A brief introduction
The Financial Resolution and Deposit Insurance Bill, 2017, or FRDI Bill, is expected to be tabled in the upcoming Winter Session of Parliament.
Together with the Bankruptcy and Insolvency Code, re-capitalisation of PSU banks, and FDI in insurance, this Bill is touted to be a landmark reform in the financial sector.
The Bill was first introduced in the Monsoon Session but was referred to a joint parliamentary committee for review. The committee will submit the report during the Winter Session, after which an amended Bill is expected to be tabled.
Main provisions of the Bill
The FRDI Bill seeks to create a framework for resolving bankruptcy in banks, insurance companies and other financial establishments.
The Bill proposes to establish a ‘Resolution Corporation’ to:
- monitor financial firms
- calculate stress
- take “corrective actions” in case of a failure.
This Corporation will classify financial firms based on their risk factors as low, moderate, material, imminent, and critical.
In case of critical firms, the Corporation will be empowered to take over and resolve issues within a year.
The Bill empowers the Corporation to take corrective actions such as merger or acquisition, transferring the assets, liabilities to another firm, or liquidation.
India never had such a resolution authority before.
At present, the Reserve Bank and the IRDAI are handling these functions for the banking and insurance sectors respectively.
The RBI, in the past, had asked PSU banks to take over stressed banks in order to protect their depositors and employees.
The Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, established in 1971 insures all kinds of bank deposits upto a limit of ₹1,00,000. In case a stressed bank had to be liquidated, the depositors would be paid through DICGC.
However, the proposed Bill seeks closure of the DICGC, as the credit guarantee will be taken care of by the Resolution Corporation itself.
- The Resolution Corporation will be under Finance Ministry with representatives from SEBI, RBI, IRDAI, and PFRDA.
- The Chairperson, two independent members and other members of the the Board would effectively be appointed by the Union Government.
- The Bill provides one year time for the Corporation to resolve issues in a ‘critical’ firm. It has provisions to extend this time frame to another year.
- As a part of resolution the Corporation may scale-down the number of employees in the stressed firm, transfer them or issue pay-cuts.
- Beyond two years, the firm would be liquidated.
- The Corporation shall, in consultation with the appropriate regulator, specify the total amount payable by the Corporation with respect to any one depositor, as to his deposit insured under this Act.
The issues of concern
- The Bill is facing strong opposition from the bank employees union. In August 2017, banking employees went on a strike against the proposed legislation.
- The Bill has also raised concerns among depositors due to Bail-in clause.
- Until now it was mandatory for banks to pay a sum to the DICGC as insurance premium. Though the Bill proposes the banks to pay a sum to the Resolution Corporation, it neither specifies the insured amount nor the amount a depositor would be paid. It is thus unclear how much a depositor would be paid in case of liquidation.
- The bail-in clause: The Bill proposes ‘bail-in’ as one of the methods to resolution, where the banks issue securities in lieu of the money deposited. Why is it a cause of worry? In the past, the bail-in efforts had largely worked against depositors. In Cyprus, depositors lost almost 50 per cent of their savings when a bail-in was implemented.
- While the provisions of the Bill ensures the stability of financial sector and resolution of issues in time-bound manner, the ambiguities on how the depositors would be repaid needs to be addressed.
- The Resolution Corporation will exercise certain powers including: (i) classification of firms based on risk, and (ii) directing the management of a firm to return their performance based incentive. However, the Bill does not specify a review or appeal mechanism for aggrieved persons to challenge the decision of the Resolution Corporation.
- A financial firm will have to be resolved within two years of being classified as ‘critical’. However, the point at which the resolution process ends is not specified in the Bill.
- Under the Bill, the Resolution Corporation will take over a firm classified as ‘critical’. However, it may choose to resolve the firm. It is unclear why the Corporation is given a choice to undertake resolution.
Why the Bill is needed
- The banking sector is reeling under stress due to bad loans. According the RBI’s Financial Stability Report released in June 2017, the gross non-performing advances (GNPAs) ratio of all banks stood at 9.6% as of March 2017. The RBI had recommended that banks initiate insolvency proceedings for 12 large defaulters, constituting 25% of the system’s NPAs.