The Financial Resolution and Deposit Insurance Bill, 2017, also known as the FRDI Bill tabled in August this year in the Parliament has become the centre of the controversy recently.
Members of the public have raised alarm regarding some provisions dealing protection for bank deposits.Already an online petition against the Bill titled “Do not use innocent depositors’ money to bail in mismanaged banks #NoBailIn” had attracted nearly 90,000 signatories by last week
The furore has forced the government to release a statement to assuage worries stating that the law seeks to aim the interests of the depositors better and in a “more transparent manner”.
Prime Minister Narendra Modi also addressed the issue in a recent election rally in Gujarat alleging that opposing party Congress was “spreading lies” on the FRDI Bill that it will lead to “bankrupt banks taking away people’s hardearned deposits”, assuring he would not allow such a thing to happen.
The Bill is currently under review with the Joint Parliamentary Committee.
What is the FDRI Bill about
The FDRI bill is similar to the legislation passed recently to handle insolvency of companies quickly and efficiently.
The FDRI bill’s provisions aims to handle failures of financial sector firms like a bank or an insurance company fails efficiently, by offering a range of quick solutions such as selling it, merging it or closing it with minimal disruption to the economy and the system as a whole.
This process happens under a new authority named Financial Resolution Corporation — which will categorize the companies as per the risks posed by them, carry out inspections and in later stages take over the company. This is based on a recommendation made by the Financial Sector Legislative Reforms Commission (FSLRC) led by Justice B N Srikrishna.
Understanding the “bail-in” provision
The phrase ‘bailout” has long been used in context of government stepping in to protect failing institutions in interests of depositor or savers. An example is that of the UK government bailing out banks like the RBS and Lloyds in the aftermath of the 2008 crisis. Similar bailout packages were given out by governments in the US and Europe as well.
The usage of public or taxpayer funds to rescue banks led to criticism that such support incentivized bank managements to take undue risks, which has led governments worldwide to look for other solutions.
New regulations have been therefore introduced that lay down that shareholders and creditors of a financial institutions must bear losses rather than the public. One of the methods used to do this is the “bail-in” provision.
Under it, resolution agencies can override the rights held by the shareholders of the firm which can mean either writing down of the institution’s equity and debt to absorb losses, or transforming debt holdings to equity. It can also result in overriding the rules regarding necessary approvals from shareholders to disposing of the assets
The rationale for the bail-in provision
The main aim of the bail-in clause is limiting the use of public funds to rescue failing financial companies. Another objective is ensuring that creditors and shareholders of banks also share the costs of failure, rather than government or the public bearing all the losses.
The Bank of England has been urging UK banks to put aside large amounts of funds to cover potential failures. The aim is to ensure banks are no longer “too big to fail”, and investors are able to appropriately price the risks taken by banks.
Reasons for the depositors’ worries
Bank deposits are the primary form of financial savings in India. The provision has raised fears the savers in India may be asked to take up the same role as in other countries in order to reduce overall risks and burden on public.
Furthermore, deposits in banks are currently insured by the Deposit Insurance and Credit Guarantee Corporation, for a maximum of Rs 1 lakh The latest bill fails to mention amount of protection available for deposits, or the rules to classify deposits.
The government’s response so far
According to the government, the FRDI Bill is friendlier to depositors than similar laws in other countries which mandate statutory bail-in.
It has also clarified that it will not be limiting its scope related to financing and support to banks, including public sector banks.
The Finance Ministry has further sought to reassure that the government’s implicit guarantee remains to public sector banks unaffected, which can imply that the government is not against the route of rescuing a failed bank.
Other changes introduced by the law
Under this law, all financial sector firms like banks, insurance companies and pension funds will need to develop resolution plans that will come into force in case of a failure. These plans will be reviewed by the proposed authority, Resolution Corporation on a regular basis.
A similar authority, the US Federal Deposit Insurance Corporation (FDIC), has so far handled 527 bank failures since 2008, which seven cases in 2017.
Such bodies in the US, UK and Canada classify the risks posed by firms supervised by them and reviews them regularly. It also carries out regular mock drills and simulation tests of the resolution plans.
