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.