Revival of the Financial Resolution and Deposit Insurance Bill —A Need of the Hour

Introduction

A bank or other financial firms form the basis of the financial economy of any country. In a world largely driven by credit, and fueled by debt, this reality becomes even more jarring. Their failure has the potential to ignite a chain reaction capable of precipitating multi-sectoral contagion. The high probability of exposing the economy to systematic risks makes their effective and expeditious resolution a pertinent condition for the overall economic well-being. As the fire sale of assets indulged into by the financial institutes to recalibrate their balance sheet and acquire liquidity for staying afloat not only plummets the market price of similar assets but also creates a doubt in their capabilities to meet their obligations to other similar institutes, therefore, causing an apprehension on the collective health of the sector.¹

Interestingly, multifaceted exposure of these entities also gives rise to a nearly irresistible urge to take a “gamble for resurrection”, a scenario in which the bankruptcy proceedings are delayed in hopes of an imminent revival, inviting a run on the deposits of the institution. Therefore, it is essential to treat the financial institutes as a class distinct from other firms in the market, their insolvency proceedings must be carried out by an expeditious and specialised body capable of limiting the impact of the consequent disruption.

The Financial Crisis of 2008 signposted by the collapse of the bank, Lehman Brothers , was a wake-up clap required by the world governments to create such empowered, autonomous bodies capable of not only effectuating suitable resolution of failing financial firms but also monitoring the conduct of banks (which were already being supervised by the Central Banks) but also banking institutions other than certain designated cooperative banks, insurance companies, financial market infrastructures (stock exchanges), non-banking financial companies (NBFCs), and even the holding companies of these financial firms along branch offices of financial MNCs carrying out their business in the country.²

Subsequently, advanced economies such as the US, the UK, and the European Union each passed their version of specific laws and rules to deal with the supervision and resolution of financial firms.³ As our country was not impacted by the recession in the same manner as the Western markets, the urgency to formulate such a code was not visible. However, the Central Government did realise the need to reform the process keeping in mind the huge amount of taxpayer’s income being spent just to keep the NPA-ridden financial sector intact.⁴ Thus, after a series of recommendations by various committees set up to examine the health of various sectors in the economy, the Government in 2017, decided to combine the role of various regulators in dealing with the various financial institutes and form a resolution corporation by tabling for passage of the Financial Resolution and Deposit Insurance Bill, 2017⁵ (the Bill), in Parliament.

As it is hardly possible to examine in detail all the provisions of such an exhaustive Bill in the length of this article, the author shall be focusing on the few key tenets of the Bill, the reasons why it was withdrawn, the legitimacy of these concerns, and will conclude after analysing certain methods via which these concerns can be accommodated to make the Bill more acceptable.

Key elements

The draft Bill was enumerated by 163 sections divided into 18 chapters.⁶ It not only aimed to create a comprehensive framework for deposit insurance and resolution mechanism of financial institutions, and to establish a Financial Resolution and Deposit Insurance Corporation (FRDIC) but also sought to amend in one sweep the Banking Regulation Act⁷, State Bank of India Act⁸ Insurance Act⁹, the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970¹⁰ to minimise the chances of regulatory overlap. The Bill if passed would have also repealed in to the Deposit Insurance and Credit Guarantee Corporation (DICGC) Act, 1961¹¹ thus, dissolving DICGC an RBI-owned institute that provides deposit covers to the banks, and replacing it with the liability of FRDIC to pay the depositors out of its deposit insurance fund which was to be constituted by collecting premium from the financial service providers (Chapter 4 of the Bill).

The ambit of the Bill

The Bill applied to all the covered service providers (CSPs) including banks, insurance companies, stock exchanges, depositories, payment systems (Gpay, etc.), NBFCs, and their parent/holding companies, along with the branch office of the MNCs providing financial services in India. However, not all cooperative banks were covered under the Bill since some of them are controlled and owned by the State Government in line with the constitutional mandate.¹² Furthermore, it incorporated the idea of “too big to fail” by providing for the Central Government to classify certain institutes not covered under the Bill as systemically important financial institutions (SIFIs), which were then covered under the Bill similar to any other CSP. The issue of providing the Central Government with the power to notify the SIFI and the criteria thereby would lead to arbitrariness and politicisation of the process. Consequently, it too should have been left to the FRDIC to decide, however, it is the view of the author that the FRDIC formed based on its competence to resolve the imbalance in financial firms is not equipped (at least in the form provided in the Bill) to side by side examine the functioning of all other players in the market, and judge upon their centrality. It is a policy decision that can only be based on the wide range of economic data that the Finance Department receives regularly. Thus, no changes are required here.

