Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill)

Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill)

First of all, Bank is also a company and controlled by various other acts such as Banking Regulation Act and regulated by RBI.  The financial sector is a backbone of the economy and trust should always be maintained for maintaining financial stability.  In India, RBI is maintaining the stability of the Indian Financial system and trust of common men that his deposit is safe with the Indian Banking System.

Deposit Insurance and Credit Guarantee Corporation:

The government has incorporated an insurance corporation in the name of Deposit Insurance and Credit Guarantee Corporation which guarantee the deposits made in the bank up to a limit of Rs. 1.00 Lacs and guarantees loans to the Small Scale Industries, small business finance and also loans under government sponsored schemes to the maximum of 75% of the loan outstanding subject to certain Conditions. Later the Credit Guarantee has withdrawn and the corporation remains as Deposit Insurance only.

Reserve Bank of India

Reserve Bank of India, is regulating the banking industry in India effectively and following the principle of “TOO BIG TO FAIL:”.  They merged a failed bank with another state-owned bank to maintain the depositors’ confidence.  When Global Trust Bank was failed, RBI force-merged Global Trust Bank with Oriental Bank of Commerce to prevent widespread losses to depositors It does not matter that the decision may have been motivated by a need to avoid a close scrutiny of how it was sleeping on its job. In fact, over the past several decades, the only payments made out of deposit insurance is on account of failed cooperative banks, which are under dual regulation (RBI and registrar of cooperatives) and completely controlled and manipulated by politicians across the spectrum.

What is the need for the Bill

The FRDI Bill is based on a 2014 working paper of RBI, in line with a global movement to create statutory structures to contain the contagion effect of the kind that shook the world in 2008 by the failure of large financial institutions. In November 2014, India, as part of the G20 nations, had agreed to create a legal structure which includes a ‘bail-in provision’ to recapitalize banks. But such a contingency is a matter of last resort. In fact, most global banks, including those in India (State Bank of India, ICICI Bank and Bank of Baroda had done this), have been asked to work on the concept of a ‘living will’, where they put in place a disaster management plan, if you will, on what is to be done in the event of a massive meltdown.  

 New regulation:

The government has introduced the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) in parliament this June in order to provide to provide for the resolution of certain categories of financial service providers in distress; the deposit insurance to consumers of certain categories of financial services; designation of systemically important financial institutions; and establishment of resolution Corporation for protection of consumers of specified service providers and of public funds for ensuring the stability and resilience of the financial system and for matters connected therewith or incidental thereto.. The FRDI Bill aims to limit the use of public money to bail out distressed organizations in the event of a financial crisis, by providing a resolution framework to handle the failure of banks, insurance companies, and financial sector entities. It seeks to create a framework for resolving bankruptcy in financial firms (such as banks and insurance). This bill repeals the Deposit   Insurance and Credit Guarantee Corporation Act, 1962 and amends 12 other laws.

Resolution Corporation:

The central government will establish a Resolution Corporation. The corporation will have a Chairperson and its members will include representatives from the Finance Ministry, RBI, and SEBI, among others.

Functions of the Corporation will include:

 (i) Providing deposit insurance to banks (to repay deposits to consumers in case of failure),

 (ii) Classifying service providers (such as banks and insurance companies) based on their risk,

and (iii) undertaking resolution of service providers in case of failure.

It may also investigate the activities of service providers, or undertake search and seizure operations if provisions of the Bill are being contravened.

Risk based classification:

The Corporation shall, in consultation with the appropriate regulator, specify by regulations, objective criteria for classification of a specified service provider into any one of the following categories of risk to viability, namely:—

(a) Low, where the probability of failure of a specified service provider is

substantially below the acceptable probability of failure;

(b) Moderate, where the probability of failure of a specified service provider is marginally below or equal to acceptable probability of failure;

(c) Material, where the probability of failure of a specified service provider is marginally above acceptable probability of failure;

(d) Imminent, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure;

(e) Critical, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure, and the specified service provider is on the verge of failing to meet its obligations to its consumers:

While classifying the financial institutions into the above 5 categories The Corporation may specify different criteria for different categories of specified service provider but take into account the following attributes of a specific service provider

(a) Adequacy of capital, assets, and liability;

(b) Asset quality;

(c) Capability of management;

(d) Earnings sufficiency;

(e) Leverage ratio;

(f) Liquidity of the specified service provider;

(g) Sensitivity of the specified service provider to adverse market conditions;

(h) Compliance with applicable laws;

(i) Risk of failure of a holding company of a specified service provider or a connected body corporate in India or abroad; and

(j) Any other attributes as the Corporation deems necessary;

The above attributes are nothing but the enhanced CAMEL requirement prescribed by the regulator (RBI)

Action program of the Corporation

 If a service provider has been categorized under “CRITICAL” category, they need to submit a restoration plan to the regulator and resolution plan to the Corporation. The plan should contain the following points

1.   Details of assets and liabilities

2.   Steps to improve risk-based categorization,

3     Information necessary for resolution of the service provider

Based on the above details, The Corporation will undertake resolution of a service provider classified under Critical using either of the following options

ü  Transfer of its assets and liabilities to another person,

ü  Merger or acquisition,

ü  Liquidation, among others.

