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The Union government has brought about a proposal for a Financial Resolution and Deposit Insurance(FRDI) Bill, which is a part of a host of banking reforms and enactment of laws that aim to resolve the conditions of the failing banks. The Bill has been the cause of worry for depositors across the country.
Banks has always been associated with financial security. It is the trust of the depositors in the bank that helps the banking institution to run easily. What if the bank’s financial situation deteriorates to an extent that it becomes unable to repay the deposits, then to whom will they turn to?
To deal with situation, way back in 1961 the Deposit Insurance and Credit Guarantee Corporation Act was passed by the Indian Parliament.
The law guarantees the deposits would be under the insurance cover for up to Rs 1 lakh, including interest. This means that the payment of all deposits up to Rs 1 lakh are protected even if the bank collapse. But anything over and above Rs 1 lakh does not have this protection. So, if the bank scuttles, a bank account holder with a large deposit might lose a lot of money.
21 public sector banks control 82% of the banking business in India, and they roughly pay about Rs 3,000 crores as insurance premium to the Deposit Insurance and Credit Guarantee Corporation, a subsidiary of the Reserve Bank of India.
A different set up proposed by the government
Though, this framework is all set to witness a drastic change when the Parliament takes up the FRDI Bill, 2017, in Lok Sabha, possibly in the upcoming Winter Session. The FRDI bill, 2017 was tabled in the Lok Sabha in August this year following which it was referred for review to a joint parliamentary committee. The report by the committee is due to be submitted during this Winter Session, after which an amended Bill is expected to be tabled in the upcoming winter session of Parliament beginning 15 December.
The FRDI Bill seeks to resolve bankruptcy in a banking institution, insurance companies and other financial establishments.
Along with the Bankruptcy and Insolvency Code, re-capitalisation of PSU banks, and FDI in insurance this Bill is set to create a landmark in the financial sector.
What is the issue?
The Bill is facing stiff opposition from the bank employees union and depositors as well. In August, banking employees went on a strike against the proposed legislation.
This bill is being opposed for a variety of reasons. In a joint statement, the union said that the proposed law would allow the public-sector banks for liquidation or amalgamation, which could put deposits of the customers under severe risk. Even worse, provisions dealing with deposit insurance are unclear in the draft law, and there is no explanation for the amount which has to be insuredby the banks.
A bail-in option is also provided in the bill, which means depositors could lose the control of their money, i.e. in case the bank’s financial situation deteriorates, deposits could be converted into securities such as shares in the bank.
A breakdown of the clauses of the FRDI Bill
Although India never had such a resolution authority before, the Reserve Bank and the Insurance Regulatory and Development Authority of India (IRDAI), an autonomous,statutory agency regulated and promoted the insurance industries.Recently in the past, RBI had asked PSU banks to take over stressed banks to protect the depositors and its employees.
The Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, established in 1971 insures all kinds of bank deposits up to a limit of ₹1,00,000. In case a stressed bank had to be liquidated, the depositors would be paid through DICGC.
However, the proposed Bill seeks closure of the DICGC, as the credit guarantee will be taken care of by the Resolution Corporation itself.
Excerpt from the Bill talking about the DICGC
The Bill suggests for the establishment of ‘Resolution Corporation’ which will monitor financial firms, evaluate stress and take “corrective actions” in case of a failure. Financial companies will be classified by the Corporation based on their risk factors as low, moderate, material, imminent, and critical.
In case of ‘critical’ firms, the Corporation will be empowered to take over and resolve issues within a year such as acquisition or merger, transferring the assets, liabilities to another firm, or liquidation.
This Corporation will be governed by the Finance Ministry with representatives from SEBI, RBI, IRDAI, and PFRDA. The Chairperson, two independent members and other members of the Board would efficiently be appointed by the Union Government.
In case of a ‘critical’ firm the Bill provides one-year time for the Corporation to resolve issues. This time frame can be extended to another year as provisions.
It was mandatory for the banks to pay a sum to the DICGC as the insurance premium. But now the Bill proposes the banks to pay a sum to the Resolution Corporation but doesn’t specify the insured amount. It is also unclear how much a depositor would be paid in case of liquidation.
Excerpt from the Resolution talking about establishment of a Resolution Corporation
The depositors will be affected immediately by the bail-in provision included in the proposed law. This is where the creditors of the bank would be forced to bear a part of the loss in case the institution descends. In the past, it had worked mainly against depositors. The bail-in provision was used in Cyprus in 2013 where depositors lost as much as 50 percent of their savings when a bail-in was implemented.
In banking terms, depositors are considered creditors. They are in fact unsecured creditors while making their deposits no depositor seeks security from banks. The bank uses these deposits to extend loans and earn interest. When the economy is in downturn banks come under pressure, as large corporations do not repay the money on time, leading to stress.
The problems faced by banks could also be due to lack of regulatory oversight that allowed banks reckless lending, or mismanagement of the bank.
As proposed in the bill, in consultation with the appropriate regulator a bail-in will be triggered in case of banks as deemed fit by the RBI and the Resolution Corporation.If they think that a bank requires capital to absorb losses and continue to function without breaking down, the deposits in the bank could be converted into securities like stocks of the bank.
Excerpt from the Bill that talks of the ‘bail-in’ instrument in Clause 52