Much Ado About ‘Bail-In’ And FRDI Bill
Tamal Bandyopadhyay
Consulting Editor, Business Standard & Senior Adviser, Jana Small Finance Bank. Linkedin Top Voice in 2015 & 2019
In the early 1990s when India’s banking law was amended to bring down the 100% government’s stake in its banks to 51%, there were all-round protests and the trade unions took to the streets. The so-called crony capitalism which spoils the quality of assets of government-owned banks, leading to periodic recapitalisation of such banks, also draws flak from different quarters. But none can match the mass hysteria that is being created by the Financial Resolution and Deposit Insurance Bill (FRDI), 2017.
While the Insolvency and Bankruptcy Code deals with the corporations that have taken money from the banks but are unable to pay back, the FRDI Bill outlines how the insolvency of a financial intermediary—banks, non-banks and even insurance firms—can be tackled. The need for such a regulation stemmed from the 2008 global financial crisis which killed iconic US investment bank Lehman Brothers Holdings Inc. and brought many large financial intermediaries to their knees, forcing large-scale bailouts by governments.
The bill envisages setting up of a resolution corporation which will replace the existing Deposit Insurance and Credit Guarantee Corporation or DICGC. Established in 1978, DICGC is a Reserve Bank of India (RBI) arm that offers an insurance cover of up to Rs1 lakh to the depositors. The proposed corporation will closely monitor financial companies, classify them in accordance with their risk profiles and step in to resolve in case of a failure (this could mean taking over a financial company).
Till here, the narrative flows quite smoothly. It takes a different turn when the bill empowers the corporation to “bail-in” a failing financial company. What’s that? A “bail-in” involves rescuing a financial institution on the brink of failure by making its creditors and depositors take a loss on their holdings. It is the opposite of a “bail-out”, which involves the rescue of a financial institution by external agencies, typically governments, using taxpayers’ money. In other words, instead of the government rescuing a failing bank or any other financial intermediary by infusing capital, depositors’ funds are being proposed to be used for this purpose. So, the depositors run the risk of losing their money or facing inordinate delays in realizing the money—and that too may not be the full amount as deposits may get converted into other financial instruments such as equity or a quasi-equity.
Will the existing deposit cover of Rs1 lakh be taken away? The answer is an emphatic no. All depositors will continue to enjoy that.
There has been a demand from certain quarters that the limit should be raised. Is there any justification in such a demand? Well, since this limit was fixed 24 years ago in 1993, and inflation has substantially eroded the value of money over this period, it can definitely be looked into.
In fact, during the financial crisis in 2008, the Indian government and RBI did have rounds of discussions on raising the limit but they refrained from doing so. It was felt that raising the limit would have made depositors suspicious about the vulnerability of Indian banks which were absolutely safe, with sovereign backing. Besides, the Rs1 lakh limit covers 93% of the depositors (in number) and 30% of the deposits (in value). In other words, the masses have been covered by this limit and the 7% who keep more than Rs1 lakh in bank deposits are presumably savvy on financial matters and well aware of the efficacy of other financial assets.
One pertinent point here: the Rs1 lakh limit is for depositors in a particular bank and not for their deposits. This means, if a depositor has a savings bank account, recurring deposit and a fixed deposit in a bank, and that bank fails, the individual is entitled to Rs1 lakh (and not Rs3 lakh even if there is more than Rs1 lakh in each of the accounts)—that too inclusive of interest.
The proposed regulation will retain the insurance cover. So, what’s the problem? The uncertainty is about the money kept in banks beyond Rs1 lakh. Now, in case a bank goes for liquidation, depositors are entitled to get only Rs1 lakh. Beyond this cover, they can get money, if any, only after the liquidation proceedings are complete and the bank’s secured creditors are taken care of. A depositor is an unsecured creditor.
