{"id":34117,"date":"2018-10-30T15:54:14","date_gmt":"2018-10-30T10:24:14","guid":{"rendered":"https:\/\/blog.forumias.com\/?p=34117"},"modified":"2018-10-30T15:54:14","modified_gmt":"2018-10-30T10:24:14","slug":"banking-on-legislation-financial-resolution","status":"publish","type":"post","link":"https:\/\/forumias.com\/blog\/banking-on-legislation-financial-resolution\/","title":{"rendered":"Banking on Legislation \u2013Financial Resolution\u00a0"},"content":{"rendered":"<p><a href=\"http:\/\/www.thehindu.com\/opinion\/op-ed\/banking-on-legislation\/article20005363.ece\"><span style=\"font-weight: 400;\">Banking on Legislation \u2013Financial Resolution<\/span><\/a><span style=\"font-weight: 400;\">\u00a0<\/span><\/p>\n<p><b>Context:<\/b><\/p>\n<p><span style=\"font-weight: 400;\">The recapitalization of public sector banks (PSBs) through bailouts be they as budgetary allocation or some sort of bond issue, has evoked much discussion.<\/span><\/p>\n<p><b>Introduction<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The Insolvency and Bankruptcy Code is cited as adequate punishment for defaulting borrower companies.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Under the code, the resolution process has brought little succor to banks as the recovery rate from defaulting companies has so far been merely 15-20% of the original amount lent.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">There is no attempt so far by the Reserve Bank of India (RBI) to issue guidance to PSBs to blacklist these entities from getting further loans or prevent their management from retaining a majority equity state during the resolution process as penalty for the huge haircuts being taken by banks.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The Banks have been continually reporting losses in each successive quarter.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Six PSBs have already been placed under prompt corrective action by the RBI.<\/span><\/li>\n<\/ul>\n<p><b>Financial Stability Board (FSB) Peer Review Report 2016:<\/b><\/p>\n<ul>\n<li><b><span style=\"font-weight: 400;\">According to the Financial Stability Board (FSB) Peer Review Report August 2016, 63% of the financial investments ordinary Indians make are within the banking system; PSBs account for 63% of the market share while private banks control 18%.<\/span><\/b><\/li>\n<li><span style=\"font-weight: 400;\">The deposits in these banks are very much at risk.<\/span><\/li>\n<\/ul>\n<p><b>Financial Resolution and Deposit Insurance (FRDI) Bill, 2017:<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">This covers bankruptcy of businesses such as banks and insurance.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Financial resolution includes solutions for banks facing \u2018material\u2019 or \u2018imminent\u2019 risk to viability depending on their capital and asset worth.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The Bill also introduces the provision for a \u201cbail-in\u201d, whose purpose is to provide capital to absorb the losses of a bank and ensure its survival.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Survival does not mean safety of depositors\u2019 money, but restoration of capital of the bank.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The bail-in empowers the proposed Resolution Corporation to cancel a liability owed by the bank or change the form of an existing liability to another security.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The only money owed to depositors that cannot be bailed-in is the amount covered by deposit insurance.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The Deposit Insurance and Credit Guarantee Corporation Act, 1961 which insured deposits worth one lakh for each depositor has been replaced by the cabinet.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The FRBI Bill empowers the Resolution Corporation to decide the amount insured for each depositor. It is possible that the insured amounts will not only vary for customers in different banks, but may also be different for different customers of the same bank.<\/span><\/li>\n<\/ul>\n<p><b>\u201cBail-in\u201d clause<\/b><\/p>\n<ul>\n<li><b><span style=\"font-weight: 400;\">The \u2018bail-in\u2019 clause changes the nature of relationship between the customer and the bank.<\/span><\/b><\/li>\n<li><span style=\"font-weight: 400;\">It would mean that money is no longer safe in a bank.<\/span><\/li>\n<li><span style=\"font-weight: 400;\">An account would lose its sovereign guarantee and instead become an investment.<\/span><\/li>\n<li><span style=\"font-weight: 400;\">The customer would need to monitor the level of toxicity of his bank with respect to its losses and accordingly keep switching bank accounts.<\/span><\/li>\n<li><span style=\"font-weight: 400;\">The customer is not privy to the leading decisions in a bank unlike any vendor or investor dealing with a company. Hence the rules for bankruptcy of a regular business cannot be applied to bank failures.<\/span><\/li>\n<li><span style=\"font-weight: 400;\">The government must take a stand and defy the FSB\u2019s diktat on the \u2018bail-in \u2018clause.<\/span><\/li>\n<\/ul>\n<p><b>What is Bank recapitalization?<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Bank recapitalization means recapitalising banks with new capital to improve their balance sheet.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The government, using different instruments to add capital into banks which undergoing credit deficiency.