By Manali Joshi
70 years after the Great Depression, India faced a catastrophic crash in 2007-08 which led to a bank run in financial parlance. The aftermath of the events of 2007-08 witnessed the creation of Financial Resolution and Deposit Insurance Bill 2017 (FRDI Bill), which was introduced in the Parliament in the monsoon session.
The independent new regulator
The FRDI Bill provides for the setting up of an independent new regulator, the Resolution Corporation (RC). The RC will consist of representatives from all financial sector regulators like the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India and the Pension Fund Regulatory and Development Authority. The RC includes the ministry of finance as well as independent members.
The RC has been tasked with handling situations of distress in financial institutions. The health of a financial institution will be graded on a five-point ‘risk to viability’ scale, ranging from low risk to critical risk. The RCs role in case of a healthy financial institution will be extremely limited and confined to mere supervision. For a financial institution which is on the brink of failure, the regulators will work in tandem with the RC in attempting its revival. However, once an institution has failed, the RC will take over and oversee its orderly demise.
Resolution tools
The RC has been armed with various ‘resolution tools’, which are a mix of traditional methods such as mergers, acquisitions and portfolio transfers. Some of them are completely novel ones like bail-in, bridge service providers and run-off.
The tool of bail-in utilises the existing resources of the failing institution by converting debt into equity. Bridge service provider is essentially a temporary institution which is set up to take over the operations and critical functions of a financial institution, for a period of one year at the most. A run-off is a specialised tool for insurance companies, which allows the present policies (like life insurance policies) to run their course while discontinuing the writing of new business.
Yet to be passed, why?
The FRDI Bill has still not been passed because a lot of stakeholders have issues with certain clauses of the Bill as it affects their right in some manner.
The primary concern expressed by banking unions is that the new law creates a new Resolution Corporation. In the current scenario, the Reserve Bank of India has exclusive powers to determine the financial health of a bank and recommend remedial measures in case banks get into financial trouble. However, the proposed Resolution Corporation will usurp this crucial power, thereby weakening the regulatory role of the central bank.
Moreover, according to CH Venkatachalam, general secretary of the All India Bank Employees Association, The new law seeks to amend all exclusive laws governing financial institutions, including the State Bank of India Act. For instance, the State Bank of India Act makes it clear that the bank cannot be liquidated. However, the new law is getting rid of this important provision.
Secondly, Venkatachalam pointed out that the law gives all powers to the Company Law Tribunal in case of liquidation. Under the proposed law, no court other than the Company Law Tribunal will be able to take cognisance of disputes on liquidation.
Labour rights
Another major concern is the violation of labour rights. There are clauses in the bill that enable the Resolution Corporation to terminate employment or change the compensation structure of bank employees when the bank goes through the various stages of resolution. The employees may not be able to claim compensation for loss of employment. The Unions said that it is a direct violation of the right to constitutional remedies guaranteed under Article 32 of the Constitution.
The bail-in clause
The bail-in clause included in the proposed law is the provision that immediately tends to affect the depositors. A bail-in clause is one where the depositors of the bank would be forced to bear a part of the loss in case the institution sinks. They are rather considered to be unsecured creditors, in the sense that no depositor seeks security from banks while making their deposits. Under the proposed bill, a bail-in will be triggered when the RBI, in consultation with RC, realises that the bank needs an infusion of some capital to help it absorb losses and prevent liquidation. This clause excludes insured deposits, which, under existing rules, means a sum of up to rupees one lakh with interest from getting their deposits converted into securities like the stock of the bank.
Moreover, depositors put their money in public sector banks because they know the government will bail out the bank if it collapses. However, if the new bill is passed, the government is virtually indicating that there will be no bailout from its side. According to Franco, such a no-bailout situation will create a panic if the depositors come to know the bank is financially sick and hence would rush to take their deposits out. This will only expedite the liquidation of the bank.
Insured deposits
In the current scenario, regulations with respect to deposit insurance were specified in the Deposit Insurance Corporation Act, 1962. Under the Act, a maximum of rupees one lakh is insured for each depositor. This provision was extended to depositors of all commercial banks and most cooperative banks. Banks then had to pay a deposit insurance premium, which is held by the Deposit Insurance Corporation. Out of this, the bank would be paid the assured amount in case of its liquidation.
However, rarely have depositors needed to resort to deposit insurance. Even in situations where small banks have found themselves in trouble, the Reserve Bank of India often restricted deposit withdrawal by eventually merging the weak bank with a stronger bank.
Once the new bill is cleared, it will replace the existing deposit insurance framework. The RC, in consultation with the appropriate regulator, will specify the total amount payable by the Corporation with respect to any one depositor, as to his deposit insured under this Act. A Corporation Insurance Fund would be the vehicle through which the deposit insurance would flow.
The above provision suggests that deposits to a certain extent would continue to be insured just like in the current regime. However, it has not yet given any indication, about the number of deposits insured being lower or higher than the present provision of rupees one lakh in insured deposits, which would be decided by the RBI, banking sector regulator.
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