FRDI Bill: Understanding the basis of bail-in, and depositors’ fear

As the government tries to allay swirling apprehensions, The Indian Express explains the background, aims and rationale of the proposed new FRDI law.

Written by Shaji Vikraman | Updated: December 11, 2017 9:49 am
Modi govt, Financial Resolution and Deposit Insurance Bill, Bankruptcy, bail-in, Arun Jaitley, banking new India now has a law to swiftly address the issue of insolvency of companies in the manufacturing sector.

Some provisions of The Financial Resolution and Deposit Insurance Bill, 2017, popularly referred to as the FRDI Bill, which was tabled in Parliament this August, have given rise to concerns over protection for bank deposits in the proposed law. An online petition against the Bill — “Do not use innocent depositors’ money to bail in mismanaged banks #NoBailIn” — had attracted almost 90,000 signatures by Saturday night. The government has been forced to issue a statement saying the law is, in fact, aimed at protecting the interests of depositors in a “more transparent manner”. On Saturday, Prime Minister Narendra Modi spoke directly on the controversy, telling an election rally in Gujarat that the Congress was “spreading lies” that the FRDI Bill will lead to “bankrupt banks taking away people’s hardearned deposits”. “Do you think I will let that happen?” he asked. The Bill is now with the Joint Parliamentary Committee.

What is the FRDI Bill about?

India now has a law to swiftly address the issue of insolvency of companies in the manufacturing sector. Essentially, that law aims at finding and finalising a resolution plan to get a troubled company back on track, or, in the event of failure, ensure a quick winding up. The plan is to have a similar law for firms in the financial sector — so that if a bank, a Non Banking Finance Company (NBFC), an insurance company, a pension fund or a mutual fund run by an asset management company, fails, a quick solution is available to either sell that firm, merge it with another firm, or close it down, with the least disruption to the system, to the economy, and to investors and other stakeholders. This is to be done through a new entity, a Financial Resolution Corporation — envisaged as an agency that will classify firms according to the risks they pose, carry out inspections and, at a later stage, take over control. This was recommended by the Financial Sector Legislative Reforms Commission (FSLRC) headed by Justice B N Srikrishna.

What is the “bail-in” provision in the proposed law that is causing all anxiety?

Everyone has long been used to the word “bailout”, where governments step in to protect the interests of savers or depositors — like in the UK when there was a run on the deposits of banks such as Northern Rock, Llyods Bank, or RBS. There were cases in the US and other parts of Europe, too. The fact that huge public funds were used for such support, and criticism that bailouts incentivised bank managements to take risky bets — called “moral hazard” by economists — led governments to seek other solutions. Regulators put in place laws and rules to discourage or prevent such bailouts with new resolution regimes. Losses of these financial firms had to be borne by shareholders and creditors rather than taxpayers. One of the tools for such resolution is “bail-in”. It allows resolution agencies to override the rights of the shareholders of the firm — this could mean writing down of a company’s equity and debt to absorb losses, or converting debt into equity. This could also mean overriding requirements such as approvals by shareholders and disposing of the firms’s assets. The G20 at its Cannes Summit in 2011 endorsed some of the key attributes of such resolution, including transfer or sale of assets and liabilities, and legal rights and obligations including deposits liabilities and ownership in shares, to a third party without any requirement for consent. In other words, deposit holders do not have any superior claims.

What is the rationale behind this bail-in provision?

The principal aim, of course, is to minimise the cost of any such failures of financial firms to taxpayers. The other objective, as the EU’s Bank Recovery and Resolution Directive, 2014, indicates, is that shareholders of banks and creditors must also pay their share of costs, rather than governments or taxpayers absorbing all losses. The Bank of England has been pushing banks in the UK to set aside more funds to cover for potential failures. The aim, the UK central bank says, is to ensure banks no longer remain “too big to fail”, and to make sure that the risks that banks take are properly priced by investors who know they will suffer if things go wrong.

What is the worry that depositors and others have regarding the provision in the proposed Indian law?

India’s financial sector is bank-dominated, and bank deposits make up the dominant share of financial savings. The fear is Indian policymakers may want to nudge savers on the same path as in many other parts of the world — to ultimately lower risks and the potential burden on taxpayers, although there is no explicit mention of this in the proposed law. In India, deposits in banks are insured for a maximum of Rs 1 lakh by the Deposit Insurance and Credit Guarantee Corporation, which is now an arm of the RBI. There are concerns that the Bill may not clearly lay down the quantum of protection for deposits, or classify deposits separately.

What has been the government’s response?

The government has said that India’s FRDI Bill is more depositor-friendly than that of many other jurisdictions that provide for statutory bail-ins, where the consent of creditors or depositors is not required for bail-ins. It has also said that it does not propose in any way to limit the scope of powers to extend financing and resolution support to banks, including public sector banks. The government’s implicit guarantee for public sector banks remains unaffected, the Finance Ministry has said. That is perhaps an indication that the sovereign may not want to foreclose the option to back a failed bank. In the United Kingdom too, the Treasury retains the power to transfer a failing firm into public ownership, or make a public equity injection as the last resort.

