Government of India Volume I: Analysis and Recommendations

SYSTEMIC RISK
Table of Recommendations 9.7 Designation as Systemically Important Financial
Institutions
◮ The FSDC will agree on the methodology for identifying SIFIs, which will embrace global standards to the
extent possible for the Indian financial system. All the recommendations for the regulation-making process
put forth by the Commission will be enforced on the construction of the methodology;
◮ Using this methodology, the FSDC will identify SIFIs. The list of such institutions will be released into the public
domain annually;
◮ SIFIs will have the choice of appealing their designation at the appellate tribunal;
◮ This designation will be used by micro-prudential regulators, and by the resolution corporation, to exercise
a higher standard of regulation and supervision; and
◮ The FSDC will monitor the higher standard of regulation and supervision by the regulatory agencies.
Financial firms can be adversely affected by being designated systemically important
and being called upon to face higher regulatory standards and supervisory focus.
The Commission therefore believes that financial firms must have an opportunity to appeal
this designation to ensure that the FSDC’s decisions comport with basic principles of
regulatory governance.
The process followed in this field must, hence, follow a carefully structured set of
steps, as detailed in Table 9.7.
9.7. System-wide measures
Financial regulators worldwide are gradually evolving measures for regulation which apply
at a system scale. For example, measures that seek to resolve the problems caused
by systemic cyclicality include the increase of capital requirements – across the financial
system – in good times, and vice versa. This area also requires co-ordinated movement
by all financial regulatory agencies. If, for example, capital requirements are raised in the
banking sector alone, but not in other parts of the financial system, business will simply
move away from banks, leading to regulatory arbitrage.
Therefore, there is considerable interest worldwide in identifying appropriate measures
for counter-cyclical capital variation that are applicable to the entire financial system,
or large parts of the financial system. At the same time, systemic risk as a body of
professional, scholarly and policy knowledge is relatively underdeveloped. Therefore the
Commission proposes laying the legal foundations for one measure - the counter-cyclical
capital buffer.
The FSDC must conduct research and formulate a mechanism for the implementation
of a counter-cyclical capital buffer such that it is applicable to the entire financial system,
or large parts of the financial system - thus preventing concerns of regulatory arbitrage.
Once such a measure has been formulated, the members of the FSDC will will move in
unison to increase or decrease capital requirements in counter-cyclical fashion. It must
be noted that the counter-cyclical capital buffer is in addition to each regulator’s power
to specify capital requirements under its micro-prudential mandate.
Various types of system-wide measures which seek to resolve problems that are not
solely cyclical in nature are also being debated internationally, such as sectoral capital
requirements and leverage ratio requirements. In the coming decades, as the global
consensus on such measures, as well as the experiences of countries in the use of such
measures will increase, the FSDC may need to develop and authorise other system-wide
measures.
When such a scenario arises, the systemic risk law should be amended to provide the
legal foundations of additional measures. The Commission recommends that the FSDC
should research the applicability of other system-wide measures to the Indian financial
96 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION