Systemically Important Financial Institutions

An institution is considered a systemically important financial institution (SIFI) if a shock to that institution causes significant disruption to other financial institutions, and hence threatens financial and economic stability (FSB 2011). This feature of systemic importance is usually driven by the size, complexity, substitutability, and interconnectedness of these institutions. However, during economic distress some institutions considered non-systemic may gain importance due to the nature of the environment and their exposure to economic players. Therefore, it is important to develop a framework for identifying and monitoring these types of institutions throughout the economic business cycle, in order to assess and mitigate systemic risk.

In assessing the degree of systemic importance, both quantitative and qualitative analysis is employed. The quantitative approach uses a weighting system on select indicators to uniformly measure systemic importance across banks, while qualitative assessment is informed by intimate knowledge of the financial infrastructure and business environment (BCBS 2012). Together, quantitative and qualitative results provide the basis for identifying systemically important banks (SIB).

The primary quantitative indicators used are related to size, complexity, substitutability, and interconnectedness. The size of specific instruments relative to the total balance sheet or off-balance sheet assets, as well as an institution’s asset size relative to economic output, is usually an indicator of importance as it highlights those institutions with a large market share. Moreover, when size is considered with the complexity of the business and its connectedness, more meaningful conclusions can be drawn about the level of systemic importance of an institution.

The more complex the bank’s business structure and cross-border activity, the greater the expected associated systemic risk as there are greater avenues for the transmission of externalities.

Substitutability looks at concentration and captures the role the institution plays in providing key services, such as treasury services, for other financial institutions. Therefore, the more concentrated the institution is, the more likely it is to be systemically important.

Macroeconomic and counterparty exposures are also analysed under interconnectedness. This offers an indication of how exposed the institution is to other financial institutions, in addition to its role in macroeconomic developments in specific sectors. Weights are generally applied evenly across these four categories but may be adjusted to reflect domestic conditions.

On identification of a domestic systemically important bank, the Basel Committee recommends that regulators impose additional loss absorbing measures on these institutions whether subsidiaries, financial groups or domestic banks. This is usually administered through an additional capital charge. Additionally, these indicators also become important in resolution management, as it indicates those institutions which cannot be easily resolved in the event of a detrimental shock, due to their relatively large size, concentration, high interconnectedness and complexity.

It is important for regulators to regularly assess and identify systemically important institutions. Ongoing monitoring of institutions identified will help to inform regulatory practices and initiate the implementation of proactive measures to ensure financial stability is maintained.  

Taken from the 2019 Financial Stability Report.

References:

Basel Committe on Banking Supervision. 2012. “A Framework for Dealing with Domestic Systemically Important Banks.” BIS Consultative Document.

Basel Committee on Banking Supervision. 2017. “Global Systemically Important Banks - Revised Assessment Framework.” BIS Consultative Document.

Financial Stability Board. 2011. “Policy Measures to Address Systemically Important Financial Institutions.” FSB Policy Document (1-4).