Question: It is fair to say that no depositor in any commercial bank in India has lost money since the failure of the Palai Central Bank in 1960, although some banks have failed. The Reserve Bank of India has used its powers under the Banking Regulation Act and the Deposit Insurance Scheme to ensure that the interests of depositors in commercial banks are protected. Then, why have the Financial Resolution and Deposit Insurance (FRDI) Bill?
Answer: It is true that the RBI has used the powers available under the Banking Regulation Act to deal with bank failures and weaknesses in case of private sector banks. The Deposit Insurance and Credit Guarantee Corporation (DICGC) schemes have been used only to a limited extent in case of commercial banks but they have been used extensively to protect depositors of weak and failing urban cooperative banks. The RBI has no powers of resolution in case of public sector banks. Under the existing legislation, there are no legal provisions for the RBI to resort to options such as receivership, bad bank-good bank, bridge bank etc. The proposed bill gives such options to the Resolution Authority.
The background of this Bill is the global financial crisis. During the crisis, many governments had to use taxpayers’ money to bail out banks deemed “too big to fail “. Citizens felt this was not justified. Moreover, the regulators and supervisors had neither seen the crisis coming nor had they ensured that banks held sufficient provisions and capital to bear the losses. In case of complex firms, like Lehman Brothers, the problem was compounded because the inter-relationships within the group made it unclear as to how the liabilities of its various entities could be resolved.
Thus, under the auspices of the G20 Financial Stability Forum, it was recommended that each jurisdiction should have clear legal provisions for dealing with the resolution of financial firms.
Such firms cannot be dealt with under the normal bankruptcy laws. They operate with public funds — as deposits or insurance premium or contribution to pension funds or money invested by public in units of mutual funds — and in debt instruments issued by non-banking financial companies. There needs to be clarity on how the assets of the financial firms can be used to settle different types of debt liabilities. For example, how can priority be given to certain types of liabilities?
It is also important to have a resolution authority with sufficient legal powers to explore a variety of options for resolution, without recourse to the sovereign’s budget, under any circumstance. In the case of large and complex financial firms, regulators insist on living wills. In addition to capital reserves and provisions that create a buffer against losses, regulators can also require banks to issue a special category of debt instruments that have a loss-bearing capacity or bail-in provisions. In many countries where such laws have been already enacted, there is a bail-in provision as well. These include the UK, Canada, Australia, EU — but, in some cases, deposits have been excluded from the purview of bail-in.
The proposed bill is thus a comprehensive one to deal with the resolution of all financial firms in accordance with the global standards while bringing in an optimal deposit insurance system within the same law. This is in line with the recommendations of the Working Group on Resolution of Financial Institutions set up by the Financial Stability Development Council (FSDC).
Question: But this does not mean that we need to follow the global practices in every respect. In a country like India, where there has not been any banking crisis and where the public needs to have a safe place where they can invest their savings rather than keeping it under the mattress or buying gold, depositors need to have safety of funds. If some countries have excluded deposits from the purview of bail-in, why can this not be done in India ?
Answer: In fact, the FSDC Group had suggested that bail-in clause should exclude bank deposits: “The Group recommends that the bail-in framework should cover the capital instruments (additional Tier 1 and Tier 2) as well as other unsecured creditors, while deposit liabilities, inter-bank liabilities, and all short-term debt, which if subjected to bail-in can induce financial instability, would be excluded from bail-in.” But other unsecured creditors, such as bonds or commercial papers (CP), can be subject to such a bail-in. The regulators can also ask banks to have a certain proportion of liabilities issued with the bail-in clause. So, in case the capital reserves and provisions are not sufficient to absorb the NPA losses, the bail-in clause can be invoked. But these will usually be for informed and large investors
Question: Bringing in this bill now with the bail-in clause, without incorporating the suggestion of the FSDC group, is even more worrying. What is the provocation? We have been repeatedly hearing about the huge bad loans, especially in the public sector banks, that are not fully covered by the banks’ provisions, reserves and capital. We also read that the government has committed to provide recap funds of Rs 2.11 lakh crore. We also hear that the amount allocated for the recap may not be sufficient and the gap could be much more than what is envisaged. With the government so concerned about restricting its fiscal deficit and retaining the country’s rating, we are worried that it may find it easier to operate the bail-in clause for bank deposits. If the intention is to cover all financial institutions, why not keep bank deposits outside this bill and let the RBI handle bank failure as it has done all these years? If there are any gaps in these two Acts to deal with bank resolution, then there could be amendments to cover the lacunae. At least the RBI will then be responsible.
Answer: It is inconceivable that the government, as the dominant owner of the public sector banks, will invoke the bail-in provision for deposits in such banks. It is understood that this bill covers public sector banks and cooperative banks. In case of the public sector banks, it is not clear how the bail-in provision is consistent with the implicit sovereign guarantee underlying bank deposits.
Public trust in the banking system is the most important condition for financial stability. The banker-depositor relationship is a fiduciary relationship. The ordinary bank depositor is not looking at the banks’ balance sheets or their relative strength before deciding which bank he or she should place his/ her savings. Depositors go by the convenience of location and use of the savings bank or current account for a variety of transactions. A bank depositor is not a market wala or an informed investor. We are talking of financial inclusion and bringing more people into the banking system and keeping their savings in financial form rather than physical assets like currency, gold and property. Banks are highly leveraged and even the most solvent bank in the world can face a run, on account of a contagion, if bank depositors get worried about the safety of their deposits. The government would, then, do well to exclude bank deposits from the bail-in provision in the FRDI bill. But the bail-in clause could include other types of unsecured liabilities such as bonds and CPs. The government could, in fact, also consider keeping banks outside the purview of the proposed Bill. Instead, it could amend the DICGC Act, to provide for similar powers to the DICGC for bank resolution as proposed under the Bill. In this case, too, bank deposits may be excluded from the bail-in provision as has been recommended by the FSDC group.