By Snehil Sharma
The financial crisis which took place globally in the year 2007-08 had serious impacts. It highlighted the limited ambit of resolution frameworks in numerous countries and the governments were forced to bail out the banks which were failing.
As a consequence, to such crisis, the countries started taking initiatives to figure out the existing loopholes in the regime of resolution and further enhance their capabilities of resolution for safeguarding the national economy along with customers associated with financial service providers during the times of financial distress.
If we consider Indian scenario, rapid increase has been noted in the gross NPAs of banking institutions and has been considered as alarming situation. This has highlighted the capabilities of Indian banks towards taking risk and triggered the debate regarding the banking system failure.
If the banks are not able to maintain adequate capital which will absorb the losses which are occurred due to NPAs, they will be unable to meet the depositor’s obligation. Such situation will eventually be catastrophic for the Indian economy.
Financial Resolution Framework in India
The Banking Regulation Act of 1949 gives various powers to RBI (Reserve Bank of India) for coping with those situations where the banks are not able to meet financial obligations to the depositors. RBI takes appropriate steps towards the financial resolution of such banks to safeguard the interest of depositors.
DICGC (Deposit Insurance and Credit Guarantee Corporation) is a subsidiary wholly owned by the RBI, which compels the banking companies towards insuring per depositors upto One lakh rupees if such company goes into liquidation.
The Act inhibits two methods through which banking companies can be financially resolved i.e. winding up & amalgamation.
- Amalgamation: This method enhances the operational strength and size of small banking companies for making them able to compete with banking institutions which are comparatively larger. It also helps in protecting depositor’s interest through proper management of those banks which have the risk of failure towards meeting the obligation towards depositors. The merger on banking companies as per this act can either be through Section 44A (voluntary manner) or through Section 45 (forced manner).
- Winding up: This method deals directly with those situations where the banking corporations are failed to meet obligations towards the depositors. The Hon’ble High Court can pass appropriate order regarding the winding up procedure and an official liquidator is appointed to carry out such procedure and satisfy every liabilities and debt of the banking corporation.
Financial Resolution and Deposit Insurance (FRDI) Bill
The FRDI (Financial Resolution and Deposit Insurance) Bill of 2017 was introduced seeking remedies for those situations where banks fail to comply with the obligations towards depositors.
This Bill provides mechanism which is specialized to cope with the issues emerging from insolvency of banking corporations through establishing FRC (Financial Resolution Corporation).
The FRC inhibits representatives of central government & financial regulators. As per the proposed Bill, all the functions of DICDC will be dealt by FRC and DICGC will be ceased to exist.
The RC is supposed to classify five categories of financial firms and such categories shall be decided according to the risk of failure. These five categories are Low, Moderate, Imminent, Material and Critical risk to viability.
This bill introduced various concepts as an instrument for resolution such as Bail in, transfer of portfolio and Run-off. The Bail in focuses on utilizing the resources which are existing and Run- off prescribes the continuation of those liabilities which are coupled with present policies while prohibiting any new business.
These instruments are in addition to the already existing methods of winding up and amalgamation.
After its introduction it was examined through the Joint committee of the Upper house and Lower house. Its basic objective is to monitor the financial risk of banking institutions and resolve the same through appropriate measures in the cases of failure.
Controversial Bail-in Provision
The FRDI Bill provides numerous tools for resolution of financial firms which are failing such as liquidation, transfer of assets & liabilities, and mergers etc. One such method prescribes the internal restructuring of debts to rescue the financial firm which is in the verge of failure. This particular method is termed as the Bail-in method.
This method is distinct from the concept of bail-out which prescribes resolution of financial forms through infusing external sources or by the government.
The internal restructuring of Bail-in can be done in the following manner:
- Cancellation of liabilities which the financial firm owns to the creditors of such firm.
- Converting such liabilities into any other form of instrument.
This concept was supposed to be utilized in those instances where it is not feasible to sell the firm and its services are supposed to be continued due to its importance.
The Bail-in leads to absorption of losses and eventually allows the financial firms to prevail for a reasonable time frame and maintain the market confidence. This method can be either used individually or coupled with other methods in a wider resolution scheme such as merger & acquisition.
Criticism & Withdrawal
The FRDI was in debate for various controversial inclusion and establishment of FRC, which was empowered to decide the mount which are insured for every depositor of financial institution.
This bill received a higher share of criticism from the stakeholders due to the controversial provisions which was introduced including the clause of ‘bail-in’, which prescribed using depositor’s hard earned money to save financial institutions which are failing.
Finally, the government decided to withdraw FRDI as consequence to the public apprehensions regarding the ‘bail-in clause’ of financial resolution.
This clause was considered by the people to be against the depositor’s interest. This clause created a fear amongst people that their deposits will be directly used as a bailout if any bank fails to perform its obligations. Various other concerns regarding the insurance of deposits were also highlighted in FRDI.
It cannot be perceived that withdrawal of FRDI is the end of efforts made by central government regarding resolution of financial institutions.
The government is still taking initiatives to create a mechanism to deal with the same. There were rumors regarding the re-introduction of FRDI Bill.
However, it was clarified by the government in July,2020 that no specific decision has been taken regarding re-introduction of FRDI Bill of 2017.
These clarifications were coupled by the mainstream & social media reports which were stating that government was working towards reintroduction of legislation concerning framework of financial resolution which was failed.
The government is finding ways to cope with the problem faced by banking institutions. The Bill, once it is implemented, is expected to achieve every objective for financial stability of banking institutions.
Stability will eventually ensure the continuance of crucial financial services without any hindrance and will further contribute towards ease of doing business within the country.
The estimated time and cost of resolution required for financial institutions and banking companies will be less if the appropriate legislation is introduced for the same.
Hence, the legislation regarding financial resolutions should be designed in such a manner that it eventually results in procedural clarity which will help in speedy, transparent and predictive procedure and will safeguard the interest of stakeholders.
Section 52, The Financial Resolution and Deposit Insurance Bill, 2017 ↑
Mayur Shetty, 2020. No Decision On FRDI Bill: Government – Times of India. ↑