated with identifying a bankas TBTF as well as the subsequent costs of public sector
intervention necessitates the need for regulatory policies to focus on minimizing the
probability of failureof SIBs and its subsequent impact on the economy (RBI, 2014).
India’s banking systemprovides a unique opportunity for examining the systemicrisk of
banks. First, it is an integralpart of the economy and contributes immensely to itseconomic
development (Rizvi et al.,2018). The commercial banks alone hold a share of more than 64%
of the total assets of India’sfinancial system (India Brand Equity Foundation, 2020) and
extend around 90% of commercial credit in the country(Sengupta and Vardhan, 2017). This
leads to a correlation between the growth of the economy and the health of the banking
industry (Rizvi et al., 2019).Second, the banking system is dominated by public sector banks
(PSBs) that are predominantlyconsidered to be more stable than private banks. This allows
us to understand whether the implicit guarantee given to PSBs by the government impacts
their systemic risk. Third, Indian banks continued to operate in an orderly manner during
the GFC as they had limited and indirect exposure to the credit derivatives.However, there
still lies an opportunity to capture the changes in the systemic risk of the Indian banking
system post the crisis. An understanding of the systemic risk in the banking system will
help the regulatoryauthorities to prepare the system in case another crisis arises.
In response to the crisis, Basel Committee on Banking Supervision (BCBS) introduced the
Basel III reforms to enhance the quality and quantity of regulatory capital of the banks by
advancing their risk coverage and setting a standard for liquidity risk management [Basel
Committee on Banking Supervision (BCBS), 2010]. The Indian regulatory authorities also
undertook additional measures to ensure the stability of the banks. RBI has been publishing the
Systemic Risk Survey semi-annually since 2011 as a part of its Financial Stability Report to
capture experts’perceptions on principal risks faced by the financial system (RBI, 2010). It
identifies domestic systemically important banks (D-SIBs) using size, complexity, lack of
substitutability and interconnectedness. D-SIBs are then segregated into different buckets based
on these indicators’aggregate scores, and a capital surcharge is charged accordingly (RBI, 2014).
JFRC
29,4
388
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