When banks fail: A “bail-in” can be provided without undermining depositor interests–13.12.2017

The current generation of economic reforms revolves around creating a sound institutional architecture for a market economy. In this regard, an important legislation was the insolvency and bankruptcy code which allows for a clean end to a business failure. In the same vein, a bill which deals with failure of financial intermediaries is currently being scrutinised by a parliamentary committee. Financial intermediaries are unique, which is why they need standalone legislation. Even rumours about problems of a single financial intermediary can lead to a contagion which cripples the entire banking system.

It is to the credit of RBI that it oversaw a resolution process for five troubled banks over the last 15 years, without allowing depositors to lose money or instability to creep in. Now, the central bank along with finance ministry feels we need to move to an institutionalised resolution mechanism which covers the entire spectrum of financial activity. Consequently, the Financial Resolution and Deposit Insurance bill was introduced in Lok Sabha in August. An effective resolution mechanism needs a wide variety of tools at its disposal which the bill provides. One of them, “bail-in”, has triggered anxiety.

“Bail-in” refers to statutory power given to resolution authorities to convert existing creditors to shareholders. This has triggered fears that bank deposits, for instance, may not be safe. That need not be the case. An insured deposit cannot be bailed-in. India’s Rs 1 lakh deposit insurance has remained unchanged for years. It should be immediately enhanced to cover the size of most deposits. For remaining deposits, a “bail-in” provision should apply only after consent of the deposit holder which will have to be compensated with higher interest rates. It’s possible to simultaneously provide all resolution tools and safeguard depositor interests. That should be the focus of parliamentary debate on this legislation.

DISCLAIMER : Views expressed above are the author’s own.
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via When banks fail: A “bail-in” can be provided without undermining depositor interests

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