What other changes could the proposed law set off?

Like elsewhere, once this kicks in, banks, insurers, pension funds, asset management companies, all will have to put in place resolution plans or “living wills” that will address a potential failure of the firm in the least costly manner. This plan will be continuously reviewed by the proposed Resolution Corporation, like the Federal Deposit Insurance Corporation (FDIC) in the US, which has handled 527 bank failures since 2008, including seven in 2017 so far. Resolution corporations in the US, UK and Canada classify the risks of firms they supervise, review them periodically, and carry out simulation tests and mock drills of resolution plans. The Bank of England is going one step ahead with plans to publish the summaries of resolution plans of banks while they are “alive”, or healthy. In cases of bank failures, the announcement of a shutdown is typically made on a Friday evening, and by Monday, cheques reach customers, or money is credited to their accounts in two working days. A closure or shutdown will be the final option — the first option would be to transfer the assets and liabilities to another firm, or to create a “bridge service provider” to which they would be transferred until eventual sale, revival, merger, or acquisition.

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  1. Kamalaksh Rao
    Dec 17, 2017 at 6:40 pm
    There are a large number of non-pensioners in the country .They mostly depend on deposit interest.The returns are dwindling day by day.for instance,I used to receive around 3to 3.5 lakhs in 2005 on a deposit of 30 lakhs ,received as terminal benefit.This has come down to 2lakhs ,a steep decrease. Pensioners get the benefit of annual increase ,on DA revision!Also the payment is assured!It is ic to compare with US where such nonpensioners are taken care of by State through social security schemes. Here,this category of people have to sell their houses, if any ,and move to ghettos,if interest rates further go down or if they lose their deposits .The income disparity is unimaginable the 1960s,in erstwhile USSR,the ratio of highest to lowest ,was five till Gorbochev a US agent took over .The ratio is infinity here .The BCCI has announced Kohli is like to receive 380crores per annum ! Modi has not made any attempt to reduce this disparity at all.ratio can be at the most 2digit!
    1. Chidambaram Murugappan
      Dec 12, 2017 at 6:44 am
      All the negative comments published here are from the same MFs who tolerated 65years of incompetence,loot scam and dishout out of. Big Loans to Corporate Mafias just by verbal instructions and without any financial fundamentals, Now the present gobverbment wants to clean the system and insulate the citizens from financial turmoils transparently liberal commy stooges cant digest reality,
      1. Mohan Akula
        Dec 12, 2017 at 1:27 am
        " In other words, deposit holders do not have any superior claims." Clarification here. s: quora /What-do-you-think-about-the-FRDI-bill-introduced-by-the-Modi-Government-which-allows-banks-to-deny-giving-back-money-to-depositors/answer/Mohan-Kumar-A-6?srid vl2N
        1. Satwant Sodhi
          Dec 11, 2017 at 8:12 pm
          We can not trust in the Indian way of working. Arun Jaitley's saying that this has been done in US or Uk we do not weigh. Reason the people, laws and the level of sincerity , speed in action and decision making etc. is far more higher than in India. The level of honesty is also too high than the that of people in India. We should not say that they could do this and that why we can not do ? First improve and show, than claim to be equal to them. In our country audits are not done honestly, registrations are done of fake companies without sincere verifications, There are no checks and actions on the defaulters, and no one is held responsible and punished for such blatant faults and frauds.
          1. Vishnu Vardhan
            Dec 12, 2017 at 8:08 am
            If they are so honest in US and UK, why is the FI failing? The fact is G 8 has implemented this and are putting pressure on G 20 to follow suit. In US and other G8 nations there are other avenues for investments (moderate to low risk) so the investment is spread in different baskets. In India, for example, a retired person is most likely to put all his money in PS bank. Therefore even if Deposit Insurance is increased to say Rs.10.00 lakh (unlikely) it will not be enough. MFs and Bonds are riskier and needs more financial awareness on part of the investor. In a country where we are still striving for financial literacy, financial awareness/ knowledge is far fetched. Having said that, I have faith in Mr.Modi to do the right thing and if he says depositors ‘ interest would be protected, then so he will.
          2. Sankaranarayanan Sivaramakrishnan
            Dec 11, 2017 at 3:23 pm
            1. Subramanian Ranganathan
              Dec 12, 2017 at 11:42 am
              Read this. There is no concern whatsoever. This is pure political propaganda to protect vested interests s: economictimes diatimes /news/economy/policy/finance-ministry-says-new-frdi-bill-wont-take-away-your-money-in-the-bank/articleshow/61963327.cms
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