(Source: BloombergQuint)

BQExplains: Should Depositors Fear The New Financial Resolution & Deposit Insurance Bill?

The process to put in place a new Financial Resolution and Deposit Insurance Bill is expected to move to the next step soon. The joint parliamentary committee, which is studying the bill, is scheduled to submit its report during the winter session. If that happens, the bill may be taken up during the upcoming sitting of parliament.

Ahead of that, concerns have been raised about whether provisions of the bill could compromise the interest of depositors. On Sept. 18, wire agency PTI reported that bank unions have asked the government to withdraw the bill as it gives sweeping powers to authorities to wind up public sector banks.

BloombergQuint explains the key provisions of the bill pertaining to depositors.

Will Deposits Still Be Insured?

Deposit insurance was introduced in India well before the economy was liberalised. The Deposit Insurance Corporation Act came into effect starting 1962. Under the Act, a maximum of Rs 1 lakh is insured for each depositor. This provision was extended to depositors of all commercial banks and most cooperative banks. So in a hypothetical scenario where a bank is liquidated, principal and interest up to Rs 1 lakh is insured. Banks pay a deposit insurance premium, which is held by the Deposit Insurance Corporation, and in turn used to pay out depositors if needed.

This provision, while it exists, has rarely been tested. Even in scenarios where small banks have found themselves in trouble, the Reserve Bank of India has often restricted deposit withdrawal for a period of time but eventually merged the weak bank with a stronger bank. Rarely have depositors needed to resort to deposit insurance.

Once the Financial Resolution and Deposit Insurance Bill is cleared, it will replace the existing deposit insurance framework. The new bill says the following:

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 ‘Corporation’ referred to above is a ‘Resolution Corporation’ to be set up under the new framework. A ‘Corporation Insurance Fund’ would be the vehicle through which the deposit insurance would flow.

The above provision suggests that deposits to a certain extent would continue to be insured just like in the current regime. It leaves the decision on the amount to be insured in the hands of the regulator concerned. In the case of the banking sector, this would be the RBI. It would be fair to assume that once the bill is cleared, the regulator would clarify the amount to be insured. It has not given any indication, so far, that the amount of deposits insured would be lower or higher than the present provision of Rs 1 lakh in insured deposits.

Does The Bill Provide For A ‘Bail-In’’ Of Depositors?

The Financial Resolution and Deposit Insurance Bill introduces a provision for a ‘bail-in’, but specifically excludes insured deposits. The concept of a ‘bail-in’ is one under which creditors and depositors absorb some of the losses in a scenario where a financial institution fails.

In this regard, the bill says the following:

“...the Corporation may, in consultation with the appropriate regulator, if it is satisfied that it is necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider and to provide a measure of capital so as to enable it to carry on business for a reasonable period and maintain market confidence, take an action under this section by a bail-in instrument or a scheme to be made under section 48.....”

The bill, however, goes on to specify the categories that cannot be included in the ‘bail-in’. The list includes:

  • Deposits covered by deposit insurance.
  • Liabilities by virtue of holding client assets.
  • These client assets include any liability of original maturity up to seven days.
  • Obligations to a central counter party.
  • Any liability so far as it is secured.
  • Any liability owed to employees or workmen including pension liabilities.

The provisions essentially suggest that the insured amount of deposits (which is Rs 1 lakh) remains protected as it currently is. Hypothetically, if a bank were to fail, deposits beyond that may not be protected. That is the same as the current scenario.

In some ways, a bail-in provision, which clearly excludes insured deposits, can help protect depositors, said Mandar Kagade, a policy expert who has studied the Bill. “The FRDI Bill appears to enhance depositor protection including through loss protection devices like bail-in instruments,” said Kagade. He explained that bail-in instruments (such as Additional Tier-1 and Additional Tier-2 bonds) take first loss if the capital of the bank falls below a critical threshold. “In June 2017, ‘bail-in’ was successfully implemented for first time in case of Banco Popular's buy out by Banco Santander...Thus, evidence is emerging as to its utility.”

Does The RBI’s Influence Over Resolution Reduce?

A senior legal expert, who spoke on the condition of anonymity, said the concerns that the new Financial Resolution Bill raises, pertain more to the role and influence of the RBI. So far, the RBI, being the banking regulator, has managed to ensure that depositors remain protected even when a bank goes into stress. In many such cases, the regulator has called on larger banks to merge with the stressed bank, with the eventual aim to protect depositors.

Under the new regime, the Resolution Corporation, which becomes the overseeing authority in the case of stressed financial institutions may not have that kind of ‘moral suasion’ powers and may resort to liquidation. This, in turn, would test the deposit insurance framework which has remained largely untested in India so far.

KC Chakrabarty, former deputy governor of the RBI, said the new framework doesn’t change the scenario for depositors materially as compared to the prevailing framework, he said. Chakrabarty added that the new resolution framework is in keeping with interesting experience in the post-financial crisis world.