That the world economy is still grappling with the 2008 crisis triggered by unhealthy lending practices of large financial institutions in the US is a well-established fact. And the idea of maintaining proper risk-assessment and risk-tackling measures by Indian financial institutions to avoid a replay of it is finally gathering momentum.

The Reserve Bank of India (RBI) released a set of draft guidelines for dealing with systematically important banks – the ones popularly referred to as “too big to fail”. The apex bank will soon announce a separate list of banks which fall under this category by virtue of which these will have to take in more precautions in conducting their operations.

“It was observed during the recent financial crisis that problems faced by certain large and highly interconnected financial institutions hampered the orderly functioning of the financial system, which in turn, harmed the real economy. Government intervention was considered necessary to ensure financial stability in many jurisdictions,” the apex bank said in the draft guidelines issued on Monday [December 2].

The basic idea is to ensure that such banks operate with proper risk assessment and management techniques in place so that their chances of collapsing are minimised and even if they do manage to go bust then ensuring that the economy is shielded against its adverse impact.

The apex bank is in the process of identifying these banks and a final list will be released by August 2015 which will be reviewed every year, RBI has said. By April 2016, these banks will be required to maintain higher capital in a phased manner which will become fully effective from April 2019.

The apex bank has clarified that these systematically important banks (SIBs) will be identified on the basis of their size, interconnectedness, substitutability and complexity. “Based on the sample of banks chosen for computation of their systemic importance, a relative composite systemic importance score of the banks will be computed. RBI will determine a cut-off score beyond which banks will be considered domestic systematically important banks (D-SIBs),” the RBI said in its statement.

Upon figuring in this list, banks will have to work with greater restrictions imposed by the central bank and also set aside a greater amount of capital buffer to be able to effectively mitigate risks. These banks will be required to maintain additional common equity tier-1 capital ranging from 0.20 percent to 0.80 percent of risk weighted assets.

It is not as if these guidelines came out of the blue. Financial regulators and government bodies across the world have been discussing the feasibility of such an exercise ever since the sub-prime mortgage bubble burst in the US sending the global economy down the dumps. The US government and its various bodies had put in their best efforts to save various banks and ended up bailing out most of them using taxpayers’ money. The impact of this bubble burst had also severely hit the European economy with countries like Greece almost going bankrupt.

While a lot of steps including compliance with Basel norms have been taken in this direction, the risks remain. With the global economy still in a limbo, there has been a drop in the demand for credit especially by corporate houses for investment purposes. In such a situation, the chances of financial institutions adopting reckless lending practices in a desperate bid to keep the organisation sailing have only increased. And hence, it has become even more important today to ensure that banks and other financial institutions adopt stable processes and procedures.