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FRDI and Common Man’s Bank Account

Young Bites. Dated: 1/13/2018 11:28:29 AM

Shubham Mehta
What if someone, and more so Central government, makes you realise one fine day that the entire corpus of safe(assumed) bank deposits, whether running in lakhs or crores, that you have hard earned and stacked in bank accounts are insured upto a maximum sum of Rs. One Lakh! Yes, don’t read it again; you’ve read it correct- Only one lakh rupees. This means that the respective bank, where you normally deposit your earnings, turns bankrupt or declared discharged insolvent, you are guaranteed to receive only One lakh rupees. Never mind, even if your savings till the time had, no matter, crossed half a crore.
Won’t you be gobsmacked, bewildered, stunned and literally shaken to the core? Obviously, anybody would have the same reaction as you are having now especially those who haven’t anytime in the past heard about Deposit Insurance and Credit Guarantee Corporation Act, 1961(henceforth, DICGC,1961). This statute implicitly and tacitly states that your savings are insured upto a maximum capped amount of One lakh Rupees.
But why are we, at the first place, revisiting the statute that had long before been enacted, that is, DICGC, 1961? It is because the Cabinet has approved to replace DICGC,1961 with Financial Resolution and Deposit Insurance Bill, 2017(henceforth, FRDI,2017). It seeks to establish a ‘Resolution Corporation’ which will monitor the risk faced by financial firms such as banks and insurance companies, and resolve them in case of failure.
Until now, the govt is still mooting the max insured sum against individual’s deposit amount but has assured that it would be significantly high above Rs. One lakh. But the most peculiar and rather controversial feature about the act is its ‘bail-in clause’, which has led to much of hue-and-cry amid general populace and cacophony amid All India Bank Employees Association, who are contemplating strike if govt goes ahead with the provisions of the bill in present form. The bail-in process which was thus far implicitly present, is mentioned explicitly, leaving many people in utter disbelief.
The bail-in clause is situated at the diametrical opposite end of the bail-out clause. Under bail-in, the Resolution Corporation can internally restructure the firm’s debt by either cancelling liabilities that the firm owes to its creditors, or by converting its liabilities into any other instrument (ex. converting debt into equity), among others. Bail-in differs from a bail-out, which involves funds being infused by external sources to resolve a firm. This includes a failing firm being rescued by the government like the Recapitalisation funds given to Indian PSBs under the past three budgets.
And here is when it becomes significant to understand at the very outset, why govt is planning to bring in FRDI, 2017. Is Insolvency and Bankruptcy Code, 2016 along with its recent amendment in 2017, not powerful enough to resurrect and bail-out bankrupt companies in order to resolve twin balance sheet problem and curb the menace of mounting NPAs or Non-Performing Assets? Again, it becomes important to understand what are NPAs and how are they impinging upon the financial health of the economy.
All the deposits, whether time or demand deposit, which you make to a bank, become its liabilities and the loans that banks further extend to individuals and companies are its primary assets. If the borrower is unable to pay principal amount or interest or both for 90 days, the assets’ quality commences to deteriorate and slide into the domain of NPAs. Further NPAs are classified into three types: Substandard (remaining NPAs for less than or equal to 18 months), Doubtful (NPAs for more than 18 months) and Loss Assets (where the loss has been identified by RBI Annual Asset Quality Review but the amount has yet, not been written off the bank’s balance sheet).
India stands embarrassingly at fifth position in terms of highest accumulated NPAs across the globe according to CARE Ratings until Q2 of this fiscal year. In addition, the NPAs ratio remains 9.85% of the net asset proceeds which is more than Rs. 8 lakh crores, according to the same study. Public Sector Banks(PSBs) account for 90% of the sticky assets who otherwise constitute 70% of the banking industry. Highest % to advance, share of gross NPAs across PSBs is with IDBI bank followed by Indian Overseas Bank. In case of Private banks, Highest % to advance share of gross NPAs is with J&K Bank followed by ICICI bank with Yes Bank showing the best performance overall.
Such large chunk of sticky assets makes bank officials sceptical and as a result, we witness less credit growth. This is not good considering India is an emerging economy with high demand of Capital for economic development and employment generation. As a result, Public spending is the last escape route to sustain the economy if private spending is not picking up but this leaves little room for private loans amid high NPAs which might eventually trigger crowding out effect in industries. And such a mess is further aggravated by few individuals like Vijay Mallya, with their influence at the helm of affairs to extort large sums unduly from bank authorities and later turn fugitive. Recently govt has now come up with Fugitive Economic Offenders bill and made it public for comments and suggestions.
