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    Basel Committee On Banking Supervision: SCO Scope and Definitions

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    Basel Committee On Banking Supervision: SCO Scope and Definitions

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    Basel Committee On Banking Supervision: SCO Scope and Definitions

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    Basel Committee on

    Banking Supervision

    SCO
    Scope and definitions
    SCO50
    Domestic systemically
    important banks
    Version effective as of
    15 Dec 2019
    First version in the format of the consolidated
    framework.

    Downloaded on 05.09.2020 at 09:20 CEST


    © Bank for International Settlements 2020. All rights reserved.

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    Introduction
    50.1 The Committee has developed a set of principles that constitutes the domestic
    systemically important bank (D-SIB) framework. The 12 principles can be broadly
    categorised into two groups: the first group (SCO50.5) focuses mainly on the
    assessment methodology for D-SIBs while the second group (RBC40.7) focuses
    on higher loss absorbency (HLA) for D-SIBs.1

    Footnotes
    1 HLA refers to higher loss absorbency relative to the Basel III
    requirements for internationally active banks. For domestic banks that
    are not internationally active, HLA is relative to requirements for
    domestic banks.

    50.2 The principles were developed to be applied to consolidated groups and


    subsidiaries. However, national authorities may apply them to branches in their
    jurisdictions in accordance with their legal and regulatory frameworks.2

    Footnotes
    2 While the application to branches of the principles regarding the
    assessment of systemic importance should not pose any specific
    problem, the range of policy responses that host authorities have
    available to deal with systemic branches in their jurisdiction may be
    more limited.

    50.3 The additional requirements applied to global systemically important banks (G-
    SIBs), which apply over and above the Basel requirements applying to all
    internationally active banks, are intended to limit the cross-border negative
    externalities on the global financial system and economy associated with the
    most globally systemic banking institutions. Similar externalities can apply at a
    domestic level. There are many banks that are not significant from an
    international perspective, but nevertheless could have an important impact on
    their domestic financial system and economy compared to non-systemic
    institutions. Some of these banks may have cross-border externalities, even if the
    effects are not global in nature.

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    50.4 A D-SIB framework is best understood as taking the complementary perspective
    to the G-SIB regime by focusing on the impact that the distress or failure of
    banks (including by international banks) will have on the domestic economy. As
    such, it is based on the assessment conducted by the local authorities, who are
    best placed to evaluate the impact of failure on the local financial system and the
    local economy. This point has two implications:

    (1) The first is that, in order to accommodate the structural characteristics of


    individual jurisdictions, the assessment and application of policy tools should
    allow for an appropriate degree of national discretion. This contrasts with the
    prescriptive approach in the G-SIB framework.

    (2) The second implication is that, because a D-SIB framework is still relevant for
    reducing cross-border externalities due to spillovers at regional or bilateral
    level, the effectiveness of local authorities in addressing risks posed by
    individual banks is of interest to a wider group of countries. A D-SIB
    framework, therefore, should establish a minimum set of principles, which
    ensures that it is complementary with the G-SIB framework, addresses
    adequately cross-border externalities and promotes a level playing field.

    Principles on the D-SIB assessment methodology


    50.5 The principles on the D-SIB assessment methodology are set out below:

    (1) National authorities should establish a methodology for assessing the


    degree to which banks are systemically important in a domestic context.

    (2) The assessment methodology for a D-SIB should reflect the potential impact
    of, or externality imposed by, a bank's failure.

    (3) The reference system for assessing the impact of failure of a D-SIB should be
    the domestic economy.

    (4) Home authorities should assess banks for their degree of systemic
    importance at the consolidated group level, while host authorities should
    assess subsidiaries in their jurisdictions, consolidated to include any of their
    own downstream subsidiaries, for their degree of systemic importance.

