The question of the safety of bank deposits has grabbed the attention of the Indian public ever since the proposed Financial Resolution and Deposit Insurance (FRDI) Bill was introduced, with many calling it draconian.
Critics have expressed vocal opposition to the prospect of depositors’ funds being used to bailing-in of banks and to the withdrawal of deposit insurance .
Since the 2008 global crisis which led to taxpayer-funded bailout packages worth billions of dollars being used to rescue banks worldwide, several countries have introduced laws surrounding robust resolution, the standards for which have been set by the Financial Stability Board.
Finance minister Arun Jaitley suggested the introduction of such a law in his 2016-17 budget speech wherein he referred to the existing vacuum with respect to addressing bankruptcy situations in financial firms.
Joyjayanti Chatterjee, an associate fellow with the Vidhi Centre for Legal Policy who worked with the finance ministry on the bill, pointed out that the bill was aimed at “resolution and not regulation”.
He pointed out that if a big FMCG company were to fail today the impacted people would be only the creditors. However if a large financial institution failed, its impact would be wide ranging. Therefore a specific law is required to contain the effects of financial companies going bankrupt.
Understanding the FRDI bill
The new bill seeks to set up the guidelines for the orderly closure of a financial institution and suggests the setting up of a Resolution Corporation (RC) for identifying early warning signs of financial distress at institutions like banks, insurance companies, and non-banking financial companies.
In the event, any financial institution falls under the ‘critical’ risk category, the RC is required to take over, while the relevant regulator would attempt to resolve the crisis with available tools. The RC can manage the crisis through a variety of actions such as forced mergers, transferring of assets and liabilities to another firm, bailins, liquidations, etc.
So far the government or Reserve Bank of India (RBI) has not allowed banks to fail, and the government is not likely to give up its protection of the country’s financial institutions .
Sandeep Parekh, managing partner at Finsec Law Advisors pointed out that the banking system in India was “most leveraged one”, with around 20 times leverage . He noted that resolution was the accepted fact in developed markets and the FRDI bill as a “framework follows the lead of those markets.”
The Worrisome Clause Involving bail-ins
Under the provisions of the new bill, the “bail-in” tool allows the conversion of some creditors’ (including depositors’) debt into equity. This injection of funds into the organisation will result in lower likelihood of tax-funded bailouts .
These liabilities can however be utilized for bailing only in cases where the people have given their prior consent.
Further, the bill specifically excludes Deposit amounts covered by deposit insurance, pensions, and any monies payable to employees.
Chatterjee of Vidhi Centre for Legal Policy noted that the bail-in prison is not a tool that can be used “at the government’s whim and fancy to arbitrarily use depositors’ money without their consent to save failed banks.” He pointed out that the law seeks to ensure that all creditors, including depositors, “are not left in a worse position than they would have been had the entity been liquidated.”
The Safety of Bank Deposits Remains Strong
The deposit insurance clause in the FRDI Bill has been the misconstrued one, leading to people believing that their money is in jeopardy.
Currently, the Deposit Insurance and Credit Guarantee Corporation Act, 1961, offers deposit insurance of up to Rs 1 lakh with the rest of the amount being forfeited in case of a bank failure.
The FRDI bill recommends that the RC set the amount of deposit insurance in consultation with RBI. This actually means that there might be scope for the insurance to be a higher amount considering that the last compensation amount was set up nearly 25 years ago.
According to State Bank of India, deposit insurance coverage in India among the lowest worldwide at $1,508, with the coverage in the US at $250,000 and $111,143 in the UK.
Anil Gupta, vice-president at ICRA noted that the lack of the insurance amount had worried people that their money would be lost in case of a default. However he pointed out that the fears were “not correct” since even under the existing law “there was no guarantee for deposits, but no one lost out.”
Resolution Law Helps Better Regulation
Although the Insolvency and Bankruptcy Code (IBC) was introduced to deal with corporate bankruptcy the authorities believe that the existing legal laws for resolution of financial firms are not adequate.
Chatterjee observed that while regulation is “good medical treatment,” the FRDI law is “good funeral service” so that everyone is well prepared to handle even the worst outcomes.