Now coming back to the sticky aspect of FRDI, 2017, which is its bail-in clause. The insurance limit of One lakh rupees for DICGC,1961, has not been changed since 1993 even while income and deposit levels have grown substantially. Deposits up to $250,000 are protected by insurance in the U.S. while the figure is $1,15,000 in the U.K whereas it is very low at $1,600 for India. Even in the case of emerging countries like Brazil and China, the insurance limit is 9 times the per capita income while it is a little less than its per capita income in case of India.
While the Insolvency and Bankruptcy Code, 2016 is enacted for insolvency resolution of non-financial companies. The main objective of FRDI, 2017 is to ensure early recognition of a financial firm, regulated by RBI, SEBI, IRDA or PFRDA, which could potentially be in trouble so as to lower the impact on the economy. The proposed Bill complements the Code by providing a resolution framework for the financial sector. Once implemented, this Bill together with the Code will provide a comprehensive resolution framework for the economy.
When enacted, FRDI, 2017, will pave the way for setting up of the Resolution Corporation. This Corporation will take swift action for winding up or dissolving a firm. Once that happens, the Corporation will act like a receiver by ensuring quick payments to depositors up to a certain limit to which their deposits have been insured alongside settling the claims of debtors and equity holders. It will have a corpus or fund built on premiums by firms which are covered under the new law, besides contributions from the government.
Govt has mentioned the benefits of implementing this bill, unequivocally. One, that it will give comfort to the consumers of financial service providers in financial distress. Second, it aims to inculcate discipline among financial service providers in the event of financial crises by limiting the use of public money to bail out distressed entities. Third, the Bill aims to strengthen and streamline the current framework of deposit insurance for the benefit of a large number of retail depositors. And most significantly, this Bill seeks to decrease the time and costs involved in resolving distressed financial entities.
Nevertheless, the Finance ministry of the central government came up with the much needed clarification at a blistering pace. The government has said that uninsured depositors will be given preferential treatment in the event of liquidation of a bank, and the controversial bail-in clause will be used only with the prior consent of depositors. The clarification also said the bail-in clause would not be applied to public sector banks, and it would be a tool of last resort, when a merger or acquisition is not viable, in the case of private sector banks. Further the govt said that it stands ready to take care of the capital needs of PSBs. The bail-in clause will be subject to govt. and parliamentary oversight. And National Company Law tribunal can step in and order compensation in case of liquidation.
But there are a few problems with this clarification. The most significant, is that, the implicit guarantee cannot be emphasised beyond a point lest it creates moral hazard in the form of risky behavior by banks and lazy monitoring of banks by depositors. And hence as Mr. Anil Gupta, Vice President, Sector Head-Financial Sector Ratings, ICRA, said “More frequent audits with Public disclosure of audit findings would improve the transparency. Further, depositors should also evaluate performance of banks at least on a yearly basis and take informed decisions.” Evaluation by depositors implies that they need to look into the findings of Ratings agency and ensure that the NPAs of their respective banks are not mounting up unduly as a gross % and as % to advance.
Because eventually everything boils down to how can the financial institutions convince people that their money is safe and secure? One way is through prudential regulations such as capital requirements and supervision. This has been a convention under Basel norms. The other way is to guarantee through an insurance scheme that the insured part of the deposits will be paid out by an insurance company.
Ultimately, the trust needs to be built in the system about the safety and security of the deposits. Else, the financialisation or true financial utility of our savings will be impacted and the savings will get channelized to less productive assets like gold, real estate et al and as an emerging economy, we will be starved of capital for investment.
Indeed, we must heed the sound advice of govt authorities as we have done previously to endure the pain of demonetisation or the rollout of GST. We must firmly believe that the initiatives of the present regime, or for that matter, previous regimes, had been sincere, to curb the menace of mounting NPAs. This has been done by way of various initiatives like SARFAESI Act, 2002; S4A and Joint Lender Forum model; Recapitalisation to prepare banks for adoption of Basel-III norms by 2019; Amendments in Banking regulation Act and Insolvency and Bankruptcy Code and the FRDI,2017 is concomitant to these measures. Only such slew of measures can ensure that India remains a bright spot not only amid global slump and slowdown but also amid BRICS economies or tiger economies, as they are called.