FRDI: The Bill that Alarmed Bank Customers across India
[Aman Bahl is a student at Maharashtra National Law University, Nagpur.]
Almost a year after being tabled in Parliament, the Financial Resolution and Deposit Insurance Bill, 2017 (Bill) stands withdrawn following the apprehensions expressed by the public as regards it consequences.
The Bill was introduced in Parliament on August 10, 2017 and later referred to the Joint Committee of Parliament for further consideration with the objective of carrying out a speedy and efficient resolution of financial firms in distress. In order to meet this objective, the Bill provided for a ‘bail-in’ clause, by virtue of which banks could issue securities in lieu of the money deposited with them. In case of an unfortunate event resulting in the bank’s failure, the deposits could be converted into securities such as shares or debentures in the bank. By allowing deposits to be converted into securities, the Bill sought to create a class of liabilities that are liable to be treated like equity.
The Bill also proposed to establish a Resolution Corporation to monitor financial firms, calculate stress, and, if necessary, take ‘corrective actions’ such as merger/acquisition, transfer of the assets and liabilities to another firm, or liquidation of the assets of the firm to resolve issues within a period of one year. As of today, the Reserve Bank of India (RBI) and the Insurance Regulatory and Development Authority of India (IRDAI) are handling these functions for the banking and the insurance sectors respectively.
The main objective of the Bill was to tackle bank failures. It is certain that more significant and inter-connected the bank, the more adverse and prolonged are the effects of its failure. In fact, the failing of a bank can culminate into a full-blown financial crisis which can lead to “years of recession, unemployment and unsustainable fiscal costs.”
In the past, the collapse of the investment bank Lehman Brothers led to a worldwide recession during the period 2007-08, which was followed by the Great Recession and the European debt crisis. Among the countries affected by the global economic downturn was an island country in the Eastern Mediterranean named Cyprus. The worldwide recession led to a substantial slump in the tourism and shipping sectors which increased unemployment.
The Cypriot economy was hit by recession, the economic growth was weak and unable to reach its pre-2009 levels. Commercial property values declined, and non-performing loans rose, leading to a significant increase in the pressure on the banking system. Left with no choice as it came under acute financial burden, the Cypriot government requested a bailout from the European Union and bailed in the depositor’s money in order to cover its budget deficit and refinance its maturing debt. As of date, Cyprus has a government debt equivalent to 97.50 percent of the country's Gross Domestic Product. This debt will take a number of years to be paid off and unquestionably hamper its economic growth.
Considering the unfortunate incident that took place in Cyprus, it is safe to state that, as of today, countries are facing two major challenges: one, reconsidering the use of public funds to restructure or resuscitate failing banks and two, creating a separate set of authorities to effectuate resolution procedures.
The Bill introduced in Indian Parliament was an answer to both these challenges. After closely looking at the aftermath of the bank failure in Cyprus, the Indian government introduced the said Bill that provided for both, a mechanism to use public funds to restructure or resuscitate failing banks in the form of the ‘bail-in’ clause, and creation of a Resolution Corporation to effectuate resolution procedures.
However, the question that arises is whether the Bill accounted for the multiple downsides that could be faced pursuant to its enactment. Let us assume a situation where the depositor’s money could be bailed a sudden. In such a scenario, the depositors would lose faith in commercial banks and would either move their deposits to government-owned banks or invest their savings in non-financial assets. This situation is wholly undesirable as it would lead to a fall in the domestic investment capital which is used to finance companies and in turn run the economy. Therefore, considering the severe downsides of this Bill, it is in the best interest of the economy that it has been withdrawn.
However, the withdrawal of the Bill is not a solution to the problem at hand. The country needs to create a mechanism to provide for a capital buffer for an economic downturn or financial adversity, keeping the depositor’s money untouched at the same time. In the author’s opinion, the government could adopt the Financial Stability Board’s “Key Attributes of Effective Resolution Regimes for Financial Institutions”. Under this alternative remedy, all member nations of the Financial Stability Board (FSB) need to create a capital buffer to raise their total loss absorption capacity to a minimum of 18% of risk-weighted assets by 2022. India, being a member of the G20, could consider the FSB’s recommendation to build up similar capital buffers and specifically set aside public deposits instead of converting deposits into equity in the banks as a measure of last resort. The FSB’s recommendation, on the whole, would be helpful in keeping deposits outside liabilities that could be utilised to recapitalise a bank. The only shortcoming of this recommendation is the increase in the bank’s service cost, which indeed could be seen as the cost of keeping the depositor’s money safe.
As India blends more into global financial and economic networks, it is crucial to secure the system as a whole, and, in particular, to protect parts that could suddenly find themselves vulnerable. Given the implications of the Bill, its withdrawal could be seen as a step towards a better and more efficient tomorrow.
 The Financial Resolution and Deposit Insurance Bill, 2017, section 53.