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    (5) The impact of a D-SIB's failure on the domestic economy should, in principle,
    be assessed having regard to bank-specific factors. National authorities can
    consider other measures / data that would inform the bank-specific
    indicators within each of the below factors, such as size of the domestic
    economy:

    (a) size;

    (b) interconnectedness;

    (c) substitutability / financial institution infrastructure (including


    considerations related to the concentrated nature of the banking
    sector); and

    (d) complexity (including the additional complexities from cross-border


    activity).

    (6) National authorities should undertake regular assessments of the systemic


    importance of the banks in their jurisdictions to ensure that their assessment
    reflects the current state of the relevant financial systems and that the
    interval between D-SIB assessments not be significantly longer than the G-
    SIB assessment frequency.

    (7) National authorities should publicly disclose information that provides an


    outline of the methodology employed to assess the systemic importance of
    banks in their domestic economy.

    Principles 1 and 2: assessment methodologies


    50.6 A starting point for the development of principles for the assessment of D-SIBs is
    a requirement that all national authorities should undertake an assessment of the
    degree to which banks are systemically important in a domestic context. The
    rationale for focusing on the domestic context is outlined in SCO50.10.

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    50.7 SCO40.6 states that “global systemic importance should be measured in terms of
    the impact that a failure of a bank can have on the global financial system and
    wider economy rather than the likelihood that a failure can occur. This can be
    thought of as a global, system-wide, loss-given-default (LGD) concept rather than
    a probability of default (PD) concept.” Consistent with the G-SIB methodology,
    the Committee is of the view that D-SIBs should also be assessed in terms of the
    potential impact of their failure on the relevant reference system. One implication
    of this is that to the extent that D-SIB indicators are included in any
    methodology, they should primarily relate to “impact of failure” measures and
    not “risk of failure” measures.

    Principles 3 and 4: reference system and scope of assessment


    50.8 Two key aspects that shape the D-SIB framework and define its relationship to
    the G-SIB framework relate to how it deals with two conceptual issues with
    important practical implications:

    (1) what is the reference system for the assessment of systemic impact; and

    (2) what is the appropriate unit of analysis (ie the entity which is being
    assessed)?

    50.9 For the G-SIB framework, the appropriate reference system is the global
    economy, given the focus on cross-border spillovers and the negative global
    externalities that arise from the failure of a globally active bank. As such this
    allowed for an assessment of the banks that are systemically important in a
    global context. The unit of analysis was naturally set at the globally consolidated
    level of a banking group (SCO40.5 states that “systemic importance is assessed
    based on data that relate to the consolidated group”).

    50.10 Correspondingly, a process for assessing systemic importance in a domestic


    context should focus on addressing the externalities that a bank’s failure
    generates at a domestic level. Thus, the Committee is of the view that the
    appropriate reference system should be the domestic economy, ie that banks
    would be assessed by the national authorities for their systemic importance to
    that specific jurisdiction. The outcome would be an assessment of banks active in
    the domestic economy in terms of their systemic importance.

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    50.11 In terms of the unit of analysis, the Committee is of the view that home
    authorities should consider banks from a (globally) consolidated perspective. This
    is because the activities of a bank outside the home jurisdiction can, when the
    bank fails, have potential significant spillovers to the domestic (home) economy.
    Jurisdictions that are home to banking groups that engage in cross-border
    activity could be impacted by the failure of the whole banking group and not just
    the part of the group that undertakes domestic activity in the home economy.
    This is particularly important given the possibility that the home government may
    have to fund/resolve the foreign operations in the absence of relevant cross-
    border agreements. This is in line with the concept of the G-SIB framework.

    50.12 When it comes to the host authorities, the Committee is of the view that they
    should assess foreign subsidiaries in their jurisdictions, also consolidated to
    include any of their own downstream subsidiaries, some of which may be in other
    jurisdictions. For example, for a cross-border financial group headquartered in
    country X, the authorities in country Y would only consider subsidiaries of the
    group in country Y plus the downstream subsidiaries, some of which may be in
    country Z, and their impact on the economy Y. Thus, subsidiaries of foreign
    banking groups would be considered from a local or sub-consolidated basis from
    the level starting in country Y. The scope should be based on regulatory
    consolidation as in the case of the G-SIB framework. Therefore, for the purposes
    of assessing D-SIBs, insurance or other non-banking activities should only be
    included insofar as they are included in the regulatory consolidation.

