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What is the FRDI Bill about?
India now has a law to swiftly address the issue of insolvency of companies in the manufacturing sector. Essentially, that law aims at finding and finalising a resolution plan to get a troubled company back on track, or, in the event of failure, ensure a quick winding up. The plan is to have a similar law for firms in the financial sector — so that if a bank, a Non Banking Finance Company (NBFC), an insurance company, a pension fund or a mutual fund run by an asset management company, fails, a quick solution is available to either sell that firm, merge it with another firm, or close it down, with the least disruption to the system, to the economy, and to investors and other stakeholders. This is to be done through a new entity, a Financial Resolution Corporation — envisaged as an agency that will classify firms according to the risks they pose, carry out inspections and, at a later stage, take over control. This was recommended by the Financial Sector Legislative Reforms Commission (FSLRC) headed by Justice B N Srikrishna.
The government explains Financial Resolution and Deposit Insurance Bill 2017 thus:
• The Financial Resolution and Deposit Insurance, Bill 2017 when enacted, will pave the way for
setting up of the Resolution Corporation.
• It would lead to repeal or amendment of resolution-related provisions in sectoral Acts as listed
in Schedules of the Bill.
• It will also result in the repealing of the Deposit Insurance and Credit Guarantee Corporation
Act, 1961 to transfer the deposit insurance powers and responsibilities to the Resolution
Corporation.
• The Resolution Corporation would protect the stability and resilience of the financial system;
protecting the consumers of covered obligations up to a reasonable limit; and protecting public
funds, to the extent possible.
• The proposed Bill complements the Code by providing a resolution framework for the financial
sector.
• Once implemented, this Bill together with the Code will provide a comprehensive resolution
framework for the economy.
Government outlines the following merits of Financial Resolution and Deposit Insurance Bill, 2017
• The Financial Resolution and Deposit Insurance Bill, 2017 seeks to give comfort to the
consumers of financial service providers in financial distress.
• It also aims to inculcate discipline among financial service providers in the event of financial
crises by limiting the use of public money to bail out distressed entities.
• It would help in maintaining financial stability in the economy by ensuring adequate preventive
measures, while at the same time providing the necessary instruments for dealing with an event
of crisis.
• The Bill aims to strengthen and streamline the current framework of deposit insurance for the
benefit of a large number of retail depositors.
• The Bill seeks to decrease the time and costs involved in resolving distressed financial entities.
Controversial Provisions in the Bill
• The FRDI Bill has received flak from various stakeholders for some of its controversial provisions
including a ‘bail-in’ clause which suggests that depositor money could be used by failing financial
institutions to stay afloat.
• The Resolution Corporation (rescue body), proposed under the Bill, can use your money in case
the bank sinks. The bill empowers the rescue body to decide the amount insured for each
depositor.
• Under Section 52 it can even cancel the Rs 1 lakh insurance that you get under the current law
because the Bill aims to repeal the Deposit Insurance and Credit Guarantee Corporation Act,
1961.
• Section 52, Explanation II says, “The purpose of bail-in is to absorb the losses incurred, or
reasonably expected to be incurred, by the covered service provider and to provide a measure
of capital for it so as to enable it to carry on business for a reasonable period and maintain
market confidence in it.”
• Section 53 explains powers of a bail-in instrument in relation to securities:
A bail-in instrument may—
(a) Cancel or modify any securities to which section 52 applies;
(b) Convert any such securities from one form or class into another, including the creation of a new
security in connection with the modification of an existing security.
(c) Make provision with respect to rights attaching to securities issued by the covered service provider
including:
(i) A provision that specified rights attaching to securities are to be treated as having been exercised;
(ii) A provision that the Corporation is authorized to exercise specified rights attaching to securities;
(iii) a provision that specified rights attaching to securities may not be exercised for a period
specified in the instrument;
(d) Provide for the listing of securities issued by the covered service provider to be discontinued.
(e) Provide for securities issued by covered service provider to be transferred to the Corporation or any
other entity.
(f) Make any other provision for, or in connection with, the transfer of securities issued by the covered
service provider, whether or not the transfer was the subject of that instrument.
What is the rationale behind this bail-in provision?
The principal aim, of course, is to minimise the cost of any such failures of financial firms to taxpayers. The other objective, as the EU’s Bank Recovery and Resolution Directive, 2014, indicates, is that shareholders of banks and creditors must also pay their share of costs, rather than governments or taxpayers absorbing all losses. The Bank of England has been pushing banks in the UK to set aside more funds to cover for potential failures. The aim, the UK central bank says, is to ensure banks no longer remain “too big to fail”, and to make sure that the risks that banks take are properly priced by investors who know they will suffer if things go wrong.
What is the worry that depositors and others have regarding the provision in the proposed Indian law?
India’s financial sector is bank-dominated, and bank deposits make up the dominant share of financial savings. The fear is Indian policymakers may want to nudge savers on the same path as in many other parts of the world — to ultimately lower risks and the potential burden on taxpayers, although there is no explicit mention of this in the proposed law. In India, deposits in banks are insured for a maximum of Rs 1 lakh by the Deposit Insurance and Credit Guarantee Corporation, which is now an arm of the RBI. There are concerns that the Bill may not clearly lay down the quantum of protection for deposits, or classify deposits separately.
What has been the government’s response?
The government has said that India’s FRDI Bill is more depositor-friendly than that of many other jurisdictions that provide for statutory bail-ins, where the consent of creditors or depositors is not required for bail-ins. It has also said that it does not propose in any way to limit the scope of powers to extend financing and resolution support to banks, including public sector banks. The government’s implicit guarantee for public sector banks remains unaffected, the Finance Ministry has said. That is perhaps an indication that the sovereign may not want to foreclose the option to back a failed bank. In the United Kingdom too, the Treasury retains the power to transfer a failing firm into public ownership, or make a public equity injection as the last resort.
What other changes could the proposed law set off?
Like elsewhere, once this kicks in, banks, insurers, pension funds, asset management companies, all will have to put in place resolution plans or “living wills” that will address a potential failure of the firm in the least costly manner. This plan will be continuously reviewed by the proposed Resolution Corporation, like the Federal Deposit Insurance Corporation (FDIC) in the US, which has handled 527 bank failures since 2008, including seven in 2017 so far. Resolution corporations in the US, UK and Canada classify the risks of firms they supervise, review them periodically, and carry out simulation tests and mock drills of resolution plans. The Bank of England is going one step ahead with plans to publish the summaries of resolution plans of banks while they are “alive”, or healthy. In cases of bank failures, the announcement of a shutdown is typically made on a Friday evening, and by Monday, cheques reach customers, or money is credited to their accounts in two working days. A closure or shutdown will be the final option — the first option would be to transfer the assets and liabilities to another firm, or to create a “bridge service provider” to which they would be transferred until eventual sale, revival, merger, or acquisition.
