too big to fail banks

The RBI has designated SBI and ICICI bank as (domestic) systemically important banks. This would mean if these banks fail, there would be financial crisis and chaos in the country, impacting India's economy and its growth prospects. Why only these two and not other big banks can only be answered by RBI which has done the selection based on the systemic importance score, which takes into account the size, complexity and alternatives in the event of a crisis. 

The consequence of designation is that these banks will have to maintain equity capital in excess of the regulated norms for other banks. This is 0.60% for SBI and 0.20% for ICICI bank to be achieved in a phased manner by April 2019. They will also be subjected to much closer supervision, whatever that is.

The minimum Tier 1 capital ratio to be maintained as per Basel III norms is 7% as of March 2015, and 9.50% as of March 2019. While this is the minimum requirement, a prudent bank would have higher (internally) regulated equity capital ratio. While some may argue that it comes at the cost of growth, we can counter that with: growth for its own sake is no good; this is especially so for a bank. 

ICICI bank is in a comfortable position even when we set the Tier 1 capital ratio not at 7.20% as required for being a systemically important bank, but at 9.70% that is required by 2019. As of March 2015, its Tier 1 capital ratio was 12.79%. With the assumption of this ratio reducing gradually to 12% in the next five years, risk-weighted assets moving from Rs.5.5 trillion to Rs.9.7 trillion by 2020, and return on equity coming down considerably from 16.02% to 11.01%, ICICI bank should be able to generate free cash flows and payout dividends without raising further equity. Of course, Ms.Chanda Kochhar has indicated that the bank is not expected to raise fresh equity for the next couple of years; this indicates that the growth rate she is targeting is higher than what I have assumed in my estimates. Higher growth rates require higher reinvestment, and therefore may prompt external equity. 

The same cannot be said of SBI, which is a much bigger and more important bank. Although, it has a comfortable Tier 1 capital ratio of 9.49% (March 2015), due to its higher assets base it would require immediate fresh equity if it aims for growth. With the assumption of Tier 1 capital ratio increasing gradually to 12% in the next five years, risk-weighted assets moving from Rs.16 trillion to Rs.26 trillion by 2020, and return on equity coming down marginally from 11.53% to 10.98%, SBI would not be able to generate free cash flows in any of the next five years. It has to aggressively seek fresh equity of Rs.180 b, or grow assets at lower rates. Obviously, SBI won't be able to payout dividends unless fresh equity is raised; and even that would mean you take from shareholders and give it back to them; not much fun. However, if one shareholder supplies capital, it would be welcome. For minority shareholders, equity dilution is better than their entire capital at risk. And the good news is that the government is planning to give Rs.50 b to SBI soon, and has plans of Rs.700 b of equity infusion by 2019 in public sector banks.

In fact, all banks are big enough to fail and cause damage. The key, however, is to operate such that assets wouldn't have to be categorized as non-performing or bad, or to be written off. We don't want banks to continue to be in that vicious cycle.

Current times aren't too good for banks. Bank Nifty has been hit badly.

And SBI and ICICI bank stock prices have hit 52-week lows. May be the shareholders can take solace in Horace and say, many shall be restored that are now fallen...