Abstract
The health of Indian public sector banks has come under intense spotlight in recent times. In this chapter, we undertake a critical analysis of public sector banks by comparing them with new private sector banks.
Acharya is grateful to Michael Robles of V-LAB for help with NYU Stern Systemic Risk Rankings calculations for Indian financial firms. Krishnamurthy Subramanian would like to thank Venkatesh Ramamoorthy for excellent research assistance.
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Notes
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In versions of the model where the simulation is not yet implemented on V-LAB, LRMES is approximated as 1−exp(−18*MES) where MES is the 1-day loss expected if market returns are less than −2 %. MES in related to other standard measures of financial risk also reported on V-LAB, such as Corr, which is the correlation between a stock’s return and the aggregate market, and VOL, which is the annualized volatility of a stock’s return. Note that V-LAB also reports the Beta of a stock which is the %change in a stock’s price for a %change in the aggregate market price; however, Beta is symmetric and does not give the %change in a stock’s price for a downward movement in aggregate market.
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In this sense, SRISK is based on a notion of systemic risk in which a “tsunami”-type shock hits the global economy rather than a “contagion”-type shock in which an individual financial firm’s interconnectedness causes losses elsewhere in the financial system. The latter would, however, also be statistically picked up in a co-movement of a financial firm’s assets with the aggregate market providing that the contagion does have market-wide impact.
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Acharya et al. (2014) summarize the adoption of stress tests by regulators in the United States and the Europe: “An annual supervisory stress test of the financial sector in the United States has become a requirement with the implementation of Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111–203, H.R. 4173) of 2010. Macroprudential stress tests have also been used by U.S. and European regulators to restore market confidence in financial sectors during an economic crisis. As a response to the recent financial crisis, the 2009 U.S. stress test led to a substantial recapitalization of the financial sector in the U.S. In Europe, the 2011 stress test also served as a crisis management tool during the European sovereign debt crisis. The European exercise lacked credibility in this role, however, due largely to the absence of a clear recapitalization plan for banks failing the stress test.”.
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Again quoting Acharya et al. (2014): “The current approach to assessing capital requirements is strongly dependent on the regulatory capital ratios defined under Basel Accords. The capital ratio of a bank is usually defined as the ratio of a measure of its equity to a measure of its assets. A regulatory capital ratio usually employs book value of equity and risk-weighted assets, where individual asset holdings are multiplied by corresponding regulatory ‘risk weights’. The regulatory capital ratios in stress tests help regulators determine which banks fail the test under the stress scenario and what supervisory or recapitalization actions should be undertaken to address this failure.”.
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Acharya, V., Subramanian, K.V. (2016). State Intervention in Banking: The Relative Health of Indian Public Sector and Private Sector Banks. In: Ghate, C., Kletzer, K. (eds) Monetary Policy in India. Springer, New Delhi. https://doi.org/10.1007/978-81-322-2840-0_7
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