Financial Conglomerates or systemically important financial institutions (SIFIs)
The Reserve Bank of India defines a financial conglomerate(FC) as a cluster of companies belonging to a Group which has significant presence in at least two financial market segments out of banking business, insurancebusiness, Mutual Fund business and NBFC business (deposit taking and non-deposittaking).
The need for identifying financial conglomerates
Regulation and supervision of such large and diversified financial institutions assumes special significance considering the system wide damage that their failure could potentially cause. Fears of such damage lead to costly bank bail-outs by governments, as was seen in the United States and Western Europe during the course of theglobal financial crisis.
Thus, it may be potent to look at the institutions perceived as “too big and complex to fail” in a different league, requiring specific measures to reduce the systemic risks these institutions pose. Measures used by financial regulators include specific additional capital, liquidity and other prudential requirements as well as other measures to reduce the complexity of group structures and, where appropriate, encourage stand-alone subsidiaries.
Defining “Too Big to Fail”- FSB’s definition on SIFIs
What is “too big and complex to fail” was left to the judgment of the regulators and governments. When the US Government bailed out the AIG and not Lehman Brothers many questions were asked and debated on why this move; what kind of financial institutions are “too big to fail” or are systematically important for the financial system.
Post the global financial crisis, the Financial Stability Board (FSB) undertook work in this area and defined a systemically important financial institution (SIFIs)as financial institutions whose distress or disorderly failure, because of theirsize, complexity and systemic interconnectedness, would cause significantdisruption to the wider financial system and economic activity. In November 2011, the FSB published the first list of 29 global systemically important financial institutions (G-SIFIs), based on the methodology set out in the Basel Committee on Banking Supervision (BCBS) document Global systemically important banks: Assessment methodology and the additional loss absorbency requirement,using data as of end-2009.
International efforts at regulation and supervision of financial conglomerates
The Bank for International Settlements (BIS) set up a Joint Forum in 1996 under the aegis of the BCBS, the International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS) to deal with issues common to the banking, securities and insurance sectors, including the regulation of financial conglomerates.The Joint Forum published various reports in February and December 1999 that together provided an initial framework for the supervision of financial conglomerates (the “1999 Principles”).The Joint Forum's objective in preparing these Principles is to provide national regulators with a set of internationally agreed principles that support consistent and effective supervision of financial conglomerates, particularly those financial conglomerates which have international presence. These principles cover issues in supervisory powers and authority; supervisory responsibility; capital adequacy and liquidity; corporate governance and risk management.The Forum issued its final report on Principles for the Supervision of Financial Conglomerates in September, 2012.
Until the outbreak of the global financial crisis in 2007-08, the work on the regulation and supervision of financial conglomerates was progressing separately in different countries, with limited international efforts, considering that there was no major pressure to expedite and streamline policies in this regard. With an important role played by financial conglomerates in the precipitation of the global crisis, the design of policy towards financial conglomerates has now been largely subsumed under that for systemically important financial institutions (SIFIs), referred commonly as “Too Big to Fail”.
Amongst the issues widely debated during the deliberations leading to the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 in the US was how to address risks posed by SIFIs. During the same period, the FSB issued a report titled “Reducing the moral hazard posed by systemically important financial institutions”, addressing policy towards SIFIs. This set out a framework that is broadly consistent with the provisions of the Dodd-Frank Act.
The G20, at its Pittsburgh meeting of September, 2009, mandated the FSB to propose measures to address the problems of “Too Big to Fail” associated with SIFIs. The FSB proposed a framework in response to this mandate, with the objective of improving the capacity to resolve SIFIs in financial distress or insolvency, while minimising the costs to taxpayers; reducing the probability of SIFI failures and their impact if they occur nonetheless; and strengthening the infrastructure of financial markets to reduce the risk of the spreading of contagion as a result of weaknesses of this infrastructure.
As pointed out above, in November, 2011, the FSB issued a list of G-SIFIs. It also announced a package of policy measures for them, including, inter-alia, a requirement that individual G-SIFIs have recovery and resolution plans, informed by resolvability assessments, and that home and host authorities develop institution-specific cooperation agreements and cross-border crisis management groups. It also recommended improving data systems for risk management at SIFIs and assessments of the adequacy of supervisory resources. The group of G-SIFIs is updated annually based on new data and published by the FSB each November. The 2014 list may be seen here.
The next steps for the SIFI projects are extension of the global SIFI framework to domestic SIFIs and the peer review council (PRC) framework.
The Indian context
The RBI set up an inter-regulatory Working Group in 2004 to propose a list of financial conglomeratesbased on set criteria and advise on a monitoring/reporting system for them. The Group submitted its report in June 2004. The basic building blocks of the new framework proposed by the Group included identifying Financial Conglomerates that would be subjected to focused regulatory oversight; capturing intra-group transactions and exposures (which are not being captured now) amongst entities within the identified financial conglomerate and large exposures of the groups to other financial conglomerate as well as outside counterparties;identifying a designated entity within each financial conglomerate that would collate data in respect of all other group entities and furnish the same to its regulator (principal regulator for the group); and formalising a mechanism for inter-regulatory exchange of information.
How and to what extent the recommendations of this group were implemented is not well documented. However, there is a RBI notification of January, 2010 which defines FC as a cluster of companies belonging to a Group which has significant presence in at least two financial market segments out of banking business, insurancebusiness, Mutual Fund business and NBFC business (deposit taking and non-deposittaking). What constitutes “significant presence” in each of the market segments is also defined. Size of the balance sheet (on-balance sheet and off-balance sheet items); volume of financial activities of the subsidiaries/ associates and substantial nature of intra-group transactions and exposures are some indicators which determine the significance of financial groups in the Indian context.
In March 2013, the financial sector regulators (Reserve Bank of India, Securities and Exchange Board of India, Insurance Regulatory and Development Authority and Pension Fund Regulatory and Development Authority)signed a Memorandum of Understanding (MoU) for co-operation in the field of consolidated supervision and monitoring of financial groups identified as financial conglomerates.
Since India is a member of FSB, it is committed to pursuing the reforms agenda outlined by it in the area, among others, of regulation and effective supervision of financial conglomerates in the country. This is a “work in progress’ under the FSB umbrella.