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A course correction

Young Bites. Dated: 7/20/2018 12:19:38 PM

The government has done well to decide to drop the Financial Resolution and Deposit Insurance (FRDI) Bill in the face of criticism regarding some of the provisions in the proposed law which had stoked fears among deposit holders, leading to anxiety and panic withdrawal of deposits. That the government chose not to pursue it even before the joint committee of Parliament has taken a view is a recognition that going ahead with the legislation would have had an impact on financial stability in an economy where deposits still account for a large chunk of financial savings. Clause 52 in the bill on “bail in”, which said that in the event of a failure or insolvency in a bank, depositors would also have to bear part of the burden of resolution, had sparked off protests including by political parties, forcing Prime Minister Narendra Modi and Finance Minister Arun Jaitley to publicly allay such fears a few months ago. The issue then, still valid now, is whether the G-20 Stability Forum’s recommendations that various jurisdictions should have legal provisions for resolution of financial firms should be implemented in India. The compelling reason for that policy approach in many countries which form part of this rich country grouping was the huge bail-out of many banks in the West using public funds. But the Indian experience has been different. Over the last few decades, the government, the dominant shareholder in a large number of banks, or the banking regulator, the RBI, did not have to step in much even though there have been bank failures. Some countries have excluded deposits from the purview of bail-in provisions, making it easier to build a case for jettisoning this clause. What may have also weighed on the government is the suggestion of the the Financial Stability and Development Council, which has representation of the government and financial sector regulators, to exclude this clause when it comes to bank deposits. What also matters is timing. A dozen state-owned banks are now under what is known as the Prompt Corrective Action framework of the RBI which imposes severe restrictions on their operational business after having piled up a mountain of bad loans. Banking, after all, is a highly leveraged business with a huge contagion risk, especially so in a bank dominated country like India where financial literacy levels are still fairly low. A far more important task now is to strengthen Indian banks and to address governance issues so that they fulfill, in the words of a former finance minister, their dharma of lending.