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Since the government is the biggest shareholder in public sector banks, the responsibility of infusing capital majorly lies with the government.<\/span><\/li>\n<\/ul>\n<p><b>How Bank recapitalization takes place?<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The recapitalisation plan comes into action when banks get caught in a situation where their liabilities are comparatively higher than their assets.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The liquidity with banks is a liability as it is the money deposited by customers, which needs to be paid sooner or later.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Due to this their balance-sheet weakens and banks find it difficult to raise capital from the open market.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Thus, the government, which is also the biggest shareholder, can infuse capital in banks by either buying new shares or by issuing bonds.<\/span><\/li>\n<\/ul>\n<p><b>Why has Recapitalisation of the Banks Occurred?<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Recapitalisation of the Banks occurs when:<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">People defaulted on loans and mortgages;<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">banks lent money (bought CDOs) to sub-prime mortgage companies in America who lost money;<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">falling house prices means that banks assets decline further and if they repossess homes it\u2019s harder to get value of the original loan back, and<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Recession led to more defaults and losses.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Presently, the government is finalizing the structure of bonds and decision in this regard could be made very soon<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The latest figures shown in the ministry presentation put the increase in non-performing assets (NPAs) from financial year (FY) 2015 till June 2017 at Rs4.55 trillion<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The governments have recapitalized banks through various means. These can be mainly divided into direct capital infusion, issuance of public debt into banks either as a swap for bad assets or unrequited, and by assuming the bank\u2019s liabilities.<\/span><\/li>\n<\/ul>\n<p><b>Rationale behind recapitalization of banks by the government:<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">By infusing capital, the government is trying to partially improve the balance sheets of public sector banks.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">This will also help banks write off some of the Rs 10 lakh crore bad loans currently on their books.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">For tackling the problem of stressed assets.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The amount is expected to help put India\u2019s banks on the path to recovery.<\/span><\/li>\n<\/ul>\n<p><b>How recapitalization will help banks to tackle the NPA problem?<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">The Public Sector Banks will get additional capital from the government from the issue of the bonds. The amount of capital to be obtained by each PSB will be determined later and it depends upon the depth of their NPA problem.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Banks once obtained the funds, can write-off the bad assets by using the fund from recapitalization.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">As per the Basel III norms, there should be a minimum higher quality capital like equity capital.<\/span><\/li>\n<\/ul>\n<p><b>What are Non Performing Assets (NPAs)?<\/b><\/p>\n<ul>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.<\/span><\/li>\n<li style=\"font-weight: 400;\"><span style=\"font-weight: 400;\">Loss assets: As per RBI, Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.<\/span><\/li>\n<\/ul>\n","protected":false},"excerpt":{"rendered":"<p>Banking on Legislation \u2013Financial Resolution\u00a0 Context: The recapitalization of public sector banks (PSBs) through bailouts be they as budgetary allocation or some sort of bond issue, has evoked much discussion. Introduction The Insolvency and Bankruptcy Code is cited as adequate punishment for defaulting borrower companies. Under the code, the resolution process has brought little succor&hellip; <a class=\"more-link\" href=\"https:\/\/forumias.com\/blog\/banking-on-legislation-financial-resolution\/\">Continue reading <span class=\"screen-reader-text\">Banking on Legislation \u2013Financial Resolution\u00a0<\/span><\/a><\/p>\n","protected":false},"author":61,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"footnotes":""},"categories":[555],"tags":[],"class_list":["post-34117","post","type-post","status-publish","format-standard","hentry","category-test-1","entry"],"jetpack_featured_media_url":"","views":{"total":0,"cached_at":"","cached_date":1704748600},"jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/34117","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/users\/61"}],"replies":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/comments?post=34117"}],"version-history":[{"count":0,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/34117\/revisions"}],"wp:attachment":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/media?parent=34117"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/categories?post=34117"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/tags?post=34117"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}