The draft bill on resolution of financial firms is credit positive for banks as it is an important step to having a comprehensive framework in place for stressed financial firms, Moody’s Investors Service Tuesday said. After enacting a bankruptcy code for time-bound settlement of insolvency cases in non-financial firms, the finance ministry last month released a draft bill to set up a resolution corporation to address similar issues among financial firms.
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“Currently, the resolution of financial firms in India is based on minor parts of legislation enacted for other purposes,” says Srikanth Vadlamani, a Moody’s Vice President and Senior Credit Officer.
“This bill is therefore credit positive for Indian banks in terms of enhancing overall systemic stability.”
In a report titled ‘Draft Bill on Resolution Will Enhance Systemic Stability’, Moody’s said based on the draft bill, bail-ins do not seem to be the preferred form of resolution, with significant restrictions in place for their usage.
These restrictions include contractual bail-in clauses for instruments that may be bailed in and requirements that bail-ins should be used only after attempts at recovery have been made.
Consequently, Moody’s expects that the Indian banking system will continue to function without an operational resolution regime, and banks should continue to be rated under a basic loss given failure framework.
Moody’s also said the bill ranks depositors above senior unsecured creditors in a liquidation scenario. In contrast, under existing laws, senior unsecured creditors rank on equal footing with uninsured depositors.
This change is therefore credit negative for senior unsecured creditors, it said adding such depositor preference is enshrined into law in other jurisdictions in the region, including Singapore, Malaysia and Indonesia.
In those systems, senior debt ratings are on par with deposit ratings, except where they are impacted by different country ceilings.
“We would expect a similar outcome for Indian banks,” Moody’s said.
Moody’s said that under the draft bill, public sector banks will be brought under the ambit of the resolution framework.
By contrast, under existing laws, public sector bank resolution can only happen under the direction of the government.
Moody’s does not expect this change to have an impact on its assumption of the level of systemic support for public sector banks, because the banks’ core public sector character would remain unchanged.
The draft bill also provides for a significant delineation of regulatory powers between the Reserve Bank and the proposed Resolution Corporation.
“This situation will be particularly apparent with respect to some key supervisory powers over banks, including criteria for classifying banks into the various risk categories.
“Such a scenario would represent a change compared to the current structure, where the powers rest almost fully within India’s central bank. Consequently, there could be some execution risk, as the system transitions to the new arrangement,” it said.
The draft bill, it said, will have to go through multiple steps before becoming law, and hence may be subject to changes and delays.