A law is often simple; what’s interesting is its ifs, buts, and interpretations. Similar is the case with the proposed Financial Resolution and Deposit Insurance (FRDI) Bill, which has been making a lot of noise lately. In Finance Minister Arun Jaitley’s words, the FRDI Bill will “provide a specialised resolution mechanism to deal with bankruptcy situations in banks, insurance firms and financial sector entities”; what was not said was that under the ‘bail-in’ clause, it would be depositors’ money that would provide that specialised resolution.
What the bail-in clause is:
A bail-in is rescuing a financial institution on the brink of failure by making its creditors and depositors take a loss on their holdings. A bail-in is an opposite of bail-out, in which, the banks instead of saving bankrupt companies, save themselves. So, the FRDI bill, if passed in the Winter Session scheduled to commence on December 15, will allow critically ill banks to restructure their liability, which is also depositors’ monies.
“Critically ill banks can change the structure of their liabilities under the bail-in clause to rescue themselves. Restructuring of liabilities means that they can take your deposited cash and issue bonds, shares etc, which can be redeemed only after a fixed period of time,” Samir Ghosh, General Secretary, All India Reserve Bank of India Employees Association said.
A tried-and-failed formula:
In 2013, Cyprus in the eastern Mediterranean witnessed the collapse of its banking system. Banks were shut overnight, people were left with access to their money and the government refused to step in and bailout. Cyprus, then, became the testing ground for the bail-in programme, which was advocated in 2012 by the International Monetary Fund (IMF). Cyprus bail-in programme was a disaster; what can be called as ‘legal theft’ of 60% of depositors’ money.
Or maybe not…
But Cyprus was not the first country to go with the bail-in programme: It was Denmark. In its response to its financial crisis in 2011, the country came up with five bank packages which included increasing the cap of the insured amount deposited in banks, along with a safety net. During the Bank package III – bail-in was implemented and wind down a (small) bank during a weekend, including imposing losses on senior debt holders, and continue operating with no effect for ordinary customers. Since then European Countries are mulling to go bail-in instead of bail-out.
The legal framework is key:
What, perhaps, made Denmark’s bail-in case, not a disaster is was the orderly manner in which the entire process was done. In fact, the IMF, which advocated “from Bail-out to Bail-in”, also said that it is essential to have clear and coherent legal framework for bail-ins. “An appropriate balance between the rights of private stakeholders and the public policy interest in preserving financial stability. Debt restructuring ideally would not be subject to creditor consent, but a “no creditor worse off” test may be introduced to safeguard creditors’ and shareholders’ interests,” IMF said.
The crucial point is that investors need to be convinced that a recapitalization under a bail-in will provide sufficient time to restore the bank’s capital strength and hence, the bank’s long-term viability. Otherwise, the triggering of the bail-in power could be seen as a bank’s nonviability, causing a run instead of preventing it.
There are two things; first, government’s denial that the depositors’ money is in danger and second, how to introduce a legal system which actually by-and-large rescues the financial institutions and also protect the rights of depositors. Finance Minister Arun Jaitley tweeted: “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 depositors.”
However, how the government is planning to “fully protect the interest of the financial institutions and depositors” is not clear yet. The bill is indeed at an early stage and required changes can be brought given the apprehension regarding the danger it poses to depositors’ money at a time when country’s bad loans have soared to a record high.
Increase insurance cap:
The All India Reserve Bank Employee Association has written to RBI governor Urjjit Patel demanding security against the bill by increasing the maximum coverage of insured bank deposits from Rs 1 lakh to Rs 10 lakh. In 1993, there was an increase in deposit coverage from Rs 30,000 Rs 1 lakh as the outcome of the review of the scheme in the background of security scam in 1992 and the subsequent liquidation of Bank of Karad.