Conservative banking not bail-in, will bail us out

Conservative banking not bail-in, will bail us out

Context

FRDI Bill 2017

New method: Bail-in

The Financial Resolution and Deposit Insurance (FRDI) Bill 2017 now pending before the joint committee of Parliament contains a new method for saving a failing bank — a ‘bail-in’ of customers deposits instead of a ‘bail-out’ by the government

What does Bail-in means?

A bank will be recapitalized with customers’ deposits while the owners of banks will be  granted immunity by the ‘limited liability’ of a corporate identity

• Origins: The ‘bail-in’ owes its origin to the 2008 bankruptcy of the ‘too big to fail’ Lehman Brothers that spooked central bankers in G7 countries. Lehman Brothers was forced to file for bankruptcy due to its inability to pay $3 billion to its creditors
  • This triggered a chain reaction among banks and insurance firms financially interconnected with Lehman Brothers. As a consequence, the Financial Stability Board was set up and it proposed the ‘bail-in’ as a key attribute to cope with bank failures wherein the price for ‘financial stability’ is paid by the customer.

Unstable character of banking in India: Possibility of a Bail-in

The unstable character of banking is highlighted in the routine stress tests conducted by the Reserve Bank

• According to the December 2017 Financial Stability Report, if customers of 54 commercial banks in India were to withdraw 15% of their uninsured deposits, 18 banks would fail to repay the deposits of customers
• Similarly, if the top three borrower groups of each bank default, then six banks would fail to maintain their minimum capital requirement of 9%
• In a severe economic downturn, one bank can trigger failure of 18 out of the 54 banks only because of financial interconnectedness

Fragile safeguards

The safeguards in application of a ‘bail-in’ appear fragile

• In 2008, if ‘bail-in’ had been law, customer deposits would have been needlessly appropriated. It is equally disturbing that ‘bail-in’ may be triggered for reasons unrelated to banking
  • In 2013, European creditors dictated a ‘bail-in’ on the Laiki Bank in Cyprus in addition to other austerity measures and reforms as a precondition to a €11-billion bail-out package by the European Union and the International Monetary Fund

Way forward

If the ‘limited liability’ clause can protect the personal wealth of corporate borrowers despite the huge loans their bankrupt companies owe to public sector banks, the Centre must protect all retail customers from the ‘bail-in’ clause