Does the proposed regulation dilute the depositors’ rights to money beyond Rs1 lakh (or, any other amount in case the limit is raised) which doesn’t enjoy the insurance cover? I don’t think so. The regulation also proposes to ensure proper supervision of the lending activities of a financial intermediary, classification of them based on their risk profile (low, moderate, material, imminent and critical) alerting the depositors if a financial intermediary’s health is deteriorating and a time-bound resolution process. If we consider all these, the new architecture is any day superior to a mere DICGC cover.
Typically, when RBI senses a bank failing, it does not allow the bank to collect fresh deposits and the existing depositors are not allowed to withdraw their own money. The depositors of a dozen-odd cooperative banks, which have been in losses, have not been able to get their money back after years because their functions have been frozen but the licences are not cancelled. Once the new regulation is in place, the wait will be much shorter as there will be time-bound resolution. Besides, the insurance cover will be an absolute obligation of the proposed corporation and the money will be given before a case is resolved.
Most importantly, unlike many of the developed markets, India has not seen bank failures. Some of the cooperative banks which are often a political cesspool have failed, but RBI does not allow any scheduled commercial bank to fail. Protecting the interest of the depositors has all along been the topmost priority for India’s banking regulator. In rare cases of banks going belly-up, RBI plays the role of a match-maker and gets it merged with a stronger bank, deftly and without losing time.
The strong voices against the FRDI Bill seem to be ill-informed. The government-owned banks will continue to have the backing of the sovereign and the depositors don’t have much to worry over the safety of their money. The challenge before the government and the regulator is communicating this. If the canard against the bill continues, there could be a run on some of the weaker banks; also shadow banks may lure away money from the banking system.
Finally, an unsolicited piece of advice. A bank fails primarily because of wrong lending decisions; the depositors are never ever responsible for a bank failure. Even the cooperative banks have been playing an important role in collecting deposits and creating savings habits while their loan decisions often lead to their downfall. Keeping this in mind, the new law may consider giving a greater role to depositors’ representatives on bank boards. This could assuage the misplaced fears of many.
This column first appeared in www.livemint.com
If you want to read Tamal Bandyopadhyay’s earlier columns, please log onto www.bankerstrust.in
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His latest book, From Lehman to Demonetization: A Decade of Disruptions, Reforms and Misadventures will be released in Bengaluru on 22nd December.
His Twitter handle is @tamalbandyo.
Author. Growth Strategy, Strategy Implementation for mid-size Corporates and Entrepreneurs, Venture Capital.
6 年As I recall, it is standard practise to limit in all countries to have an upper limit on the amount insured in case of ban failure. A "depositor" has lent his money to the bank, and in return is getting an interest (liabilities on a bank balance sheet). There will always be an element of risk in this, and the depositor is an unsecured creditor (India is not an exception in this). It is useful to remember that even currently deposits are insured only upto Rs. 1 lakh, and this limit is not being degraded under the FRDI bill. The bill will bring some additional security, as the depositor may get some other instruments or his money back after some time instead of loosing the sum above Rs. 1 L completely. When the Rs. 1 lakh is guaranteed, this class of unsecured lender (depositor) is being given higher priority than his status as an unsecured lender would normally qualify him for. In case of depositors in SBUs, the govt is the owner and effectively the manager, so perhaps one can hold the govt responsible for making good the loss. If Depositors make a choice of "lending" to private banks for higher returns and/or better service, they need to watch for the downside too (private bank deposits also have the same limit), and make claims on the owners/promoters. If the secure limit is revised to Rs 2 lakhs, almost 96% of the depositors get covered. That is good coverage.
Banking Professional, Auditor by training
6 年Govt is advocating that it is only an enabling provision and bring clarity in financial resolution. But don't you forget Bankruptcy law was also forced on banks by RBI as soon as it is enacted. And we have instead of solving it has creating more problems and anybody and everybody can file proceedings to recover their dues. Every business is in danger. Even cheque dishonour cases under negotiable instruments act. It was being misused by every lender by taking post dated cheques instead of loan documentation.
