Systemic Importance Score

The Systemic Importance Score (SIS) is a quantitative and qualitative assessment used by financial regulators to measure the extent to which a financial institution’s distress or failure could pose risks to the stability of the overall financial system. In banking, finance, and the Indian economy, the Systemic Importance Score is a critical supervisory tool for identifying institutions that are considered systemically important, whose disruption could trigger widespread financial instability, contagion, or economic disruption.
As India’s financial system has expanded in scale, complexity, and interconnectedness, the need to assess and manage systemic risk through structured metrics such as the Systemic Importance Score has become increasingly important.

Concept and Meaning of Systemic Importance

Systemic importance refers to the degree to which a financial institution, market intermediary, or financial infrastructure entity is critical to the functioning of the financial system. An institution is considered systemically important if its failure could lead to significant disruption of financial services, loss of confidence, or cascading failures across other institutions.
The Systemic Importance Score provides a structured framework to:

• Identify such institutions
• Quantify their potential systemic impact
• Apply enhanced regulatory and supervisory measures

This approach reflects a shift from treating all banks equally to recognising differences in systemic risk contribution.

Rationale for Systemic Importance Scoring

The global financial crisis highlighted that the failure of large and interconnected institutions can have severe macroeconomic consequences. Traditional regulation based solely on individual institution soundness proved insufficient to address system-wide risks.
The Systemic Importance Score addresses this gap by:

• Capturing the broader external impact of institutional failure
• Encouraging higher resilience among systemically important institutions
• Supporting targeted regulatory intervention

In the Indian context, where a few large banks and financial institutions dominate credit intermediation, this rationale is particularly relevant.

Key Indicators Used in Systemic Importance Scoring

The Systemic Importance Score is typically based on a set of indicators that reflect the size, complexity, and interconnectedness of an institution. These indicators collectively measure how critical an institution is to the financial system.
Common indicator categories include:

• Size, measured by total assets or exposures
• Interconnectedness, reflecting linkages with other financial institutions
• Substitutability, indicating how easily services can be replaced
• Complexity, capturing the structure and nature of operations
• Cross-jurisdictional activity, relevant for institutions with international exposure

Each indicator is assigned a weight, and the composite score determines the level of systemic importance.

Systemically Important Banks in India

In India, the concept of systemic importance is most prominently applied to banks identified as Domestic Systemically Important Banks (D-SIBs). These banks are assessed annually using systemic importance metrics.
The identification and supervision of D-SIBs are overseen by the Reserve Bank of India, which uses a scoring-based framework aligned with international best practices.
Banks with higher Systemic Importance Scores are subject to:

• Additional capital buffers
• Enhanced supervisory oversight
• Stricter risk management expectations

This ensures that institutions posing greater systemic risk are more resilient to financial stress.

Role in Capital Regulation and Prudential Norms

One of the most significant implications of a high Systemic Importance Score is the requirement to maintain additional capital. This is known as a capital surcharge, imposed over and above minimum regulatory capital requirements.
The purpose of this surcharge is to:

• Absorb losses during periods of stress
• Reduce the probability of institutional failure
• Mitigate the impact of failure on the financial system

In the Indian economy, this mechanism strengthens the stability of large banks that play a dominant role in credit creation and payment systems.

Systemic Importance Score and Risk-Based Supervision

The Systemic Importance Score supports a risk-based approach to financial supervision. Rather than allocating supervisory resources uniformly, regulators focus greater attention on institutions with higher systemic scores.
This approach:

• Improves supervisory efficiency
• Enhances early detection of systemic vulnerabilities
• Encourages stronger governance and risk controls

For Indian regulators, this is particularly useful given the diversity of banks, non-banking financial companies, and financial intermediaries operating at different scales.

Implications for Financial Stability

At the macroeconomic level, the Systemic Importance Score is a key instrument for safeguarding financial stability. By identifying institutions whose distress could have disproportionate effects, regulators can take preventive measures well before risks materialise.
The broader stability benefits include:

• Reduced likelihood of systemic banking crises
• Improved confidence among depositors and investors
• Stronger shock-absorption capacity of the financial system

In a developing economy like India, where financial instability can quickly translate into economic slowdown, this preventive role is particularly critical.

Impact on Banking Strategy and Behaviour

Designation as a systemically important institution influences the strategic behaviour of banks. Higher capital requirements and supervisory scrutiny encourage banks to adopt more prudent risk-taking practices.
This leads to:

• Better capital planning
• Improved asset quality management
• Stronger internal governance frameworks

While compliance costs may increase, the long-term benefit is a more resilient banking system.

Systemic Importance Beyond Banks

Although the Systemic Importance Score is most commonly associated with banks, the concept is increasingly relevant for other financial institutions such as non-banking financial companies, insurance firms, and market infrastructure institutions.
In India, as financial markets deepen and non-bank intermediaries grow in significance, extending systemic importance assessment beyond traditional banks is becoming increasingly relevant for comprehensive financial stability oversight.

Challenges in Measurement and Application

Measuring systemic importance is inherently complex. Financial systems are dynamic, and the importance of institutions can change over time due to growth, mergers, or changes in business models.
Key challenges include:

• Data availability and consistency
• Capturing indirect and behavioural contagion effects
• Balancing transparency with market sensitivity