A controversial clause in a law proposed by the Narendra Modi government could make bank deposits a risky proposition. The Financial Resolution and Deposit Insurance Bill, 2017, intended to frame new rules for failed banks and other financial institutions, includes a provision which, if applied, could allow use of depositors’ money to bail them out.
The controversial provision, viz., the ‘bail-in’ clause finds mention in Section 52 of the Bill. While the public outcry over the provision is understandable, one also needs to look at the thinking that has led to its inception, and whether it does justice to the idea behind the proposed law.
First a look at what the law proposes.
What is the FRDI Bill all about?
Much on the lines of the Insolvency and Bankruptcy Code, the FRDI Bill seeks to establish a Resolution Corporation to monitor financial firms, anticipate risk of failure, take corrective action, and resolve them in case of such failure.
The Corporation will also provide deposit insurance up to a certain limit, in case of bank failure.
The Corporation will take over the management of a financial firm once it is classified as ‘critical’ and will resolve the firm within one year, which may be extended by another year.
The Bill sets out the methods for resolution, including: (i) merger or acquisition, (ii) transferring the assets, liabilities and management to a temporary firm, or (iii) liquidation.
If resolution is not completed within a maximum period of two years, the firm will be liquidated, the Bill specifies, while also laying the order of distributing liquidation proceeds.
How is it different from existing law?
The major difference that this law introduces is the ‘bail-in’ clause. Section 52 of the Bill lays down certain provisions, which if enacted, could land the depositors’ money at risk if a financial institution goes broke.
As per existing rules laid down by the Reserve Bank of India, deposits up to Rs 1 lakh under the Deposit Insurance and Credit Guarantee Corporation Act of 1961. While the FRDI Bill does talk about insuring a sum up to a limit, it does not specify the amount that the law will protect.
This lack of clarity has led to fears that this crucial cover could go once the FRDI bill is implemented.
On its part, the Bill does claim to be the first such law in India that intends to set the house in order as far as financial institutions are concerned.
Why the controversy?
There are several reasons why some provisions of the Bill have sparked concern and outrage in equal measure.
Two primary reasons why:
• Section 52 of the Bill says that the Resolution Corporation may ‘cancel’, ‘modify’ or ‘change’ the form of liability of the institution or cancel the liability altogether.
• The Rs 1 lakh security cover that the 1961 law provides may be done away with as the Bill does not specify the amount that a financial institution will have to pay to the depositor.
While the Bill refers to all forms of financial institutions and not just banks, the fear of people losing their bank deposits in saving accounts and Fixed Deposits etc. has gained emphasis.
Although the 1961 law also secured an individual’s deposits up to a threshold of Rs 1 lakh only, the lack of clarity in this respect is what has risen doubts in the minds of the people. For long, there has been talk about the need for raising this threshold and the new Bill only adds to that concern.
Moreover, the possibility of the Resolution Corporation cancelling the liability of a financial institution that the Bill sets out raises more doubts than one. Though there is no history of people losing their money after a bank failure, the Bill fails to place adequate safeguards in this respect. So far, the RBI has ensured that big banks take over smaller failed counterparts in order to protect people’s interests, the chances of a Resolution Professional doing the same needs to be spelt out in clear terms.
Government clears the air
The Bill, though intended to provide a mechanism to deal with failed financial institutions on the lines of businesses under the bankruptcy law and the Insolvency Code, has drawn some sharp criticism from the government.
The people’s concerns have caught the eye of the government as well and the Finance Ministry has stepped up to assuage genuine fears. Finance Minister Arun Jaitley took to Twitter to issue a clarification and assure people that their interests will be protected.
1/2 Provisions of Financial Resolution and Deposit Insurance Bill, 2017 are meant to protect interests of depositors; the Bill provides additional protections to depositors, in a more transparent manner pic.twitter.com/envwW3d3Iw— PIB India (@PIB_India) December 7, 2017
“The Financial Resolution and Deposit Insurance Bill, 2017 is pending before the Standing Committee. The objective of the Government is to fully protect the interest of the financial institutions and the depositors. The Government stands committed to this objective,” he wrote.
2/2 All possible steps and policy measures being taken to prevent the failure of banks and protection of interests of depositors; the FRDI Bill will strengthen the system by adding a comprehensive resolution regime pic.twitter.com/YkRkDL8E6l— PIB India (@PIB_India) December 7, 2017
The Finance Ministry has also listed out a series of clarifications in order to clear the people’s misgivings. The FRDI Bill, it states, is far more deposit-friendly than what other jurisdictions provide. It further claims that the Bill will not do away with the security cover of Rs 1 lakh that exists and that uninsured depositors are being given an elevated status as compared to existing legal arrangements.