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The FSDR Bill: Should we as depositors be worried?

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Moneylife, in an exclusive post on 27 Dec 2019 states that the Government proposes to introduce Financial Sector Development and Regulation(Resolution) Bill 2019 (The FSDR Bill 2019) in place of what was called the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) which was tabled 10 Aug 2017 in both the houses but withdrawn exactly one year later after JPCreview. On Feb 07, 2020, The Economic Times reported that The Union minister Nirmala Sitharaman said that the Finance Ministry is working on the FinancialResolution and Deposit Insurance (FRDI) Bill but not sure when it will be tabled in the House.

The bone of contention in the FRDI bill for citizens was the introduction of a Bail-in Clause defined by Investopedia as the ‘rescue’ of a failing financial body by cancelling the debts owed to creditors and depositors. This would call for the bank to be recapitalised using the money invested by the account holders. A total maximum amount of Rs One Lakh (now revised to Rs Five Lakhs) designated as an insured deposit amount would be ‘protected’ for the account holder.

The mechanism proposed by the FSDR would cover financial entities including banks, insurance companies, financial market infrastructure, payment systems and other financial service providers (excluding individuals and partnership firms), cooperative banks and regional rural banks. Entities such as stock exchanges, clearinghouses, depositories and other insurance and capital market intermediaries which are identified as systemically important financial institutions will also be covered in the ambit of this law. Parent institutions, as well as subsidiaries, would be covered in this bill. The aim is apparently to put in place ‘an effective resolution regime’. It envisages the installation of critical powers for resolving banks, such as “power to terminate contracts, write down debt, modify liabilities or set up bridge institutions.”

Clearly defined triggers in a Prompt Corrective Action PCA framework would bring a problem Institution into resolution so that timely intervention could be ensured. The bill covers a systemic vacuum in the law regarding bankruptcy situations and would cover the resolution of non-banking finance institutions (such as IL&FS, DHFL).

A Resolution Authority based in Mumbai would be set up a Prompt Corrective Action framework for all the institutions and be tasked to handle financial sector failures without transferring the burden to taxpayers while using a transparent mechanism. Without specifically calling it a bail-in, this RA would be authorised to cancel or modify liabilities of the errant bank to its creditors and modify the insurance limit.

Under this scheme, all service providers would be rated on a (risk) scale of low(safest) to critical. When a service provider is rated critical, the RA would suspend the BoD and take over the administration of the entity. If the NCLT decides to liquidate the entity, the RA would be appointed liquidator by the NCLT.

A host of laws would be amended to implement the FDSR, including Insolvency & Bankruptcy Act, The Companies Act 2013, Pension Fund Regulatory and Development Authority, Payment and Settlement Systems Act, the Multi-State Cooperative Societies Act, Reserve Bank of India Act, Insurance Act, National Housing Bank Act, Export-Import Bank of India Act, Banking Companies (Acquisition and Transfer of Undertaking) Act, the Central Goods and Services Tax Act, Regional Rural Banks Act, General Insurance Business (Nationalisation) Act, Income Tax Act, Customs Act, Securities Contracts Regulation Act, Life Insurance Corporation Act and State Bank of India Act, among others.

The question arises as to why such a major change is required now and what could be consequences of this change.

The Concept of bail-in was raised after the financial crash of 2008 when western governments had to pay huge amounts of money to bail-out Financial institutions that were regarded as too big to fail. This put pressure on taxpayers which was not liked by governments. Additionally, funds diverted from larger banks to protect smaller units from failure caused resistance in the larger banks as to why they had to cover the weaknesses of small banks.

One result of a bail-in would be that creditors would have to be very alert to any discrepancy in the functioning of their bank because if the bank fails, their funds would be used to bail in the bank. The creditors are therefore responsible for the safety of their investments – given the time-honored opacity of banks towards their customers, it is anyone’s guess as to how this could even be possible. But should the bank fail, the customer is almost treated like as if he is a willing co-conspirator in any alleged misdeeds by the bank at least to the extent of funding their activities. Like in equity, the customer will have to keep monitoring the working of banks and shifting funds according to the safety level of each bank. And those who cannot do this would be left with only one alternative – to take the cash home and store it under the bed.

