IN September 2008, at the height of the global financial crisis, the government and the Reserve Bank of India (RBI) had to step in to calm the depositors of ICICI Bank who, at many places, were heading to withdraw funds following rumours about the bank’s financial health. Worried about a potential run on deposits and a contagion effect on other banks in an interconnected financial system, and acting in the interest of overall financial stability in the country, the RBI issued a statement saying the private bank had sufficient liquidity, including in its current account with the central bank, to meet its depositors’ requirements. The RBI even went a step further to say that it had arranged to provide extra cash. And ICICI Bank’s chief executive, K V Kamath, told a business TV channel, “Hand on my heart, clearly the deposits are safe…”
The financial sector in India is marked by the dominance of publicly owned banks and deposits over many other financial investment avenues. One reason for this is, after the initial failure of a few banks — notably the Palai Central Bank in Kerala, which led to the introduction of deposit insurance in the country in 1962 — there has hardly been a collapse of the scale and implications seen in many other countries; India has found a solution in forced mergers or amalgamations. Depositors have, therefore, enjoyed implicit protection for decades, even though insurance has remained capped at Rs 1 lakh. Despite that limited level of legal protection for savings parked in banks, deposits with Indian banks are now well over Rs 100 lakh crore — a reflection of the confidence that savers have in the backing of the sovereign. In the 1990s, three banks that the regulator classified as weak — Indian Bank, UCO Bank and United Bank of India — continued to attract money. And a half dozen banks majority-owned by the government but which have now been put by the RBI under its Prompt Corrective Action (PCA) framework (which kicks in when bad loans are over 10% and the bank posts losses for two years or more), haven’t seen a run on deposits. One of the banks in that list, in fact, has impaired assets of over 40%.
While there are currently no worries of a run, concerns have been expressed on social media because of one of the provisions in the Financial Resolution and Deposit Insurance (FRDI) Bill, 2017 — the provision for a “bail-in”, which enables a corporation authorised to resolve issues relating to troubled financial firms to convert creditors into shareholders in order to help recapitalise a firm that has failed to ensure its solvency. This provision has been interpreted to mean that depositors, who rank low in the hierarchy of claimants, could see part of their deposits being converted to keep the financial firm solvent.
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The backdrop to this is the approach adopted by many governments after the 2008 crisis to severely limit the use of taxpayer money to bail out banks in the future. In November 2011, G20 leaders endorsed the key attributes of an effective financial resolution regime for financial institutions as an international standard, and many jurisdictions were expected to adopt such regimes by the end of 2015 itself — with bail-in as a key feature. In the UK and Eurozone, regulators have pushed banks to set aside more capital against their liabilities to prepare for a future bust. In 2011, Denmark chose to write down senior debt and unguaranteed deposits at a troubled bank.
In 2012-13, the Financial Sector Legislative Reforms Commission (FSLRC), which was mandated to rewrite outdated laws in India’s financial sector, took the view that “eliminating all failure (of financial institutions) is neither feasible nor desirable”. Such failure “is an integral part of the regenerative processes of the market economies: weak firms should fail and thus free up labour and capital that would then be utilised by better firms”. The political economy consequences of such an approach in a bank-dominated system like India’s were flagged even then. In 2014, before the Modi government took over, the Financial Stability and Development Council (FSDC) mandated a working group headed by Finance Secretary Arvind Mayaram and RBI Deputy Governor Anand Sinha, which recommended the setting up of a resolution regime for the failure of weak financial institutions, in which losses would be absorbed by shareholders and unsecured creditors, and the resolution action would respect the hierarchy of claims.
Like demonetisation, bail-in could, theoretically, be an attempt at behavioural change — nudging investors to be mindful of risks and to accept both risks and rewards. What needs to be debated thoroughly are the consequences of the implicit guarantee on deposits. The government could also classify deposits separately, compared with other financial products, exempt them, or place them at the bottom if it comes to the last resort of conversion for capitalisation. In the noise, the fact that depositors of cooperative banks have no such protection has found hardly any mention. The mountain of bad loans has not quite threatened banks, even though deposit growth has declined (which, again, may have to do with lower returns in a low-inflation scenario). The US can shutter community-based banks, but in a country where state-owned banks dominate, where bond markets have lagged behind, and where financial literacy is low and access to it is limited, it will have to be a brave government that will attempt any such behavioural change.
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