FRDI - A proposal only a few know all about !

This year has been full of bills, ordinances and many of large impact.. demonetisation, GST, Aadhaar, PMLA... to name a few.. and now FRDI.. slated to be tabled in the upcoming winter session of the Parliament.

What is FRDI?

Is this another NaMo government initiative?  

Not really !!

India is part of the Group of 20 economies group that have endorsed the Financial Stability Board’s proposal called “Key Attributes of Effective Resolution Regimes for Financial Institutions”. This proposal has a provision for a “bail-in” to ensure that a country’s economy is not destabilised in the event of a big default by a large bank(s).

 The Financial Stability Board was set up in 2009 post the global financial crisis in 2008 when US had to bail out big banks with taxpayer money to prevent a large scale systemic collapse. The learnings from this catastrophic event for central bankers was to never reach a similar situation where governments have to dip into taxpayers money to bail out banks or allow any institution to become ‘too big to fail’.

 The FRDI Bill aims to operationalise the establishment of a Resolution Corporation that would help stabilise financial institutions in an orderly manner without taxpayer exposure to loss from solvency support, while ensuring key areas of operations do not suffer.

Depositors - Should they actually worry?

The Financial Stability Board’s preamble as on their website reads as below:

“The objective of an effective resolution regime is to make feasible the resolution of financial institutions without severe systemic disruption and without exposing taxpayers to loss, while protecting vital economic functions through mechanisms which make it possible for shareholders and unsecured and uninsured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation.“

Here is where the concept of the bail-in comes into force through section 52 of the FRDI Bill. A bail-in is opposite of a bail-out and ensures that in the event of a financial institution’s collapse, the creditors and depositors will have to absorb some of the losses.

 “….the Corporation may, in consultation with the appropriate regulator, if it is satisfied that it necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider and to provide a measure of capital so as to enable it to carry on business for a reasonable period and maintain market confidence, take an action under this section by a bail-in instrument or a scheme to be made under section 48….” 

 The Bill however makes it clear that the bail-in clause will not apply to the insured deposits and several other categories.

 “The bail-in instrument or scheme under this section shall not affect

(a) any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance;

(b) any liability that the specified service provider has by virtue of holding client assets.”

From a depositor’s point of view, the risk profile has not changed substantially. Post the notification of the Act, a bail-in clause will not apply to the deposits covered by insurance. Currently, the limit is Rs.1 lakh per acocunt but the issue here might be the fact that over years, depositors have ignored this and the proposed bill has acted as a reminder..  

The Bill is however silent on the upper limit of deposit insurance Rs 1 lakh per account will be maintained or whether it will be increased.

Considering that the depositors are looking at the bail-in clause with suspicion, the finance ministry has also clarified that the legal provisions in the bill will ensure that the rights of the depositors are considered at an elevated level over unsecured creditors and dues owed to the government. The Finance Ministry in a series of tweets earlier this week clarified that rights of depositors will not be compromised by the Financial Resolution and Deposit Insurance Bill, 2017, or FRDI Bill.. 

 The ministry said that “besides providing similar protection /guarantee of Rs.1 lakh to depositors,as it exists today, the rights of uninsured depositors are being placed at an elevated status in the FRDI Bill compared to existing legal arrangements over the unsecured creditors and even Government dues.” 

The FRDI Bill does not propose in any way to limit the scope of powers for the Government to extend financing and resolution support to banks, including public sector banks. Government’s implicit guarantee for public sector banks remains unaffected. — Ministry of Finance (@FinMinIndia) December 7, 2017

The Financial Resolution and Deposit Insurance Bill, 2017 is pending before the Standing Committee. The objective of the Government is to fully protect the interest of the financial institutions and the depositors. The Government stands committed to this objective. — Arun Jaitley (@arunjaitley) December 6, 2017

When can liquidation of a bank happen and are unsecured deposits protected of customers protected in that event?

The Resolution Corporation, in consultation with the respective regulators (e.g. the Reserve Bank of India for banks, and Insurance Regulatory and Development Authority for insurance companies) will specify criteria for classifying service providers based on their risk of failure. The five categories are “low, moderate, material, imminent and critical”.

Out of these five categories, the threat to a depositor’s unsecured deposits only comes in when a institution is categorised as critical. The corporation will undertake its resolution by using options which include: (i) transfer of its assets and liabilities to another person, (ii) merger or acquisition, and (iii) liquidation, among others.

 Proceeds from the sale of assets will be distributed in the following order:

• Amount paid by Resolution Corporation as deposit insurance to insured depositors
• Resolution costs
• Workmen dues for 24 months and secured creditors
• Wages owed to employees other than workmen for the period of twelve months preceding the date of the commencement of liquidation commencement date
• Amount to uninsured depositors and other insurance related amounts
• Unsecured creditors
• Government dues and remaining secured creditors
• Remaining debt and dues, and
• Shareholders.

 Normally, the government and the regulator have never allowed this situation to come.. In 2004, when Global Trust Bank was under tremendous pressure, RBI forced a merger with Oriental Bank of Commerce.. and there have been similar other instances, some front door and some back door..

What is at risk is depositors' confidence ! But this is just a bill at the moment and might undergo 360 degree change in times to come..

PS: The above views are personal and not that of my employer's. Please research yourself before acting basis this article.