Simon Gleeson of the London School of Economics in his January 2012 Special Paper 205 on ‘Legal Aspects of Bank Bail-ins’ has likened a bail-in to an amputation procedure by which ‘bad parts’ are separated and discarded to ensure the survival of the ‘good parts’ of a human body. The‘bad’ parts would naturally be individual investors or creditors who would lose their daily sustenance and still not threaten the financial system and hence SimonGleeson has recommended that due information and ideally consent also be ensured from each account holder whose funds are to be taken. The money placed by private citizens in banks would be their day to day earnings, amounts saved and invested in the banks for meeting their expenses after retirement. When a bail-in is implanted, the amounts held in these accounts would be subject to cancellation sparing only the insured deposit amount.

While governments all over the world are totally averse to burdening the taxpayers and huge PSUs that are supporting it, the fact remains that all the tools required to prevent any discrepancies in the management of financial entities whether for monitoring or enforcement action are also with the government and diligent application of the same could avert failures in finance bodies. The entry of Resolution would be a win-win situation for banks and Governments so that they have nothing to lose and the full burden of keeping them safe would be on the shoulders of private creditors.

The manner of the bail-in/ resolution is another matter that has to be looked at very carefully. In March 2013, in the case of Cyprus, a bank holiday was declared without any notice and simultaneously all ATMs were shut down, cutting off from the citizens any access to their funds until the Government had completed the implementation of the bail-in. The extent of their losses became known to individual depositors only after the banks opened the whole process had been completed.

The government and particularly the Finance Minister have been repeatedly assuring us that the government is fully committed to keeping our funds safe. The need for the FDSR Bill came from the bailout done by Western Nations for their banks following the crash in 2008. In this regard, the International Monetary Fund has cautioned that the bail-in tool should be implemented in an orderly and clear manner, properly covered with a legal framework that ensures that even without prior consent, only a ‘no creditor worse off test’ should be applied to ensure that creditors and shareholders interests are secured.

Once this FDSR Bill is implemented the RA could in future become a Finance Supremo for all financial operations all over the country, in Banking, in Equity, and in Insurance. After having good results with the checks and balances that come into play when literally dozens of monitoring bodies are each monitoring different parts of the financial operations of the country, the results of concentrating all authority in one body will have to be considered very carefully. Credibility and transparency would become paramount to retain the trust of the private depositors who would have no choice but shift to nonbanking investments, whether in gold or real estate. Without proper enforceable accountability of the incumbent, even a tiny misstep by this body could cause creditors to opt-out of the banking system and fend for themselves with a safer option, even if less or not profitable.

Given the turmoil that we see all over the world, it is only a matter of time that failures in the financial system will start showing up – and the risk to the banks and Finance bodies themselves will be low because that risk will be covered by the private creditors who will not have the means to even protect themselves.

While on the face of it each option looks very justifiable, the fact remains that the combination would create a cocktail that without any notice could set off a chain of events that would end up in disaster for individuals and families – the corporates in the finance sector, however, would not be affected.

The 2017 FDRI bill was dropped because the government knew that the bill could not pass any public scrutiny, and the present FDSR bill is way ahead of that.

Locking a stable is no use after the horses have bolted, and this is a wake-up call for us to ensure that without proper safeguards no such bill should even be considered.

List of References:

  1. Financial Stability Board
  2. Clifford Chance-Recognition-of-EU-bail-in-clauses-key-considerations-for-the-asia-pacific-market.pdf
  3. CBCL-Bail-In Clause in the FRDI Bill: Is the Hysteria Justified?
  4. The Hindu – Banking on legislation
  5. Livemint-FRDI Bill’s bail-in clause: Two options for the government
  6. Bankbazaar-The FRDI Bill: What Does It Mean For You?
  7. The Economic Times – FRDI: FinMin working on FRDI bill, says Sitharaman
  8. The Economic Times- How to make the FRDI bill more effective – The Economic Times
  9. Moneylife Exclusive – FRDI Bill To Come Back as FSDR: Many Questions Unanswered
  10. Newsclickin Video on YouTube – ‘FSDR Bill will Demolish Indian Banking Sector’
  11. Investopedia Bail-Ins During Financial Crisis Helps Financial Institutions
  12. Bloomberg – Bail-In
  13. World Bank FinSAC-BRRD-and-Bail-In-CaseStudies.pdf
  14. India Today – New FRDI bill may take away all your money in the bank
  15. London School of Economics and Political Science –Legal Aspects of Bank Bail-Ins

 

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Arun Pinto

For Arun, Journalism is an acquired passion, one that has helped him grow as a person. As an analytical journalist who prior to adopting Journalism as a profession had wide experience in the Automotive and Pharma sector.

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