Deposit Insurance and Credit Guarantee Corpn can be an independent resolution authority given power and capital
In recent years, resolution of troubled financial institutions has attracted considerable attention in India especially after the failure of YES Bank, PMC Bank and some prominent NBFCs. At present, India lacks a special resolution regime or a comprehensive policy/ law on bankruptcy, exclusively, for financial institutions. There are some provisions in various Acts that empower the respective regulator/supervisor and/or the Central government to resolve different types of problems of financial institutions.
However, the most ‘common’ method has been an assisted or compulsory merger through which the weak bank is merged with a strong lender. Besides, there have been cases of voluntary mergers where a healthy bank took over a weak bank. In addition to making payouts to banks under liquidation, DICGC assists in mergers by meeting the shortfalls in depositors’ claims up to the coverage limit (now ₹5 lakh) when the acquiring bank is unable to meet this liability. In the case of smaller urban co-operative banks, the general approach has been to liquidate them with reimbursement made to the depositors.
One of the imperatives to reform the deposit insurance system is to establish a well-defined, well-structured and seamlessly integrated resolution mechanism for banks in trouble. The earliest attempt in this direction was made by the RBI in its Report on Reforms in Deposit Insurance in India (1999), which had recommended assigning the role of liquidator and receiver to DICGC. Reiterating this, the Committee on Financial Sector Reforms(2009) had recommended that DICGC be given powers to resolve a failing bank.
The urgent need for this was felt globally and in India in the post-2008 crisis. Following the announcement of ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ in 2011 (and updated in 2014) by the Financial Stability Board, the government set up the Financial Sector Legislative Reforms Commission, which in 2013 recommended a single Resolution Corporation (RC) for financial institutions. It also recommended that DICGC be subsumed by the the proposed RC.
Unified FRA needed?
It is argued that a “unified” Financial Resolution Authority (FRA) for all financial institutions, at this stage, isn’t necessary. The proposal to fortify the resolution mechanisms across all jurisdictions was mooted in the post-2007-08 crisis, especially against the backdrop of failure of the Systemically Important Financial Institutions (SIFIs) in some of the advanced economies. The financial systems in these economies are far more complex and interconnected than in India. Moreover, in the advanced economies, the primary concern is Global–Systemically Important Financial Institutions (G-SIFIs), not Domestic-Systemically Important Banks (D-SIBs).
By contrast, India is, and should be, primarily concerned with domestic (not global) banks (not financial institutions), which is also one of the RBI’s chief concerns because (a) India is a bank-led economy, (b) Indian banks’ cross-border operations are hardly significant, and (c) except a handful and that too to a limited extent, Indian banks do banking only, unlike the G-SIFIs which handle considerable non-banking businesses along with banking.
The risk profile of Indian banks also differs substantially from that of the global banks. Within India, banks mainly do plain vanilla lending to companies and retail clients. In the advanced economies, on the other hand, most banks have high exposure to interconnected financial products like derivatives, credit guarantees and other financial contracts. Further, Indian banks are well-capitalised.
It would not be appropriate to club banks and non-banks, as these are genetically different groups. Therefore, as far as the banking sector is concerned, DICGC can be designated as its Resolution Authority (RA) with complete independence and required statutory powers. The rationale is two fold: (a) it is widely acknowledged that banks are ‘special’, and their roles and responsibilities are fundamentally different from those of other kinds of financial institutions; and (b) hitherto, the RBI, with active assistance of DICGC, has been resolving the weak/failed banks, and, therefore, these two apex institutions possess comprehensive domain knowledge and expertise besides being aware of the ground realities.
Bank failures, unless checked through appropriate means and in time, impose huge and widespread socio-economic costs. Therefore, what should be of importance is a comprehensively efficient mechanism in terms of speed and cost (to the deposit insurer, depositors and economy) for resolving bank troubles/failures, and here, DICGC will score over a brand-new institution.
The proposed FRA is yet to be established, although considerable time has elapsed, and it will take further time to start functioning and, more importantly, stabilise. Besides the transition hassles, FRA will have to depend, to a significant extent, on support from the regulators as well as institutions. Therefore, there is merit in transforming the ‘existing’ institutional mechanism by bolstering the DICGC with appropriate statutory powers, capital, personnel and technology.
The RBI should work, in a calibrated fashion, towards making DICGC a full-fledged and independent RA, in addition to it serving as the deposit insurer for the banking sector.
The Committee on Financial Sector Reforms had recommended thus: “There are considerable benefits in separating the resolution mechanism from either the central bank or the banking regulator. Distancing DICGC from the central bank helps reduce the feeling on the part of DICGC that it has access to unlimited resources. Distancing DICGC from the banking regulator helps induce independence of thought on the part of DICGC, which must make pre-emptive decisions about the closure of a bank without worrying whether this will signal its past failure.”
Furthermore, the Committee did not propose subsuming DICGC into a RC, but argued, inter alia, for strengthening the former’s capacity to both monitor risk and resolve a failing bank.
In fact, the Report of the Working Group on Resolution Regime for Financial Institutions (2014) had recommended a ‘choice’: “The FRA can be set up by either transforming the present DICGC into the FRA, or by setting up a new authority, namely, FRA that will subsume DICGC.”
A new Act should replace the DICGC Act, 1961. Deposit Insurance and Resolution need to be treated as two sides of the same coin.
The writer is a former senior economist, SBI. Views are personal