When you move a system to rule of law from personality-based solutions, there is a period of readjustment of the old method for getting things done to the new. People, institutions and analysts all need to adjust to the new reality. The recent news about the financial resolution and deposit insurance (FRDI) bill in the winter session of the Indian parliament has pointed out one area that is section 52 of the bill, ignoring everything else in the 125 pages of the bill. And this section has resulted in panic amongst the people about the safety of bank deposits if this bill got passed as quoted by the news agencies. Such big is the discontent caused being spread by this controversy that our finance minister, Shri Arun Jaitley had to conduct a press conference and clarify that this bill is aimed at securing depositor’s money rather than being looked the other way. Now let us see in detail what this FRDI Bill is all about and try and understand the rationale behind fears in the public at large and its utility.
Introduction
The insolvency and bankruptcy code were adopted to swiftly address the issues arising in the troubled companies to bring the entity on track or else ensuring a time bound winding up of the company if needed. However, a similar structure was needed to address the financial institutions who are in distress, post the 2008 subprime crisis which killed iconic US investment bank Lehman Brothers Holdings Inc. Various government were stepping in to save the financial system to collapse by bailing out huge sums at the cost of taxpayer’s money. With the introduction of FRDI Bill, the government would quickly address a situation in which a bank, NBFC, a pension fund or a mutual fund run by an asset management company in distress can be sold off, merged with another firm or closed down with minimum disturbance to the economy, stakeholders, investors and the financial system at large. The bill proposed setting up of a new entity named financial resolution corporation with an objective of classifying different institutions on the basis of their financial viability, along with carrying inspections and if required take over control at a later stage.
Main provisions of the Bill
The bill provides for the setting up of the Resolution corporation which will be tasked with monitoring financial firms, anticipating their risk failures, taking corrective action and resolving them in case of failure. Resolution corporation is formed to replace the existing deposit insurance and credit guarantee corporation (DICGC). The resolution corporation is also tasked with providing deposit insurance up to a certain limit which is yet to be specified, in the case of failure of banks.
The resolution corporation will also classify the financial firms under five categories based on their risk of failure. These categories in the order of increasing risk are: (i) low, (ii) moderate, (iii) material, (iv) imminent, and (v) critical.
Once the firm is classified as ‘critical’ the resolution corporation will take over the financial firm. It will resolve the firm within one year (maybe extended by another year).
Resolution may be undertaken by any one of the following methods: (i) merger or acquisitions, (ii) transferring assets, liabilities and management to a temporary firm and (iii) liquidation.
Bail in provision
Till here all the things flow quite smoothly. It takes a different turn when the bill empowers the corporation of bailing in a failing financial institution. What is Bail in? A ‘Bail-in’ involves rescuing a financial institution on the brink of failure by making its creditors and depositors take a loss on their holding. It is just opposite of a bail out which involves rescuing of a financial institution from outside parties such as governments or external agencies, using taxpayer’s money. In other words, instead of government recuing a failing financial institution by infusing capital, depositor’s money is being used for this purpose.
Positive impacts
The government claims the FRDI Bill seeks to protect the customers of financial service providers in times of financial distress.
FRDI Bill along with IBC will form a comprehensive framework to deal with the Insolvency and bankruptcy of any entity in the country.
It will reduce the time and cost involved in resolving distressed financial bodies.
It will promote ease of doing business in the country, will improve financial inclusion and increases access to credit.
It will inculcate discipline in financial service providers in the event of financial crisis.
Negative impacts
The bills biggest problem is its controversial provision of the bail in clause which states that the depositor’s money will be used in case of bank failure.
Another major flaw in the FRDI Bill is that it fails to specify the deposit insurance amount which will protect the depositor if the bank fails. Right now, all deposits up to Rs 1 lakh is protected under the DICGC Act. According to the latest data available (March 2016) the average balance per term deposits account is 2.54 lakhs.
Earlier there were separate bodies such as SEBI, IRDA, RBI, but after FRDI there would be accumulation of too much power in the hands of few (resolution corporation) which is very risky.
One more fear among the public is that after demonetisation a substantial amount of cash has already been deposited in bank accounts and the balance is generally higher than Rs 1 lakh.
Conclusion
It is very clear that the financial resolution and deposit insurance act has not been presented to the public properly by the government. Thus, the bill needs to be refined further to make it acceptable to the people for whom the law is been made. In a developing country like India, where financial instruments are limited and alternatives like financial markets aren’t developed, a bail in as a resolution mechanism shall be avoided. And if the bail in clause necessarily needs to be implemented then deposits of elderly, retired and widows should definitely be exempted from the resolution mechanism. A well-defined system that makes banks more accountable and gives an early caution of ill health is progress, without exporting our deposits to more risk than they face today is progress, isn’t it?
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