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The Centre’s proposed FRDI (Financial Resolution and Deposit Insurance) bill aims at a systematic resolution of all financial firms- banks, insurance companies and financial intermediaries. The bill provides for the setting up of a Resolution Corporation which will monitor the firms, classify them based on their risk of failure and take corrective action in case of bank failure. It will also provide deposit insurance up to a certain limit in case of a bank failure. As such, the bill will work in tandem with the Insolvency and Bankruptcy Code.

It also provides for a provision of bail-in where the bank can use the unsecured creditors’ money to cover for its inadequacies. It can do so by either by cancelling its liabilities or issuing securities in lieu of the money deposited. Since the depositors in the banking terminology are considered to be a financial firm’s unsecured creditors, this provides a direct threat to the depositors by exposing them to the risk of losing their money

So Why FRDI Bill?

The primary aim of this bill is to find and finalise a resolution plan that can get a troubled financial institution back on track. It also intends to find a quick solution to problems like failure of a financial institution so that there is least disruption to the system, economy and other stakeholders involved. The Resolution Corporation shall aim at improving and stabilising financial firms so that taxpayers do not lose in a bid to save solvency while also ensuring that the key operations do not suffer. A bank is considered to be an institution of trust and any activity such as that of liquidation will have a bearing on people’s trust in the system.

Also, it is very important to understand that this is not a reform proposed by any ruling government in the history of democratic India. The reform was unanimously agreed upon by all the G20 nations including India in 2011 under the proposal called “Key Attributes of Effective Resolution Regimes for Financial Institutions”. This proposal has a ‘bail-in’ to ensure that a country is not de-stabilised in the event of a huge default by a large bank. This board was set up post 2009 after the Global Financial Crisis where the US government used the option of ‘bail-out’ to protect the banks causing a large-scale system collapse. The world realised thereafter that such an option should never be exercised in case of bank failures as it has extensive and painful repercussions. Today the bail-in feature has widely become a popular measure among other countries including but not limited to the European Union.

History of Bail-Ins

India is not the first country to follow a bail-in approach. It has previously been followed in two countries, Denmark and Cyprus. Let us consider their cases one by one.

Taking the Cyprus example, in 2013 the eastern Mediterranean country saw the collapse of its banking system. Banks were shut overnight, people were unable to access their money while the government refused to step in and bail out. It became a testing ground for IMF bail-in policy and turned out to be a disaster or what could be called a legal theft. Depositors with over €100,000 in their bank accounts lost money through 37.5% converted into equity, 22.5% held in reserve against a possible future conversion and 30% was completely frozen. The depositors lost 60% of their amount.

Now, consider another case of Denmark. In response to its financial crisis in 2011, it came up with the scheme of five bank packages which included increasing the bank insurance along with a safety net. The bail-in when implemented closed down banks for a weekend and imposed losses on senior debt holders while keeping the ordinary customers safe. The Denmark case did not result in an unavoidable disaster because the entire process was carried out in an orderly manner.

In fact, such a scheme was advocated by the IMF itself which suggested that a country needs to have a clear and coherent approach for bail-ins. It suggested “An appropriate balance between the rights of private stakeholders and the public policy interest in preserving financial stability. Debt restructuring ideally would not be subject to creditor consent, but a no creditor worse off test may be used to safeguard creditors.”

India’s Case

There are several key concerns that India has to address before resorting to the bail-in scheme. First, it needs to devise a legal system where the government is able to develop a mechanism so that the ordinary depositor does not lose money. Second, it needs to think about a clear and cohesive framework. If bail-ins ever occur in future, it would increase the strength of the concerned financial firm and volatility of the banking system. Third, the government needs to develop trust among the depositors so that the scheme protects their money and banking system from any harms. At last count, the total gross NPA in the Indian Banking System totalled 9 lakh crores. And while the rate of growth in NPAs is showing signs of slowing down, the overall problem is still far from any sort of quick resolution.

The Lok Sabha had given its nod to the motion to formulate a Joint Committee on this Bill and given time up to the last day of the Monsoon Session 2018 for submitting its report. Currently, only deposits of up to 1 lakh are protected under the Deposit Insurance and Credit Guarantee Corporation Act that is sought to be repealed by the bill. This has emerged as a major bone of contention with the depositors. Though the Union Finance Minister, Arun Jaitley has clearly stated that the bill is fully meant to protect the interest of financial institutions and depositors, it should specify how it intends to do so. Otherwise gaining trust would be a tedious task.

By Aditya Jain


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