Financial Resolution and Deposit Insurance Bill 2017---and--- Prompt Corrective Action Framework

 Financial Resolution and Deposit Insurance Bill 2017---and--- Prompt Corrective Action Framework

This is in continuation to my earlier write-up on FRDI.

Financial Resolution and Deposit Insurance Bill 2017 (FRDI), proposed banking reform act, which creates lots of doubt in the mind of the public fueled by the opposition and media that the deposit in the banks will not be safe as the banks may be bail-in, in case of failure.  We have to realize that this is the redefined, legalized initiative of the present Prompt Corrective Action framework (PCA) a regulation formed by the RBI. This bill is necessary for the wake of financial crisis in 2007 caused by Layman Brothers failure and also ineffectiveness of the PCA framework of  RBI which could not control deterioration of Bank’s Health.

What is the salient feature of Prompt Corrective Action Framework?

A. Capital, asset quality, and profitability continue to be the key areas for monitoring in the revised framework.

B. Indicators to be tracked for Capital, asset quality, and profitability would be CRAR/ Common Equity Tier I ratio¹, Net NPA ratio and Return on Assets respectively.

C. Leverage would be monitored additionally as part of the PCA framework.

D. Breach of any risk threshold (as detailed under) would result in invocation of PCA..

*CCB would be 1.875% and 2.5% as on March 31, 2018 and March 31, 2019 respectively

i.        Breach of ‘Risk Threshold 3’ of CET1 by a bank would identify a bank as a likely candidate for resolution through tools like amalgamation, reconstruction, winding up, etc.

ii.        In the case of a default on the part of a bank in meeting the obligations to its depositors, possible resolution processes may be resorted to without reference to the PCA matrix.

E. The PCA framework would apply without exception to all banks operating in India including small banks and foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators.

F. A bank will be placed under PCA framework based on the audited Annual Financial Results and the Supervisory Assessment made by RBI. However, RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances so warrant.

Mandatory and discretionary actions
Specifications	Mandatory actions	Discretionary actions
Risk Threshold 1	Restriction on dividend distribution/remittance of profits. Promoters/owners/parent in the case of foreign banks to bring in capital	Common menu Special Supervisory Interactions Strategy related Governance-related Capital-related Credit risk related Market risk related HR related Profitability related Operations related Any other
Risk Threshold 2	In addition to mandatory actions of Threshold 1, Restriction on branch expansion; domestic and/or overseas Higher provisions as part of the coverage regime
Risk Threshold 3	In addition to mandatory actions of Threshold 1, Restriction on branch expansion; domestic and/or overseas Restriction on management compensation and directors’ fees, as applicable

Common menu for selection of discretionary corrective actions'

1. Special Supervisory interactions

·         Special Supervisory Monitoring Meetings (SSMMs) at quarterly or other identified frequency

·         Special inspections/targeted scrutiny of the bank

·         Special audit of the bank

2. Strategy related actions

RBI to advise the bank’s Board to:

• ·         Activate the Recovery Plan that has been duly approved by the supervisor
• ·         Undertake a detailed review of the business model in terms of sustainability of the business model, the profitability of business lines and activities, medium and long-term viability, balance sheet projections, etc.
• ·         Review short-term strategy focusing on addressing immediate concerns
• ·         Review medium-term business plans, identify achievable targets and set concrete milestones for progress and achievement
• ·         Review all business lines to identify scope for enhancement/ contraction
• ·         Undertake business process re-engineering as appropriate
• ·         Undertake to restructure of operations as appropriate

3. Governance-related actions

·         RBI to actively engage with the bank’s Board on various aspects as considered appropriate

·         RBI to recommend to owners (Government/ promoters/ parent of foreign bank branch) to bring in new management/ Board

·         RBI to remove managerial persons under Section 36AA of the BR Act 1949 as applicable

·         RBI to supersede the Board under Section 36ACA of the BR Act 1949/ recommend supersession of the Board as applicable

·         RBI to require bank to invoke claw back and malus clauses and other actions as available in regulatory guidelines, and impose other restrictions or conditions permissible under the BR Act, 1949

·         Impose restrictions on directors’ or management compensation, as applicable.

