Jose K Mathew
Currently, in India, there is no specialised law for the resolution of financial firms. The Financial Resolution and Deposit Insurance (FRDI) Bill is, therefore, proposed to address the issue as part of a larger, more comprehensive approach by the government towards systematic resolution of all financial firms—banks, insurance companies and other financial intermediaries. The Bill comes together with the Insolvency and Bankruptcy Code to spell out the procedure for the winding up or revival of an ailing company.
The Bill provides for the setting up of a Resolution Corporation (RC) with the following major objectives:
* Replace the existing Deposit Insurance and Credit Guarantee Corporation.
*Monitor financial entities, anticipate their risk of failure, take corrective action and resolve them in case of failure.
*Provide deposit insurance up to a certain limit, yet to be specified, in the event of a bank failure.
*Classify financial firms on their risk of failure, into low/moderate/material/ imminent/critical.
If a financial firm gets classified as “material” or “imminent” risk to failure, a process is proposed that gives the firm and the system time to either recover from the illness, or if it is going towards the terminal stage, to allow the system to prepare for failure with minimal impact. If the firm gets classified as “critical” risk, then the RC can adopt several modes of resolution. It can take over the administration of the firm and can adopt any one or more of the following routes to resolve the crisis:
*Transfer the assets and liabilities of the firm to another firm.
*Merge the firm or put it up for acquisition.
* Create a “bridge” financial firm to take over the assets, liabilities and management of the failing entity.
* Use the bail-in provision or convert the debt of the firm.
* Liquidate the firm.
The bail-in clause is just one of the prescribed methods that the RC proposes to adopt, whereby the financial firms/companies issue securities in lieu of the money deposited. It means, in case the firm’s financial situation deteriorates, deposits could be converted into securities such as shares. The FRDI Bill introduces a provision for a “bail-in”, but specifically excludes insured deposits. It leaves the decision on the amount to be insured in the hands of the regulator concerned. In the case of the banking sector, this would be the Reserve Bank of India. It would be fair to assume that once the Bill is cleared, the regulator would clarify the amount to be insured. It has not given any indication, so far, that the amount of deposits insured would be lower or higher than the present provision of Rs1 lakh in insured deposits. The Bill goes on to specify the categories that cannot be included in the “bail-in”. The list includes:
*Deposits covered by deposit insurance (At present, deposits up to Rs 1 lakh).
*Liabilities by virtue of holding client assets. These client assets include any liability of original maturity up to seven days.
*Obligations to a central-counter party.
*Any liability so far as it is secured.
*Any liability owed to employees or workmen, including pension liabilities.
These provisions essentially suggest that the insured amount of deposits (which is Rs 1 lakh at present) remains protected as it currently is. Hypothetically, if a bank were to fail, deposits beyond that may not be protected. That is the same as the current scenario. Hence, there may not be any drastic change from the current scenario as is being raised from some of the quarters. If the system in place is robust, few entities will actually reach a critical stage of risk. Therefore, the approach that the FRDI Bill takes may actually help protect depositors; instead of an ad hoc approach, India will now have a rule-of-law-based approach to the resolution of financial entities.
In a statement, the ministry of finance has clarified that “the provisions contained in the FRDI Bill, as introduced in the Parliament, do not modify present protections to the depositors adversely at all. They rather provide additional protections to the depositors in a more transparent manner.” In India, 67% of term deposit accounts are of less than rS 1 lakh. Thus, even if any bank ever hypothetically fails, it would not affect small depositors, as it is covered through insurance. Experts hold the view that bail-in strategy may actually help to mitigate the systemic risks associated with disorderly liquidations, reduce deleveraging pressures, and preserve asset values that might otherwise be lost in a liquidation.