The Financial Resolution and Deposit Insurance Bill does not, contrary to social media consensus, advocate that banks in crisis be recapitalised by bailing in deposits. It essentially seeks to create a class of liabilities that are recognised at the outset as being liable to be treated like equity in case a bank falls on bad times. However, a stipulation that deposits covered by deposit insurance would be outside the ambit of bail-in suggests that deposits over this threshold could potentially be bailed-in. This has led to widespread misgivings and a law intended to protect the financial system from failure in its individual parts, via tidy resolution of the failed bits, runs the risk of falling by the wayside. The best way out is to amend the bill to specifically exclude deposits from the liabilities that the Resolution Corporation could choose for bail-in.
The Financial Stability Board wants Global Systemically Important Banks to create a capital buffer to raise their total loss absorption capacity to a minimum of 18% of risk weighted assets by 2022. Bonds that are clearly recognised at the time of issuance as being liable to be bailed in would form a large part of this capital buffer. Indian banks should build up similar, if smaller, capital buffers, and specifically leave deposits alone. This would raise the cost of a bank’s services a tad, true. But that is the price of safety.
An impression that deposits could be bailed in would result in depositors flocking to government-owned banks or trying to keep their savings in non-financial assets, which would be wholly undesirable. On the whole, it would be helpful to specifically keep deposits outside liabilities that could be bailed in to recapitalise a bank. The FRDI bill seeks to enhance the security of the financial system as a whole, which also matters to individual depositors. As India integrates more into global financial and economic networks, it is vital to secure the system as a whole, to protect parts that could suddenly find themselves vulnerable, even if they themselves are not at fault.