THE FINANCIAL RESOLUTION AND DEPOSIT INSURANCE BILL, 2016

THE FINANCIAL RESOLUTION AND DEPOSIT INSURANCE BILL, 2016

FRDI has surfaced in the Social media recently, thanks to a petition through change.org.  It is only after seeing the petition that I realized that I have already missed the window for offering comment.  It seems that FRDI did not figure in the news media with the intensity and urgency that it deserved.

I have downloaded the draft and browsed through it.  I also had to go through Banking Regulation Act to see the provisions in this act relating to winding up of banking companies that will be deleted by the proposed FRDI.

It cannot be gainsaid that economy and banking are based mostly on trust which governments and banks are under an absolute obligation to maintain and bolster.  Anything that even scratches this trust can prove disastrous.

The aforesaid is the reason that Capital Adequacy norms under the Basel Agreement are being continually refined and enforced worldwide by banking regulators.  The underlying idea behind Capital Adequacy norms is simple.  Banks have to use statistical tools to gauge the risk of losing money in their loans and investments portfolios and then provide enough capital to cover these risks so that the risk does not extend to the depositors.  This tells depositors that banks and regulators are dead serious about the safety of their money kept in the banks and will not allow it to be risked.

RBI, the regulator for the banking sector, has taken these norms in right earnest and has mechanism for Risk Based Supervision RBS) in place.  RBS ensures that no banks ever reaches the brink where its liquidation has to be contemplated:  And if it does, it loses no more than its share capital. As against this, FRDI proposes to wait till the institution reaches the brink and then pounce upon it and even breach the trust on which the financial sector rests.

FRDI proposes to move this risk assessment function to a Corporation. This hardly makes sense.  This Corporation will have 11 members on its Board.  Of these 4 will be representing the four regulatory authorities (Banking, Insurance, Pension, Financial Markets.) The remaining seven will be bureaucrats and other government appointees.  RBI and its Risk Based Supervision are working fine and cannot be bettered by this Corporation.

This proposed Corporation seriously encroaches upon the turf and erodes the credibility of regulators who are best placed to gauge and manage risk in their specific areas.  Though, their autonomy may not be liked much by the political establishment.

The act is strewn with provisions that make depositors suspicious and uneasy.  Read the subsection 1.15.ii.  It goes like this: Deposit means ………. but does not include “any amount due on account of any deposit with any insured service provider which has been specially exempted in this behalf by the Corporation with the previous approval of the Appropriate Regulator or, by a notification in the Official Gazette.”   Thus the corporation may, in its bureaucratic wisdom, exempt FD or / and RDs through a notification.  By the time this notification comes to our knowledge, the money would be gone.

The dreaded bail-in that forms the subject matter of section 52, is defined as under.

52.3 A bail-in provision means any or a combination of the following: –

(a) a provision cancelling a liability owed by a covered service provider;

(b) a provision modifying, or changing the form of, a liability owed by a covered service provider

(c) a provision that a contract or agreement under which a covered service provider has a liability is to have effect as if a specified right had been exercised under it.

In case of depositors, these means that your account balance could be written-down or written-off straight away, or could be swapped for shares in the worthless bank!  I am not able to make out what the subsubsection c means.  I guess that for FDs it could mean that your right to premature payment could be exercised by the Corporation.

There is a saving grace, though, in the form of section 55.  The relevant portion reads as under:

55.2.b "only those liabilities may be cancelled the instrument creating which contain a provision to the effect that the parties to the contract agree that the liability is eligible to be the subject of a bail-in."

If the proposed Bill goes through, we can be sure that account opening forms of banks will include a fine print saying that this deposit is eligible to be the subject of a bail-in.  While big depositors may be able to negotiate this clause out, the same leeway may not be available to people like us.

If the Bill goes through, even the existing depositors may get a communication congratulating them and announcing that their deposits have been made eligible for a bail-in!

Further, the proposed Bill effectively does away with Deposit Insurance.  As banks pay premium for this insurance, in the unlikely event of a bank reneging on its deposits, the insured amount must be paid by the insurer from its own funds.  The depositors then have to salvage whatever they can of their deposit from the liquidation proceeds.  This bill says that the first thing to be recovered by the Resolution Corporation from liquidation proceeds will be the amount it has paid to the depositors under the insurance scheme!! (Sec 29.4)

Also section 55 (1b and 1c) puts depositors and other creditors on the same footing, whereas the deleted sections of the Banking Regulation Act clearly state that depositors have to have the first preference.

FRDI also seeks to replace common sense with red tape.  Sec 68.1.3 states that, “A depositor or operational creditor may submit a claim to the liquidator in such form and in such manner and along with such supporting documents required to prove the claim as may be specified by the Board.”  Whereas the Banking Regulation Act clearly stated that depositors need not submit any claim and the balance in the books of the Bank will be automatically taken as the claimed amount.  Well, red tape is the first thing to be brought in by a bureaucrat ruled organization.

To sum up, the following questions on FRDI needs an answer from the government:

•         Basel Accord on Capital Adequacy and the current Risk Based Supervision are meant to ensure that a bank never reaches a stage where depositors’ money is jeopardised.  If, at all, it has to be liquidated it must not lose more than its capital.  In this regime where is the need for FRDI?
•         The Resolution Corporation is a serious encroachment on Regulator’s turf.
•         How is the Resolution Corporation supposed to carry out liquidation or merger of banks any better than the Regulators when bureaucrats and government nominees far exceed the regulators’ representatives on its board?

PostScript: I think I got part of the answer!  The bill says at one place that the bail-in will be used not only to absorb residual losses after entire capital is lost, but also be used to recapitalize it so that it can become viable again.  So, the government wants depositors to contribute their deposit towards share capital!