Financial Resolution and Deposit Insurance (FRDI) Bill, 2017 is constantly making headlines for now; though not for all positive reasons. Since the day the bill was tabled in the Parliament, depositors have been left worried. Sensing resentment, the government was quick to step in to calm down the nerves of the depositors. “Adequate protection is needed for depositors. Now, what should be that larger protection? I am sure the parliament standing committee will consider this and give suggestions,” Finance Minister Arun Jaitley said earlier last week. Considering the present scenario, one gets reminded of the times when the global financial crisis had struck and the government along with the Reserve Bank of India (RBI) had to step in to calm the depositors of ICICI Bank. Shaji Vikraman, Executive Editor at Indian Express draws an interesting parallel between the two situations. The writer says, “in September 2008, at the height of the global financial crisis, the government and the Reserve Bank of India (RBI) had to step in to calm the depositors of ICICI Bank who, at many places, were heading to withdraw funds following rumours about the bank’s financial health. Worried about a potential run on deposits and a contagion effect on other banks in an interconnected financial system, and acting in the interest of overall financial stability in the country, the RBI issued a statement saying the private bank had sufficient liquidity, including in its current account with the central bank, to meet its depositors’ requirements. The RBI even went a step further to say that it had arranged to provide extra cash. And ICICI Bank’s chief executive, K V Kamath, told a business TV channel, “Hand on my heart, clearly the deposits are safe…”
The depositors in India have been offered Rs 1 lakh of insurance for decades. It shows that the Indian Banking system has traditionally been fairly supportive of the depositors. Among the provisions listed in the Financial Resolution and Deposit Insurance (FRDI) Bill, 2017 the provision for a “bail-in” has left the depositors worried. “This provision has been interpreted to mean that depositors, who rank low in the hierarchy of claimants, could see part of their deposits being converted to keep the financial firm solvent.The backdrop to this is the approach adopted by many governments after the 2008 crisis to severely limit the use of taxpayer money to bail out banks in the future. In November 2011, G20 leaders endorsed the key attributes of an effective financial resolution regime for financial institutions as an international standard, and many jurisdictions were expected to adopt such regimes by the end of 2015 itself — with bail-in as a key feature. In the UK and Eurozone, regulators have pushed banks to set aside more capital against their liabilities to prepare for a future bust. In 2011, Denmark chose to write down senior debt and unguaranteed deposits at a troubled bank,” writes Shaji Vikraman.
Everyone has long been used to the word “bailout”, where governments step in to protect the interests of savers or depositors — like in the UK when there was a run on the deposits of banks such as Northern Rock, Llyods Bank, or RBS. There were cases in the US and other parts of Europe, too. The fact that huge public funds were used for such support, and criticism that bailouts incentivised bank managements to take risky bets — called “moral hazard” by economists — led governments to seek other solutions. Regulators put in place laws and rules to discourage or prevent such bailouts with new resolution regimes. Losses of these financial firms had to be borne by shareholders and creditors rather than taxpayers. One of the tools for such resolution is “bail-in”. It allows resolution agencies to override the rights of the shareholders of the firm — this could mean writing down of a company’s equity and debt to absorb losses, or converting debt into equity. This could also mean overriding requirements such as approvals by shareholders and disposing of the firm’s assets. The G20 at its Cannes Summit in 2011 endorsed some of the key attributes of such resolution, including transfer or sale of assets and liabilities, and legal rights and obligations including deposits liabilities and ownership in shares, to a third party without any requirement for consent. In other words, deposit holders do not have any superior claims.
Brave effort needed
Shaji Vikraman says, “Like demonetisation, bail-in could, theoretically, be an attempt at behavioural change — nudging investors to be mindful of risks and to accept both risks and rewards. What needs to be debated thoroughly are the consequences of the implicit guarantee on deposits. The government could also classify deposits separately, compared with other financial products, exempt them, or place them at the bottom if it comes to the last resort of conversion for capitalisation. In the noise, the fact that depositors of cooperative banks have no such protection has found hardly any mention.” Despite all the resistance, the bill may still see the light of the day. However, it needs to be a brave government effort to come out with any such behavioural change.