FRDI’s “bail-in” clause creates apprehension

Context:

• The Financial Resolution and Deposit Insurance Bill, 2017, has been red-flagged because of its“bail-in” clause (clause 52 of the draft legislation).

What is the FRDI Bill about?

• The FRDI Bill is part of a larger, more comprehensive approach by the Centre towards systematic resolution of all financial firms.
• The Bill comes together with the Insolvency and Bankruptcy Code.
• It 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.

What is the need of the Bill?

• The need for a specific regulation rose following the 2008 financial crisis.
• The crisis witnessed a large number of high-profile bankruptcies.
• With the Centre also actively encouraging people to engage more with the banking sector — both through schemes like Jan Dhan Yojana and moves like demonetisation, it becomes important to protect savers and those joining the formal economy in case a bank or insurance firm starts failing.

What are the main provisions of the Bill?

• The Bill provides for the setting up of a Resolution Corporation.
• It seeks to replace the existing Deposit Insurance and Credit Guarantee Corporation.
• The corporation will be tasked with monitoring financial firms, anticipating their risk of failure, taking corrective action and resolving them in case of failure.
• The corporation is also tasked with providing deposit insurance up to a certain limit yet to be specified, in the event of a bank failure.
• It will be tasked with classifying financial firms on their risk of failure — low, moderate, material, imminent, or critical.

What are the drawbacks of the Bill?

• Public sector bank unions argued that several provisions in the bill are against the interests of depositors.
• It will create an environment of mistrust between the banks and depositors.
• The failure of the bill to quantify the deposits that will come under the insurance scheme has also led to worries among depositors if their interests will actually be protected.

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

• Among other tools, the FRDI Bill also empowers the Resolution Corporation to bail-in the company.
• A bail-out is the use of public funds to inject capital into an ailing company.
• A bail-in involves the use of depositors’ funds to achieve those ends.
• This can be done either by cancelling the bank’s liabilities, or converting them into other forms, such as equity.
• This has caused a lot of concern among depositors who are worried they may lose their hard-earned money deposited with banks.
• There are concerns that the FRDI Bill may not clearly lay down the quantum of protection for deposits, or classify deposits separately.

What are the grounds behind this bail-in provision?

• The principal aim is to minimise the cost of any such failures of financial firms to taxpayers.
• The other objective is that shareholders of banks and creditors must also pay their share of costs, rather than governments or taxpayers absorbing all losses.

What has been the government’s response?

• The government has said that India’s FRDI Bill is more depositor-friendly than that of many other jurisdictions that provide for statutory bail-ins.
• It has also said that it does not propose in any way to limit the scope of powers to extend financing and resolution support to banks, including public sector banks.

Apart from the “bail-in” provision, what are the other implications of the proposed law?

• Once the proposed law sets in, banks, insurers, pension funds, asset management companies, all will have to put in place resolution plans or “living wills”.
• It will address a potential failure of the firm in the least costly manner.
• This plan will be continuously reviewed by the proposed Resolution Corporation, like the Federal Deposit Insurance Corporation (FDIC) in the US.
• In cases of bank failures, the announcement of a shutdown is typically made on a Friday evening, and by Monday, cheques reach customers, or money is credited to their accounts in two working days.
• A closure or shutdown will be the final option — the first option would be to transfer the assets and liabilities to another firm, or to create a “bridge service provider” to which they would be transferred until eventual sale, revival, merger, or acquisition.