Safety of bank deposits has vaulted into the centre-stage of public discourse for the first time since the minirun on savings at ICICI BankBSE 1.54 % in 2008. Selective reading —or more fittingly, misreading — of the Financial Resolution and Deposit Insurance (FRDI) Bill has led the general public to interpret the proposed legislation as draconian – one that would make fixed deposits the currency for future bank bail-ins.
Critical social media comments on the supposed use of depositors’ funds in the bailing-in of banks and the withdrawal of deposit insurance needed words of assurance from none other than the Prime Minister and the finance minister, who reiterated New Delhi’s commitment to “fully protect” public money. To be sure, the FRDI Bill is not the brainchild of this government: The need for a stronger resolution mechanism emerged after the 2008 global financial crisis, when governments across the globe were forced to bail out financial institutions or move them into routine bankruptcy.
In the US, the Federal Deposit Insurance Corporation, which in the past had successfully helped resolve failed banks and credit institutions, was found lacking in its ability to handle a few floundering non-banks and systemically important banks. The government had to choose between letting Lehman Brothers go into the regular corporate bankruptcy system, and a bailout for firms like AIG. Washington is unlikely to forget the $700-billion Troubled Asset Relief Program (TARP) it had to put in place to bail out banks when the US economy was struggling to clamber out of the subprime sinkhole.
Since then, several countries have built new laws on robust resolution, the standards of which have been set by the Financial Stability Board. In India, finance minister Arun Jaitley first brought the attention to bringing such a law in his 2016-17 budget speech where he spoke about an existing vacuum on resolving bankruptcy situations in financial firms.
“The aim of this bill is resolution and not regulation. After 2008, it was understood that countries cannot have the same treatment for financial and non-financial firms,” said Joyjayanti Chatterjee, an associate fellow with the Vidhi Centre for Legal Policy, which assisted the finance ministry in drafting the bill. “If an FMCG company, howsoever big, were to fail today, the impact would solely be on the creditors and it can be easily contained. If SBI, LIC or the BSE were to fail, the impact would be disastrous, and we need a separate law to contain insolvency of financial institutions.”
What is the FRDI bill? Why is it contentious?
The bill recognises that financial firms are different and, hence, should be handled differently. Simply put, the new bill aims for an orderly winding up of a financial institution. It talks about setting up of a Resolution Corporation (RC) that will identify early warning signs of distress at financial institutions, including banks, non-banking financial companies, insurance companies, stock exchanges, etc.
If any financial institution falls under the ‘critical’ risk category, the RC will immediately take over, while the sector regulator would continue to use its tools to resolve the crisis. The tools at the RC’s disposal will be transferring assets and liabilities to another firm, bailins, forced mergers, liquidations, or temporarily running the firm under a bridge entity.
So far, the government or Reserve Bank of India (RBI) has not been bold enough to let some banks die. Takeovers and mergers have been a taboo for RBI and since the liberalisation of the banking industry in 1991, there have been only 19 takeovers. Barring a couple, all others were bailouts for struggling lenders, and not aimed at improving efficiency or extracting synergies.
“The banking system is the most leveraged one, with 20 times leverage, and no government can accept a loss of faith in banks,” said Sandeep Parekh, managing partner at Finsec Law Advisors.
“Resolution in financial services is now an accepted fact in the developed markets, and this framework follows the lead of those markets.”
Hence, if the government and RBI do not allow banks to die an unnatural death, what is the hype all about? Bailout is a sovereign right of the government, and no law needs to either provide for that, or can take it away. That option will always remain with the government. However, since zero failure for financial firms is not always possible, the government and the regulator need to ensure that the failure is contained, and that these failed firms do not rely on taxpayer funded bailouts.
Do we need bail-ins?
There has also been a huge public outcry over how depositors’ money will be arbitrarily used to save dying banks. The “bail-in” tool will mean the conversion of certain creditors’ (including depositors’) debt into equity.
This would entail injection of funds within the organisation so that tax-funded bailouts become less likely. Only those liabilities can be bailed in where the people have given their prior consent. The law clearly says that the regulator along with RC will identify certain liabilities that will be subject to bail-ins.
Deposit amounts covered by deposit insurance, pensions, and sums payable to employees have been expressly excluded from the scope of bail-ins. “Bail-in does not imply that this tool can be used at the government’s whim and fancy to arbitrarily use depositors’ money without their consent to save failed banks,” says Chatterjee of Vidhi Centre for Legal Policy. “For any action that RC takes, the law ensures that all creditors, which includes depositors, are not left in a worse position than they would have been had the entity been liquidated.”
Are your deposits safe?
Perhaps the most misconstrued is the deposit insurance clause in FRDI Bill, which has led many to believe that public money is in jeopardy. Let us step back a bit. Currently, the Deposit Insurance and Credit Guarantee Corporation Act, 1961, provides deposit insurance of up to Rs 1 lakh and the rest of the amount is forfeited in the event of a bank failure. Under the proposed law, the resolution corporation will consult with RBI to set the amount for deposit insurance, which means that it is providing scope for a higher amount since the last compensation was fixed almost 25 years ago. As per State Bank of India, data on cross country deposit insurance coverage limit shows that deposit insurance coverage in India is one of the lowest at $1,508 against $250,000 in the US and $111,143 in the UK.
“The concerns about this bill are because the insurance amount is not specified,” said Anil Gupta, vice-president at ICRA. “There are fears that deposits being liabilities will be written down in case of a default. However, these fears are not correct: In the previous regime, too, there was no guarantee for deposits, but no one lost out.”
With the Insolvency and Bankruptcy Code (IBC) that deals with corporate bankruptcy now deployed for about a year, the government and the regulators have realised that the existing legal framework for resolution of financial firms in India is far from adequate. A new legal framework is immediately needed to ensure that failures of financial firms in India can be orderly and their impact contained.
“Regulation is good medical treatment, while this law is good funeral service so that you are well prepared to deal with the worst outcome,” Chatterjee said.