Bank insecurities

Bank insecurities

Context

Banking regulator should continue to handle bank failures, instead of the Resolution Corporation

FRDI bill

• It is not often that the prime minister and the Union finance minister have to step in to publicly assuage retail depositors, and that too when there is no perceptible threat of any banks, public or private, being shuttered
• Such an intervention by top government leaders has come in the wake of a controversial provision in the Financial Resolution and Deposit Insurance (FRDI) Bill, which seeks to put in place a framework for resolution plans of firms which are in trouble in the financial sector — what the Insolvency Law enacted well over an year ago aims to do for manufacturing companies.

Cause of concern

What has sparked concern is Clause 52 of the Bill which empowers the Resolution Corporation to, for instance, change some of the rights and obligations of shareholders and creditors to recapitalise a financial firm, including banks, to minimise the cost to the exchequer or the taxpayer in the event of its failure.

Aping the west?

This is an approach which has been adopted in the West after the 2008 financial crisis when many governments had to bail out banks at huge fiscal cost. The wisdom of such an approach in a bank-dominated system such as India is questionable.

Bank Dominated System in India

Bank deposits still dominate financial savings unlike the more mature economies in the West where savings portfolios are far more diversified.

Implicit Trust and Faith

• That’s because of the implicit trust and faith in the sovereign, though legally the insurance cover on deposits is capped at Rs 1 lakh
• Over the last few decades, the banking regulator has done well — the proof of which is that there has not been any major run on any bank in the last several years even when the financials of many of them were weak.

Difference in resolution of a Company and a Bank

• There is also a major difference between the resolution of a manufacturing firm — such as a steel or automobile company and a bank — with the risk of a financial contagion and stability and the collateral damage to the broader economy
• Banking is inherently a leveraged business and these financial intermediaries, even highly capitalised banks, will not be able to stay afloat if most depositors were to scramble to withdraw.

What all this means

• All this means that the sensible course to pursue would be to exclude deposits in banks from the purview of these provisions and to explicitly mandate the RBI to handle all cases of resolution in the banking sector, leaving the proposed Resolution Corporation to handle all other financial sector firms.
• We have already seen a number of co-operative banks, which are under the purview of state governments, going bust. This is hardly the time to cause another shock — especially when the government is engaged with the task of putting state-owned banks, weighed down by bad loans, back on track

Conclusion

It might be better if the government focuses more on governance in the banks it owns.