    50.13 The assessment of foreign subsidiaries at the local consolidated level also
    acknowledges the fact that the failure of global banking groups could impose
    outsized externalities at the local (host) level when these subsidiaries are
    significant elements in the local (host) banking system. This is important since
    there exist several jurisdictions that are dominated by foreign subsidiaries of
    internationally active banking groups.

    Principle 5: assessing the impact of a D-SIB’s failure


    50.14 The G-SIB methodology identifies five broad categories of factors that influence
    global systemic importance: size, cross-jurisdictional activity, interconnectedness,
    substitutability/financial institution infrastructure and complexity. The indicator-
    based approach and weighting system in the G-SIB methodology was developed
    to ensure a consistent international ranking of G-SIBs. The Committee is of the
    view that this degree of detail is not warranted for D-SIBs, given the focus is on
    the domestic impact of failure of a bank and the wide ranging differences in each
    jurisdiction’s financial structure hinder such international comparisons being
    made. This is one of the reasons why the D-SIB framework has been developed as
    a principles-based approach.

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    50.15 Consistent with this view, it is appropriate to list, at a high level, the broad
    category of factors (eg size) that jurisdictions should have regard to in assessing
    the impact of a D-SIB's failure. Among the five categories in the G-SIB framework,
    size, interconnectedness, substitutability/financial institution infrastructure and
    complexity are all relevant for D-SIBs as well. Cross-jurisdictional activity, the
    remaining category, may not be as directly relevant, since it measures the degree
    of global (cross-jurisdictional) activity of a bank which is not the focus of the D-
    SIB framework.

    50.16 In addition, national authorities may choose to also include some country-specific
    factors. A good example is the size of a bank relative to domestic gross domestic
    product (GDP). If the size of a bank is relatively large compared to the domestic
    GDP, it would make sense for the national authority of the jurisdiction to identify
    it as a D-SIB whereas a same-sized bank in another jurisdiction, which is smaller
    relative to the GDP of that jurisdiction, may not be identified as a D-SIB.

    50.17 National authorities should have national discretion as to the appropriate relative
    weights they place on these factors depending on national circumstances.

    Principle 6: regular assessment of systemic importance


    50.18 The Committee believes it is good practice for national authorities to undertake a
    regular assessment as to the systemic importance of the banks in their financial
    systems. The assessment should also be conducted if there are important
    structural changes to the banking system such as, for example, a merger of major
    banks. A national authority’s assessment process and methodology will be
    reviewed by the Committee’s implementation monitoring process.

    50.19 It is also desirable that the interval of the assessments not be significantly longer
    than that for G-SIBs (ie one year). For example, a systemically important bank
    could be identified as a G-SIB but also a D-SIB in the same jurisdiction or in other
    host jurisdictions. Alternatively, a G-SIB could drop from the G-SIB list and
    become/continue to be a D-SIB. In order to keep a consistent approach in these
    cases, it would be sensible to have a similar frequency of assessments for the two
    frameworks.

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    Principle 7: transparency on the methodology
    50.20 The assessment process used needs to be clearly articulated and made public so
    as to set up the appropriate incentives for banks to seek to reduce the systemic
    risk they pose to the reference system. This was the key aspect of the G-SIB
    framework where the assessment methodology and the disclosure requirements
    of the Committee and the banks were set out in the G-SIB rules text. By taking
    these measures, the Committee sought to ensure that banks, regulators and
    market participants would be able to understand how the actions of banks could
    affect their systemic importance score and thereby the required magnitude of
    additional loss absorbency. The Committee believes that transparency of the
    assessment process for the D-SIB framework is also important, even if it is likely
    to vary across jurisdictions given differences in frameworks and policy tools used
    to address the systemic importance of banks.

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