4. Capital-related actions

·         Detailed Board level review of capital planning

·         Submission of plans and proposals for raising additional capital

·         Requiring the bank to bolster reserves through retained profits

·         Restriction on investment in subsidiaries/associates

·         Restriction in expansion of high risk-weighted assets to conserve capital

·         Reduction in exposure to high-risk sectors to conserve capital

·         Restrictions on increasing stake in subsidiaries and other group companies

·          

·         5. Credit risk related actions

·         Preparation of time-bound plan and commitment for reduction of stock of NPAs

·         Preparation of and commitment to plan for containing generation of fresh NPAs

·         Strengthening of loan review mechanism

·         Restrictions on/ reduction in credit expansion for borrowers below certain rating grades

·         Reduction in risk assets

·         Restrictions on/ reduction in credit expansion to unrated borrowers

·         Reduction in unsecured exposures

·         Reduction in loan concentrations; in identified sectors, industries or borrowers

·         Sale of assets

·         Action plan for recovery of assets through identification of areas (geography wise, industry segment wise, borrower wise, etc.) and setting up of dedicated Recovery Task Forces, Adalats, etc.'

6. Market risk related actions

·         Restrictions on/reduction in borrowings from the inter-bank market

·         Restrictions on accessing/ renewing wholesale deposits/ costly deposits/ certificates of deposits

·         Restrictions on derivative activities, derivatives that permit collateral substitution

·         Restriction on excess maintenance of collateral held that could contractually be called any time by the counterparty

7. HR related actions

·         Restriction on staff expansion

·         Review of specialized training needs of existing staff

8. Profitability related actions

·         Restrictions on capital expenditure, other than for technological upgradation within Board approved limits

9. Operations related actions

·         Restrictions on branch expansion plans; domestic or overseas

·         Reduction in business at overseas branches/ subsidiaries/ in other entities

·         Restrictions on entering into new lines of business

·         Reduction in leverage through reduction in non-fund based business

·         Reduction in risky assets

·         Restrictions on non-credit asset creation

·         Restrictions in undertaking businesses as specified.

Any other specific action that RBI may deem fit considering specific circumstances of a bank

What is the change in the proposed bill?

 The bill provides resolution of the financial service provider in distress and deposit insurance. The Resolution Corporation to be formed by under the act will be provided i. deposit insurance, ii. Classify the service provider, iii. Undertake resolution in case of failure and iv. Investigate the activities of the service provider including search and seizure operations.

The financial service provider will be classified into six categories based on risk and viability viz. a. Low, b. Moderate c. Material d. imminent e. Critical. All the rating will be made public to understand the bank’s rating except Critical.

What is the benefit out of the new bill?

Although RBI has formulated the PCA framework in Mar 2001 and monitoring the banks on the parameters specified therein. In my view, RBI could not control effectively through PCA framework due to the reasons are known to them. They could not found out the concealment of Non-performing assets by the management in order to show a better balance sheet.  After all, damages are done, RBI has put many bankers under the scanner of PCA which includes Corporation Bank, Oriental Bank of Commerce, UCO Bank, Central Bank of India, IDBI Bank, Dena Bank, United Bank of India, Bank of Maharashtra and Bank of India. Had action initiated at the appropriate time this might not have happened.

Hence, this action of the forming a Resolution Corporation may help in controlling the bank effectively.  However, without the supervision rights, I have my own doubts about monitoring the rating of the banks by the Corporation. Hence, it is high time the government should segregate the supervision function of RBI into banking supervision body which should conduct Compliance AUDIT on the bank not only at the head office but also at major business branches to validate the rating parameters. Further, the supervisory body must have the right to punish the management of the erring bank. As per the regulation the rating of the bank will be made available to the public and hence there will be awareness among the public about the functioning of the bank. The action of winding up of the bank may be started early and done by the Resolution Corporation benefit the depositors.

All these points depend upon the management of the resolution corporation and it is effectiveness otherwise the bill will not have any benefit to the public. The establishment of resolution will reduce the time log in case of winding up of a bank as in normal course an official receiver is to be appointed by the Court who will collect all the due and distribute to the depositor.  The Bill also covers the insurance sector to protect the interest of the public as there is much private insurance player are in the field.

However, any bail-in process will result in systemic risk causing distrust on the banking sector hence, it should be avoided.  

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