The management of the service provider will be taken over by the Corporation and it will be resolved in within a year of classifying under Critical

The liquidation and distribution of assets will require the approval of National Company Law Tribunal and the proceeds will be distributed on the following priority

Ø  Amount paid by Corporation as deposit insurance to insured depositors,

Ø  resolution costs,

Ø  workmen dues for 24 months and secured creditors

Ø  wages to employees for 12 months,

Ø  amount to uninsured depositors and other insurance-related amounts,

Ø  unsecured creditors,

Ø  government dues and remaining secured creditors (remaining debt  if they choose to enforce their collateral),

Ø  remaining debt and dues,

Ø  Shareholders.

The Bill did specifies penalties for offenses such as concealment of property, and destruction or falsification of evidence.

Special efforts of the bill:

 Bail-in clause in the FRDI Bill that allows the government to convert the depositors' money into equity in order to recapitalize and bail out banks that are facing bankruptcy. In case the Bank was liquated as per the corporation the uninsured depositor will be paid only after the secured creditors.  What is a bail-in? It is the opposite of bailout, where governments use taxpayers’ money to save large institutions. A bail-in gives statutory powers to a resolution authority to convert existing creditors (including depositors) into shareholders in order to recapitalize the bank. The FRDI Bill creates the statutory basis for such action by replacing the current deposit insurance guarantee corporation (or converting it) with a Resolution Corporation that will cover banks, financial institutions, and insurance companies. 

The FRDI Bill also envisages a ‘Corporation Insurance Fund’ that will insure a part of the deposits. The extent of deposits insured is likely to be substantially higher than Rs1 lakh insured today. These insured deposits will be out of the purview of appropriation for a ‘bail-in’. 

What is needed at this point?

1.   The FRDI bill should also include Cooperative Banks and non-Banking Financial Companies besides including the payment banks.

2.   The Bad loans are increased through because of the financing of infrastructure projects and greediness to achieve the targets. Loan drives in retail sector without proper infrastructure leads to increase in bad loans. The Banks fails to train the workforce in loan processing and maintenance of the loans leads to an improper assessment of loan and defective follow-up. This issue to be addressed first. Further, there is no Board level responsibility for bad loans of large caps and defectives policies; If a big loan fails the responsibility should be assigned to the top management as they have failed to take corrective actions. Government action of the mass write-off of loans pertaining to agriculture sector has instilled bad precedence in the minds of the agriculture borrowers that their loan will be written off if they do not pay. (During such mass write off  only affluent and bad borrowers were benefited instead of the needy one)

3.   Allowing a financial institution to fail will have a cascading effect on the economy. This is evident in 2007 crisis. Had the Lehman brothers bailed out in 2007, the whole financial crisis would have been averted. We have seen the worst part of non-bailout of Lehman Brothers. 

 Further, Indonesia is also the best example for bail-in of the banks. In 1999, Bank Rama was allowed to fail, it leads to financial crisis where the currency was taken to a spin. The exchange rate of the Indonesian Rupiah moved from less than 2000 per USD to 30000 with high volatility It stabiles to 10000 in 2007. The depositors also lost confidence in Banks and start in short terms tenure (one month) and renew on maturity. On the contrary, Malaysian Government has bail-out the banks and stabilized their financial system. We need to learn lessons from these incidents.

4.    Up to now Indian financial market is stable and won the trust of the depositor due to actions were taken by the Reserve bank in merging the failing bank with a strong Bank instead of bail-in.

5.   It appears some banks are now focusing on cross-selling instead of their core business as an incentive is attached to it for the Branch Manager to the top management. Hence, everyone was pressured to do cross-selling. Due to the pressure, lots of mis-selling happens. I am not against cross-selling but the incentive should be only for the person who is marketing the product i.e. the Branch Manager not everyone up above him.

6.   Banking Supervision should be delinked with RBI and formed a new corporation to monitor the banking system more efficiently. The Risk rating of the Banks may be handed over to the Bank Supervision body which will ensure rating really reflecting the health of the bank. We are also coming across incidents increasing bad loans/ provisions whenever the incumbency changes, indicate suppression of NPA to show a rosy picture. Such incident will be avoided if meaningful supervision is done by the regulator.

7.   BASEL III implementation is being postponed to 2019 in India although sufficient time for preparedness is allowed. It should be implemented in full so that the Banks will address the liquidity risk efficiently besides providing adequate capital to act as buffer for the expected/ unexpected loss.

Conclusion

The Bill is being revisited by the Finance Ministry and let us hopes the issues are addressed. 

_______________________________________________________

Based on the draft FRDI bill and also comments/ article/ views expressed on the bill over Internet (web pages)