Another tool of resolution 

Another tool of resolution 

Context

The Financial Resolution and Deposit Insurance Bill does not take away from the government’s implicit guarantee to depositors.

The Financial Resolution and Deposit Insurance Bill does not take away from the government’s implicit guarantee to depositors

The reason we need bank resolutions and also a special law to deal with the demise of a bank is simply because banks are special

Faith in the banking system

• They have become a repository of public faith in the financial system
• So long as consumers have unrestricted access to deposits, their faith in the banking system is maintained.
• The fractional reserve system works on this faith

Failure of bank has repercussions

• Thus, a failure of a bank has repercussions that go well beyond savings and lending; it has an impact on the systemic stability of a country
• The rules for bankruptcy of a regular business cannot be applied to bank failures

The FRDI bill

The Financial Resolution and Deposit Insurance Bill is exactly that — an attempt to make the system more credible, less chaotic, and systematic in times when credibility is at risk, by treating banks differently from regular corporations

Risk-based monitoring

The Bill brings in a system of risk-based monitoring of financial institutions

Bail-in: Corporation that takes all decisions, and not the bank

At the stage of ‘critical’ risk to viability, when the proposed Resolution Corporation takes the decision to use a particular method of resolution which includes the tool of a ‘bail-in’, it is the Corporation that takes all decisions, and not the bank.

Consultation with the regulator

A bare reading of the relevant provisions of the Bill shows that the Resolution Corporation can use this tool only in consultation with the regulator

An exaggeration

It is an exaggeration to suggest that the Reserve Bank of India (RBI), along with the Resolution Corporation, will ‘bail-in’ depositor’s money to recapitalise the bank, especially when the Bill is designed to take away power from the failed financial institution at the stage of failure.

The Financial Crisis

• This is exactly what happened during the global financial crisis, when tax-payer money was used to recapitalise the banking industry
• Large financial institutions and their managements took unprecedented risks.
• When the crisis hit and bankruptcy loomed close, the risk-takers were not penalised. Instead, governments across the world panicked and recapitalised using public money
• ‘Bail-in’ was an attempt to break this cycle of moral hazard and distributional inequity associated with ad hoc government hand outs. 

Safeguards in the law

On the larger issue of a bail-in and the threat to depositor money, among the most ignored provisions of the Bill are the safeguards to the use of bail-in tool

• The Bill makes it explicitly clear that only such liabilities may be cancelled where the liability/instrument contains a bail-in provision
• It makes it abundantly clear that the Resolution Corporation will specify the liabilities to be bailed in. These will be specified in regulations that will be put up in the public domain before finalisation
• Creditors/depositors will need to consent in advance to have their liabilities bailed-in
• Even when liabilities are being bailed in, the Bill makes it incumbent upon the Resolution Corporation to follow the prescribed route. Here, uninsured depositors are placed higher over unsecured creditors and amounts due to the Central and State governments.
• Lastly, the Bill gives aggrieved persons a right to be compensated by the Resolution Corporation if any of the safeguards have not been followed during a bail-in or in the conduct of any other resolution action.

Ex-Ante Consent

• Before terming this a draconian law, it should be noted that the law provides for an ex-ante consent for certain liabilities to be bailed in
• Some of the most developed resolution regimes in the world have a more stringent, mandatory regime in place

EU Bank Recovery and Resolution Directive and Single Resolution Mechanism

For instance, the EU Bank Recovery and Resolution Directive and Single Resolution Mechanism empowers authorities to impose mandatory restructuring of shareholder and creditor claims. This is not the case in India. 

Conclusion

Almost a decade later, when the rest of the world is finding ways to make its financial system more robust, we seem to be continuing with public discourse using incomplete information. The Bill simply adds another tool of resolution without taking away from the government’s implicit guarantee to depositors