Good intentions, bad articulation
While providing a streamlined exit route for failed financial entities, the Financial Resolution and Deposit Insurance Bill should ensure that customers’ deposits are protected
After the Financial Resolution and Deposit Insurance (FRDI) Bill 2017 was introduced in the Lok Sabha (it was subsequently referred to a Joint Parliamentary Committee), apprehensions have been aired about the safety of customer deposits maintained with banks. The Bill provides for the setting up of a Resolution Corporation (RC), akin to the Insolvency and Bankruptcy Board of India for business and commercial entities, to oversee the resolution of bankrupt financial entities. Clause 52 of the Bill empowers the RC to allow, in the resolution process, failed entities to use their liabilities (which are deposits of customers that the financial entities need to repay on demand) to stay afloat and remain functional in the larger interest of the entity. This is the “bail in” clause, which is the cause of the furore. However, since it is yet to be vetted by experts, the FRDI Bill in its present form cannot be considered final.
Such an enabling provision without explicit granular conditionalities permitting use of deposits for absorbing losses has left bank customers worried about the safety of their deposits. But the appropriation of public deposits towards absorbing accumulated business losses of bankrupt financial entities may not be permitted in the normal course of business. It will be a rare phenomenon that brings disrepute to all stakeholders — more importantly, regulators, the government, the company and its board. It will also draw the attention of global rating agencies and overseas investors, and can impinge upon the sovereign reputation of the country. Moreover, regulations and systemic controls are robust enough where bankruptcies in financial markets are rare. If any financial intermediary fails, it is tantamount to failure of the financial system, which no regulator can allow. After enactment of the bill into law, the monitoring of risk management systems in financial intermediaries is set to become more rigorous, to ensure the continuity of financial entities.
The need for financial resolution stems from the global financial crisis of 2008, which led to the collapse of Lehman Brothers and the simultaneous failures of many smaller financial entities. But in India, there have been few bankruptcies in the financial sector. All such instances so far have been dealt with deftly, without loss to depositors. Some examples are the smooth takeover of Global Trust Bank by Oriental Bank of Commerce and the Bank of Credit and Commerce International Ltd by State Bank of India, where the depositors were fully protected. Therefore, the government and regulators are sensitive about protecting depositors’ interests.
But globally, among the reasons that triggered the financial crisis, one key reason was the absence of defined bankruptcy laws. Therefore, it was felt that timely handling of bankruptcy among financial companies is also necessary on a par with bankruptcy laws for business and commercial entities. Such provisions also find weightage in the “ease of doing business” index of the World Bank. With the Insolvency and Bankruptcy Code 2016, an exit route for failed non-financial entities is in place. A similar law was felt essential for banks, non-bank financial companies, insurance and other financial intermediaries, to streamline the exit route for them. Permitting easy entry and exit in business is part of good governance. With these developments in mind, a committee was formed to enact the bankruptcy law for financial entities. The present FRDI Bill is the result of their work.
At present, the Deposit Insurance and Credit Guarantee Corporation (DICGC) formed under the DICGC Act 1961 insures retail bank deposits of up to ~1 lakh per depositor. Deposits of over ~1 lakh are open to risk. Since the banking system in India is well-regulated and a majority of banks are owned by the government, depositors have full faith that their deposits are safe. Banks have evolved over a period time into trustees of depositors. Ultimately, the price of failure of banks and financial entities has to be borne by the government from out of taxpayers’ money.
But the moment there is any meddling with customers’ deposits, there will be an uproar that can mar the sovereign reputation of the government. Even now, except in the case of some cooperative banks, the DICGC has never been required to pay even ~1 lakh to depositors. In the last seven decades, deposits of the public have rarely been put at risk. Hence, despite the “bail-in” clause, it will not be allowed to be used as a routine tool. There will be granular provisions and rigour to prevent entities from using the tool.
However, in order to allay the fears of bank customers, it is desirable that the “bail-in” provisions under clause 52 are appropriately modified by prescribing a ceiling up to which deposits are fully protected, as is available currently from DICGC, perhaps with enhanced protection. It will be prudent to restrict failed financial entities from using more than the extent of their capital. With the current thrust on financial inclusion, ever more customers are set to be connected to banks. Unless faith in the robustness of the financial system is demonstrated, even banks in the rest of the world may not like to transact with the Indian banking system.
The intention behind enacting the FRDI Bill is to imbibe global best practices in providing financial resolution to failed financial entities. But the manner in which certain clauses have been built into it has invited the ire of bank customers. In any financial system, capital is provided as a cushion to meet business risk. But business risk cannot be stretched to allow financial entities to eye customer deposits. Therefore, any sensible commercial entity has to build risk appetite commensurate with its capital base and not beyond. The laws have to define the boundaries between capital and other liabilities. Only then can the sanctity of the financial system be protected, and depositors’ faith and global respect retained.
In India, bankruptcies in the financial sector have been deftly handled. The government has been sensitive to depositors’ concerns