Founder at Rhizodesic LLP; Fellow - SDA Bocconi School of Management, Milan
6 年You write.....The regulation also proposes to ensure proper supervision of the lending activities of a financial intermediary, classification of them based on their risk profile.....Are these not the same conditions under which the banks lend to corporates? Which of these elements were missing in lending to the private steel corporates that in under two decades of existence the steel segment lending spiralled into unmanageable NPAs of banks? If banks were not able to hold up accountability despite their robust governance focus, in which way will the bail in regulator be superior and credible to the common investor? Also is the bail in collateral against FD not in the form of a preferential share? Can that instrument qualify as a sovereign guarantee?
Now I mainly work as a SEBI registered Research Analyst (Reg. No. INH000016515.) In the past, in the corporate I worked at Arcelor Mittal (Europe), ICICI and KK Birla Group. Post corporate was an MBA faculty also.
6 年Even with very high respect for all the articles you write, since you are also primarily associated with a new bank, shall we not take your advice with a pinch of salt? Will you not recall the Cyprus incidents, when depositors where asked to take a haircut on their deposits, to keep the banking sector afloat?Incidentally this month Moodys upgraded Cyprus credit rating to Ba3 still a non-investment speculative grade, even after bank restructuring at depositors' cost. As you yourself point out, when the liquidity situation of a bank gets messy, deposits are not allowed to make fresh deposit and withdraw their money. So why should the depositors not move their moneys to more solvent banks , mainly to SBI ( because it is too big to fail without causing an upheaval like the Lehman Brothers situation and not because it has safe NPA level ) and HDFC ( the safest banking model ). RBI has been merging the weak banks with stronger banks is correct, but now there is no strong bank in the public sector and the only real strong bank in the private sector HDFC Bank, will not touch these weak banks in the public sector with a barge pole. On the other hand the latest Basel norm is hanging on the head of the banking sector, with new requirement of capital adequacy. Where would the government will get funds to take care of the weak banks in the public sector? Government will try to sell these banks to private sectors, even entities with no good track record. And that's the time when the provisions of the FRDI Act will come in handy. Sec 52 (3) of the proposed FRDI Act reads as follows : A bail-in provision means any or a combination of the following: – (a) a provision cancelling a liability owed by a covered service provider; (b) a provision modifying, or changing the form of, a liability owed by a covered service provider (c) a provision that a contract or agreement under which a covered service provider has a liability is to have effect as if a specified right had been exercised under it. There is no distinction between a secured and an unsecured creditor in the section here. The sub-sub clause (a) means our deposits can be made nil The sub-sub clause (b) means the term of the deposit can be changed say from 1 year to 10 years The sub-sub clause (c) means interest obligations can be reduced or even the interest rate can be made zero. The government has not given up on the bill. There is a plan to introduce it in the last day of the Budget Session of 2018. My advice remains as I wrote in my article, people should move away their money to safer banks like SBI or HDFC as early as possible. This may buy you night's sleep for next 2-3 years. If they can find other avenues for using their funds rather than keeping in banks with hopeless interest rates( that too after tax) they should do it ( investment in equity market or bit coin though are more riskier bets ) . No law is passed for the heck of keeping it in the almanac, sooner than later the provisions of the act will be used against the hapless creditors ! Mark my words. Then it will be too late. However, I must also point out to a ray of hope for the depositors. The home buyers were also hapless unsecured creditors in the bankruptcy and insolvency case on Jaypee Infratech. But Supreme Court has stepped into protect their interest in public interest, in so much so, the government is thinking of changing the Bankruptcy Code to accommodate the home buyers. Same of similar fate is awaiting the mindless provisions of section 52 of the FRDI Bill, when it is passed into an act, because no doctrine of equity will permit the depositors' tax paid deposits to be appropriated for maintaining the health of the mismanaged banks, who lent money to the rougues, because of political influence or otherwise. There