Do we need an FRDI Bill?

The Bill, in its current form, is almost equivalent to the Deposit Insurance and Credit Guarantee Corporation Act. The question we therefore need to answer is how we clear the supposed misgivings regarding the FRDI Bill

Recently, there has been a lot of noise in the public domain regarding the proposed Financial Resolution and Deposit Insurance (FRDI) Bill. The resolution method of the FRDI Bill which has spread a lot of confusion among depositors is the “bail-in” clause. It means, in case the financial situation deteriorates, deposits over and above the insured (currently at ~1 lakh) could be converted into securities such as shares in the bank.

We believe such a confusion and panic is not strictly justified. Currently, the Deposit Insurance and Credit Guarantee Corporation (DICGC) provides deposit insurance for deposits of commercial banks (ASCBs), regional rural banks (RRBS), local area banks (LABs) and co-operative banks of up to ~1 lakh and the rest of the amount is forfeited in the rare event of a bank failure. The FRDI Bill is similarly contemplating a mechanism of deposit insurance up to a specified limit (at least ~1 lakh) for not only banks but non-banking financial companies (NBFCs), insurance companies, pension funds, stock exchanges and depositories. However, contrary to the DICGC Act of 1961, the FRDI Bill is examining whether the amount of money exceeding ~1 lakh — that was supposed to be forfeited in DICGC — could now be effectively used by a bank in distress by the “bailin” clause. So in essence, the FRDI Bill in its current form is almost equivalent to the DICGC Act. The question we therefore need to answer is how we clear the supposed misgivings regarding the FRDI Bill.

There are indeed several questions that merits serious attention in the FRDI Bill. First, whether the concept of bail-in is justified in the Indian context. This is similar to the strategies adopted by EU countries such as Cyprus. Interestingly, the bail-in provision was used in Cyprus in 2013 where deposits above 100,000 were classified as “disposable or frozen” as the number of accounts above 100,000 mostly belonged to the affluent class. In contrast, the use of the concept of “bail-in” may be avoided in the Indian case where the average incomes of a vast majority of depositors are modest.

There are more points that need to be dealt with. Banks are required to pay premium on the entire assessable deposits, whereas strangely the liability of the corporation is limited to only ~1 lakh/$1500. No wonder, such level of deposit insurance is significantly inadequate and must be increased. Data on cross country deposit insurance coverage limit shows that deposit insurance coverage in India is one of the lowest — at ~1 lakh/$1,508/0.9 times India’s per Size of deposits Less than ~25,000 ~25,000 and above but less than 1 lakh ~1 lakh and above but less than 15 lakh ~15 lakh and above but less than 1 crore ~1 crore and above Total capita income. Furthermore, if we compare India with the BRICS group of countries such as Brazil and Russia, the comparative insurance figure rises to ~42 lakh and ~12 lakh respectively! If we compare the deposit insurance limit in India with countries having similar per capita incomes, we find that the insurance cover is even unlimited in some countries.

Next, an analysis of the deposit base of the banking system shows two divergent trends. First, in terms of the number of accounts, 67 per cent of the total accounts are less than ~1 lakh and 99 per cent are less than ~15 lakh. So clearly, it seems on paper that the number of small depositors are adequately covered in terms of insurance. However, in terms of quantum of deposits, we observe that the percentage of deposits that is less than ~1 lakh is only 8 per cent of the deposit base. Seventeen per cent of the deposits are contributed by customers having deposits of more than ~15 lakh but less than ~1 crore with average deposits of ~37 lakh. Even though 38 per cent of deposits are more than ~1 crore, with an average deposit of ~9.7 crore, we believe most of such may be categorised as bulk deposits and may not be strictly relevant for our discussion. Effectively, the customers (with balance between ~15 lakh and ~1 crore) get protection only to the extent of 2.7 per cent of their deposits though the premium is paid on the entire value of deposits held by them. Is it not unfair?

The common argument could be that people holding such large deposits are rich. However, such an argument is incorrect in the Indian context, where senior citizens/retired people have no social security in place and mostly keep fixed deposits for earning interest income which in many cases becomes a part of their current income for regular upkeep. There are also many small savers who have fixed deposits with the same intent. It is possible that a large percentage of accounts having balance in excess of ~15 lakh but less than ~1 crore belong to senior citizens who have kept their hard-earned money for meeting family needs like daughter’s marriage/higher education/medical emergency. In the extreme event of a bank failure, it is unfair if such hard-earned money is forfeited. Alternatively, logic demands that at least the average balance in deposit accounts of such retiree class (~37 lakh) needs to be protected.

One alternative to “bail-in” could be that if depositors get incentive to spare a part of their total deposits to buy bank bonds that provide guaranteed coupon rates on a half-yearly basis and is tax free. Simultaneously, the distressed banks could be encouraged to improve their management strategies with a tenure-based plan for recovery and viability. Tax-free and guaranteed payments of a certain income will do much to encourage people to come forward with offers to provide a part of their savings in exchange for the shares in the banks. The bonds may be allowed to be traded after three years or five years. The time period for tradeability clause may be fixed with reference to the banks’ recovery and viability strategy plans.

In the end, a comprehensive social security plan is a sine qua non for any “bail-in” that is still not available to 97 per cent of India’s population!