Financial Resolution and Deposit Insurance (FRDI) Bill, 2017

What is FRDI Bill?

The Financial Resolution and Deposit Insurance (FRDI) Bill 2017 is more comprehensive approach by the government towards systematic resolution of all financial firms. It creates a framework for resolving bankruptcy.

As per FRDI bill a Resolution Corporation will be formed to monitor the financial firms and take corrective measure in case of failure. The salient points of the bill are:

·   Resolution corporation will replace Deposit Insurance and Credit Guarantee Corporation (DICGC) .

·   It will be monitoring the financial institutions and take corrective actions in case of failure.

·    It will also classify the financial firms as low, moderate, material, imminent, or critical based on their risk of failure.

·    It will take over the management of company if its risk becomes critical.

·   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 Resolution Corporation will provide deposit insurance up to a certain limit which is yet to be specified. This limit will be set only after passing the bill in the parliament.

Resolution Corporation:

The Bill proposes to establish a ‘Resolution Corporation’ to monitor financial firms, calculate stress and 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.

Existing method:

While India never had such a resolution authority before, the Reserve Bank and the  Insurance Regulatory and Development Authority of India (IRDAI) were handling these functions for the banking and insurance sectors. The RBI, in the past, had asked PSU banks to take over stressed banks in order to protect the depositors and employees.

The Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, established in 1971 insures all kinds of bank deposits up to 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.

Key Issues:

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, in the same capacity and in the same right," the draft Bill states.

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. 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, Thomas D. Franco, general secretary of the bank employees association AIBOC( All India Bank Officers' Confederation) said.

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.

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.

Is your money really SAFE with the bank?

At present, in India, Banks are regulated by Reserve Bank Of India and Insurance Companies are regulated by Insurance Regulatory and Development Authority of India (IRDAI).

The Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary, established in 1971 insures all kinds of bank deposits .

Indian Parliament passed the Deposit Insurance and Credit Guarantee Corporation (DICGC) Act in 1961 and as per that law, deposits of up to Rs 1 lakh, including interest, are protected by the insurance cover that the bank takes.

Banks will pay a sum to the DICGC as insurance premium.

Figures from banking unions suggest that the 21 public sector banks, which corner 82% of the banking business in India, together pay about Rs 3,000 crores as insurance premium on deposits to the Deposit Insurance and Credit Guarantee Corporation.

For Example: Mr.A has deposited Rs.5 Lakh in Bank X . In the event of bankruptcy, as per the DICGC act, only Rs.1 Lakh will be given to Mr.A. He will lose the balance Rs.4 Lakh which is not covered under the insurance.

This means that the payment of all deposits up to Rs 1 lakh are guaranteed even if the banks fail. Anything over and above Rs 1 lakh does not have this protection, which means that a bank account holder with a large deposit might lose the money above 1 lakh if the bank sinks.

Most of us are not aware of this existing rule.

Originally under DICGC law, the insurance cover was limited to Rs 1,500. It was raised from time to time, eventually reaching the current Rs 1 lakh. As of March 31, 2017, more than 92 % of deposit accounts were fully insured as they were below Rs One Lakh. Beyond this sum, the depositors are considered to be “unsecured creditors”.

FRDI bill empowers the corporation to “bail-in” a failing financial company.

What is Bail-in and Bail-out?

The most controversial part of the FRDI bill is the bail-in clause which is widely debated. The current system has bail-out method. FRDI bill 2017 introduces bail-in clause.

In the existing system, in case of bankruptcy, depositors will get amount insured by DICGC (Deposit Insurance and Credit Guarantee Corporation is a subsidiary of Reserve Bank of India. It was established on 15 July 1978 under Deposit Insurance and Credit Guarantee Corporation Act, 1961 for the purpose of providing insurance of deposits and guaranteeing of credit facilities) i.e.Rs.1 Lakh. The remaining amount will be lost.

In case of Bail-in clause in FRDI, depositors will get the amount covered by the insurance (The insurance coverage amount is not yet specified in FRDI bill) and the balance amount will get converted into financial instruments like equity.

The government has finally clarified that the bail-in clause will not be used for public sector banks (PSBs). Government said that it is ready to bail-out the PSBs if needed, removing the need for a bail-in.

Also government clarified that the bail-in clause can only be used in private banks, and that too only if the customers allow it.

Why did government propose FRDI Bill?

Remember 2008 global financial crisis which killed iconic US investment bank Lehman Brothers Holdings Inc. and brought many large financial intermediaries to their knees, forcing large-scale bailouts by governments.

In November 2014, India, as part of the G20 nations, had agreed to create a legal structure which includes a ‘bail-in provision’ to recapitalize banks in order to overcome financial crisis like 2008.

2008 financial crisis made the global countries to create such a resolution to save the financial institutions from bankruptcy.

Will FRDI bill protect our money?

India cannot afford to be stumped in the event of financial crisis like many nations were in 2008. FRDI bill will put India on a par with the nations that learned their lessons from the 2008 crisis.

The fact is that the risk is no more or no less than it ever was. The Deposit Insurance and Credit Guarantee Corporation provides deposit insurance of up to Rs.1 lakh. The rest is forfeited in the event of a bank failure.

The main reason for people opposing FRDI bill is because of the introduction of “Bail-in” clause which creates fear among the depositors. Government need to address this Bail-in clause issue as depositors cannot afford to loose their money.

As of now, there is is no need to panic as banks in India in last 70 years have hardly been liquidated. In the past we have seen RBI forced the banks under the brick of failure to merge with stronger banks. Eg: Global trust bank which was under the brick of bankruptcy was merged with Oriental bank of commerce.

Parliamentary standing committee deferred the FRDI bill which was introduced in Lok Sabha in August and will submit its report in the upcoming Budget Session. The bill is under reconstruction of classes before re-submission. We need to wait for the reconstructed bill to know further.

Some Interesting Facts:

·         The concept of bail-in first used in Cyprus in 2013.

·    In Cyprus, depositors lost almost 50 per cent of their savings when a bail-in was implemented.

·    Govt of India gave 30000 cr bail out package to Air India in 2012.

·     Way back in 2002, the Indian government bailed out Unit Trust of India by infusing over Rs 14,500 crore and repaid the investors that had invested in UTI schemes. After 15 years Indian government can recover its capital by just selling its stake in Axis Bank. As on July 19 2017, the government holding in Axis Bank was valued close to Rs 14,300 crore. Through UTI, the Indian government has holding in other listed giants — L&T and ITC.

·         Federal Deposit Insurance Corporation (FDIC) in the US, which has handled 527 bank failures since 2008, including seven in 2017 so far.

·   “The gross non-performing assets of public sector and private sector banks as on September 30, 2017 were Rs 7,33,974 crore, Rs 1,02,808 crore, respectively,” the finance ministry said citing RBI data.

·   Insurance Regulatory and Development Authority of India (IRDAI) Act was passed upon the recommendations of Malhotra Committee report (7 Jan,1994), headed by Mr R.N. Malhotra (Retired Governor, RBI).Main Recommendations — Entrance of Private Sector Companies and Foreign promoters & An independent regulatory authority for Insurance Sector in India.In April,2000, it was set up as statutory body, with its headquarters at New Delhi.The headquarters of the agency were shifted to Hyderabad, Telangana in 2001.

To conclude, the government is awaiting the recommendations of the Joint Committee of Parliament in regard to the FRDI Bill and would favourably consider the recommendations.