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FRDI Bill: Understanding the basis of bail-in, and depositors' fear -Shaji Vikraman
-The Indian Express

As the government tries to allay swirling apprehensions, The Indian Express explains the background, aims and rationale of the proposed new FRDI law.

Someprovisions of The Financial Resolution and Deposit Insurance Bill, 2017, popularly referred to as the FRDI Bill, which was tabled in Parliament this August, have given rise to concerns over protection for bank deposits in the proposed law. An online petition against the Bill —“Do not use innocent depositors’ money to bail in mismanaged banks #NoBailIn” — had attracted almost 90,000 signatures by Saturday night. The government has been forced to issue a statement saying the law is, in fact, aimed at protecting the interests of depositors in a “more transparent manner”. On Saturday, Prime Minister Narendra Modi spoke directly on the controversy, telling an election rally in Gujarat that the Congress was “spreading lies” that the FRDI Bill will lead to “bankrupt banks taking away people’s hardearned deposits”. “Do you thinkI will let that happen?” he asked. The Bill is now with the Joint Parliamentary Committee.

* What is the FRDI Bill about?

Indianow has a law to swiftly address the issue of insolvency of companies in the manufacturing sector. Essentially, that law aims at finding and finalising a resolution plan to get a troubled company back on track, or, in the event of failure, ensure a quick winding up. The plan is to have a similar law for firms in the financial sector — so that if a bank, a Non Banking Finance Company (NBFC), an insurance company, a pension fund or a mutual fund run by an asset management company, fails,a quick solution is available to either sell that firm, merge it with another firm, or close it down, with the least disruption to the system,to the economy, and to investors and other stakeholders. This is to be done through a new entity, a Financial Resolution Corporation — envisaged as an agency that will classify firms according to the risks they pose, carry out inspections and, at a later stage, take over control. This was recommended by the Financial Sector Legislative Reforms Commission (FSLRC) headed by Justice B N Srikrishna.

* What is the “bail-in” provision in the proposed law that is causing all anxiety?

Everyonehas long been used to the word “bailout”, where governments step in to protect the interests of savers or depositors — like in the UK when there was a run on the deposits of banks such as Northern Rock, Llyods Bank, or RBS. There were cases in the US and other parts of Europe, too.The fact that huge public funds were used for such support, and criticism that bailouts incentivised bank managements to take risky bets— called “moral hazard” by economists — led governments to seek other solutions. Regulators put in place laws and rules to discourage or prevent such bailouts with new resolution regimes. Losses of these financial firms had to be borne by shareholders and creditors rather than taxpayers. One of the tools for such resolution is “bail-in”. It allows resolution agencies to override the rights of the shareholders ofthe firm — this could mean writing down of a company’s equity and debt to absorb losses, or converting debt into equity. This could also mean overriding requirements such as approvals by shareholders and disposing of the firms’s assets. The G20 at its Cannes Summit in 2011 endorsed some of the key attributes of such resolution, including transfer or sale of assets and liabilities, and legal rights and obligations including deposits liabilities and ownership in shares, to a third partywithout any requirement for consent. In other words, deposit holders donot have any superior claims.

* What is the rationale behind this bail-in provision?

Theprincipal aim, of course, is to minimise the cost of any such failures of financial firms to taxpayers. The other objective, as the EU’s Bank Recovery and Resolution Directive, 2014, indicates, is that shareholdersof banks and creditors must also pay their share of costs, rather than governments or taxpayers absorbing all losses. The Bank of England has been pushing banks in the UK to set aside more funds to cover for potential failures. The aim, the UK central bank says, is to ensure banks no longer remain “too big to fail”, and to make sure that the risks that banks take are properly priced by investors who know they will suffer if things go wrong.

* What is the worry that depositors and others have regarding the provision in the proposed Indian law?

India’sfinancial sector is bank-dominated, and bank deposits make up the dominant share of financial savings. The fear is Indian policymakers maywant to nudge savers on the same path as in many other parts of the world — to ultimately lower risks and the potential burden on taxpayers,although there is no explicit mention of this in the proposed law. In India, deposits in banks are insured for a maximum of Rs 1 lakh by the Deposit Insurance and Credit Guarantee Corporation, which is now an arm of the RBI. There are concerns that the Bill may not clearly lay down the quantum of protection for deposits, or classify deposits separately.

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