Demystifying the FRDI bill 2017

The Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill), introduced in the Lok Sabha in August, 2017, is under consideration of the Joint Committee of the Parliament have given rise to concerns over protection for bank deposits in the proposed law. 

The FRDI Bill provides for the setting up of a ‘Resolution Corporation’ which would replace the currently existing Deposit Insurance and Credit Guarantee Corporation (DICGC) which is now an arm of the RBI.

Certain misgivings have been expressed in the media regarding “bail-in” provisions of the FRDI Bill. Finance Ministry stated that The FRDI Bill do not take away from the government’s implicit guarantee to depositors. They provide additional protections to the depositors in a more transparent manner. 

What are financial firms?

• Financial firms include banks, insurance companies, and stock exchanges, among others.
• Since they transact with each other, their failure may have an adverse impact on financial stability and result in consumers losing their deposits and investments.
• e.g In 2008, the failure of a Lehman Brothers impacted the financial system across the world.
• Currently, there is no specialised law to resolve financial firms.
• Provisions to resolve are found scattered across different laws.

What are the highlights of the Bill?

• The Bill seeks to create a consolidated framework for the resolution of financial firms.
• It repeals the Deposit Insurance and Credit Guarantee Corporation Act, 1962 and amends 12 other laws.
• Resolution Corporation - The central government will establish a Resolution Corporation.
• The Corporation will have a Chairperson and its members will include representatives from the Finance Ministry, RBI, and SEBI, among others.
• The Corporation will-
    1. Provide deposit insurance to banks
    2. Classify service providers based on     their risk,  and
    3. Undertake resolution of service providers in case of failure.
• It may also investigate the activities of service providers, or undertake search and seizure operations if provisions of the Bill are being contravened.
• Risk based classification - The Corporation, in consultation with the respective regulators specify criteria for classifying service providers based on their risk of failure.
• A service provider categorized under the ‘imminent’ or ‘critical’ category will submit a restoration plan to the regulator, and a resolution plan to the Corporation. These plans will contain information, including: (i) details of assets and liabilities, (ii) steps to improve risk based categorisation, and (ii) information necessary for resolution of the service provider.
• Administration - The Corporation will take over the management of the service provider from the date when it is classified as ‘critical’.
• Resolution - The resolution of a service provider classified under the ‘critical’ category can be done by using
    1.  Transfer of its assets and liabilities      to another person,
    2.  Merger or acquisition, and
    3.  Creating a bridge financial,
    4.  Bail-in and
    5.  Liquidation
• Time limit - The service provider will automatically be liquidated if its resolution is not completed within the maximum time period of two years.
• Liquidation and distribution of assets - The Corporation will require the approval of the National Company Law Tribunal to liquidate the assets of a service provider.
• Offences - The Bill specifies penalties for offences such as concealment of property, and destruction or falsification of evidence. 

The Financial Resolution and Deposit Insurance Bill, 2017

• The Government has said, FRDI Bill is far more depositor friendly than many other jurisdictions, which provide for statutory bail-in, where consent of creditors or depositors is not required for bail-in. Ministry of Finance said, Government’s implicit guarantee for Public Sector Banks remains unaffected.

Provisions Resolution Corporation

• The Bill establishes a Resolution Corporation to monitor financial firms, anticipate risk of failure, take corrective action, and resolve them in case of such failure.
• The Corporation will also provide deposit insurance up to a certain limit, in case of bank failure.

Classification financial firms

• The Resolution Corporation or the appropriate financial sector regulator may classify financial firms under five categories, based on their risk of failure.
• These categories in the order of increasing risk are: (i) low, (ii) moderate, (iii) material, (iv) imminent, (v) critical.

Taking over the management

• The Resolution Corporation will take over the management of a financial firm once it is classified as ‘critical’. It will resolve the firm within one year.

Resolution methods

• Resolution may be undertaken using methods including: (i) merger or acquisition, (ii) transferring the assets, liabilities and management to a temporary firm, or (iii) liquidation.
• If resolution is not completed within a maximum period of two years, the firm will be liquidated.
• The Bill also specifies the order of distributing liquidation proceeds.

How does it work? 

• In case of a bank failure, the proposed corporation will provide deposit insurance up to a certain limit, which has not been specified. 
• Currently, bank deposits of up to Rs 1 lakh are insured but there are few banks that have failed in India in recent years as the Reserve Bank of India (RBI) has stepped in to work out a resolution plan without creating any risk for depositors.
• The bill has suggested that the use of the ‘bail-in’ provision may result in cancellation of a liability, which could extend to bank deposits or could lead to modification of the terms or changing the form of the asset class. This provision would be last in the line for payments in case of liquidation.
• The deposit insurance scheme currently covers all banks, commercial, regional rural and co-operative banks.
• So far in 2017, more than Rs 28 crore was sanctioned from the insurance scheme to all co-operative banks according to information on the DICGC website.
• The bill proposes to establish a resolution corporation to monitor financial firms and oversee the liquidation, which was not the case in so far.
• The RBI which has been in charge of bank liquidations or resolutions will also no longer be in charge.
• Once a financial services company, including a bank, slips into critical category, the resolution corporation will take over the firm and prepare a resolution plan during a year, which can be extended by another 12 months.
• The controversial provision of ‘bail in’ to resolve the stressed financial services companies.
• The other options include mergers, transfer of assets and liabilities to another entity, a bridge financial firm (where a new company is set up to take over the assets, liabilities and management as was the case with UTI), or liquidation via the National Company Law Tribunal.
• The Parliamentary panel is expected to submit its report, which will be considered by the Union Cabinet before the Bill is tabled in Parliament again.
• But the plan has generated a lot of heat with bank unions as well as political parties criticizing the move that has the potential to use deposits, beyond the insured amount, for reviving the bank.
Benefits
• The government believes that the bill seeks to protect customers of financial service providers in times of financial distress and also help encourage discipline among the financial service providers by putting a limit on the use of public money to bail out distressed entities. It also seeks to decrease the time and costs involved in resolving distressed financial entities.
• A large number of retail depositors can benefit as the FRDI Bill seeks to decrease the time and costs involved in resolving distressed financial entities and help in maintaining financial stability in the economy by ensuring adequate preventive measures as well as provide necessary instruments in an event of crisis.
• It will provide a comprehensive resolution framework for the economy and inculcate discipline among financial service providers in the event of financial crisis.
• It promotes ease of doing business in the country, improves financial inclusion and increase access to credit, which may lead to the reduction of the cost for obtaining credit.
• It would give increased access to finance enhancing enterprise growth, which in turn leads to preserving employment, growth and the creation of new job opportunities.

The problems The main points of objections to the legislation

• The bill’s biggest problem is its controversial provisions of a “bail-in”clause which suggests that depositors’ money could be used by failing financial institutions to stay afloat.
• The Resolution Corporation (rescue body), which is proposed under the bill, can use public money in case the bank starts to sink. The bill empowers the rescue body to decide the amount insured for each depositor. The rescue body can cancel even the Rs 1 lakh insurance that depositors get under the current law and a bank can even declare that they don’t owe them any money at all.
• People are worried that if this bill is passed in Parliament, the depositors’ rights may go down the drain, but that is ONLY if the bank is going down the drain, and that is a rare scenario.
• It may seek to place the entire financial structure of the country at the mercy of the government.
• The legislation proposes to amend the SBI Act in order to insert a clause for its liquidation which gives rise to apprehensions that in due course the government might even take recourse to privatisation of the SBI.

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.