Role and functions of Financial Resolution and Deposit Insurance Corporation

The FRDIC has the mandate to supervise and direct the abovementioned financial institution with the larger aim of maintaining the health of the financial market including reasonable protection of the consumers and the public funds. Its key functions include monitoring vital financial institutes, classification of CSPs based on their financial health, undertaking resolution or liquidation of financial firms in case of failure, and provide deposit insurance, etc. Therefore, the corporation dons the double hats of supervisory (directing, appointing, and supersession of board when required, as per the framework of the Bill) and resolution authorities, similar to the current role of Reserve Bank of India (RBI) in the banking sector, and a limited sense NBFCs.¹³

Furthermore, the Corporation was envisaged to be an autonomous body capable of taking essential actions without any need for a court or government order, its duties and powers were sufficiently defined in the Bill itself to remove any chances of a clash with other regulators (SEBI, RBI, etc.). The Bill also provided for close cooperation between the other regulators and corporations, however, primacy was provided to the decision of FRDIC in the process of classification as well as in deciding the nature of the action required for the resolution process.¹⁴ As a consequence, the proposed corporation would have been an empowered and autonomous body capable of discharging its task with alacrity.

Process of classification and resolution

Chapter VI of the Bill dealt with the classification of the institutions on the basic viability of a firm, i.e. risk of failure. This is based on the principle of precaution was better than cure with idea that intermediate intervention may avert a larger collapse. The parameters based on which covered service providers would be classified were not established in the Draft Bill, but the criteria that could be considered while formulating the classification were given.

The 5-pronged classification included low, moderate, material, imminent, and critical. The restoration and resolution steps were then to be decided based on the classification. Low and moderate grouping meant no intervention from the regulators or the corporation, whereas material risk meant the position of the firm is less than acceptable. Thus, such CSPs would have to make a periodic submission about their financial position to the regulator concerned. They were also supposed to submit a prompt corrective action framework – a plan for restoration and resolution of the firm’s position. In case of the CSI is put under imminent risk (close to failure), a plan must be put forth in front of FRDIC, after which the corporation will give directions to the regulator concerned to resolve the issues.

Critical risk is the category that demands steps on war-footing to stabilise the situation. It signifies the failure of the CSP to meet its obligations. At this stage, the directions given to the corporation are to “reduce the financial obligation of the covered service provider or to lower the category of risk it falls under at the time of inspection”.¹⁵ It must be noted that this was only a broad skeleton, and proper rules and criteria were still required to be drafted to make the process more systematic, predictable, and uniform.

However, the classification also gives rise to the fear that it may decrease confidence and trigger a run on the institute. The author believes that it is not necessarily a bad thing, as it would provide the consumers with an idea about the assets in which they are investing their capital. Furthermore, it would provide an incentive for the institutions to keep themselves in shape.

Once the steps provided by the corporation in the consultation are put into place FDRIC may effectuate the following processes¹⁶—

1. transfer the whole or part of the assets and liabilities of the covered service provider to another person, on terms agreed between the FRDIC and such person;

2. creating a bridge service provider;

3. bail-in;

4. merger or amalgamation of the CSP;

5. acquisition of the CSP.¹⁷

The resolution process must end in 1 year which may be extended for one more year failing which liquidation process begins under Chapter XII.

Key contentions against the Bill

It would not be wrong for us to terminate the proposed Bill as one of the biggest institutional and structural reforms of our times. Unfortunately, it was unable to survive the scrutiny of the Indian public and was subsequently withdrawn from Parliament after the recommendation of the Joint Committee of Parliament.¹⁸ The Minister stated the reasons for withdrawal to include concerns about insurance of deposits, the process of bail-in being acceptable for the public, and the issue of public banks.

bail-in is the process that allows failing banks and financial organisations to lawfully seize depositors’ funds to avert an economic disaster caused by a bank failure. This replaces the taxpayer’s money used in the bailout with the depositor’s funds. This has been largely inspired by the US Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, passed in response to the public outcry against the usage of public revenue to bail out too big to fail corporations.¹⁹ Combined with the fact that the Bill was aiming to repeal the whole of DICGC that form the basis of deposit insurance which covers about 92% of all savings kept in the Indian Banks.²⁰ The depositors became worried about their economic security. The feeling of indirectly making the public responsible still stays.

Thirdly, the decisions as per the Bill can only be challenged in National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT), on the ground that the corporation did not have the mandate under the Bill to take the relevant action. The Bill excludes the jurisdictions of the other courts. Concerning the same, there is also a major concern about labour rights as the Bill enables the Resolution Corporation to terminate employment or change the compensation structure of bank employees during various stages of resolution.²¹ It was done to reduce the delay caused by litigation and keep the process strictly time bound. This, however, will not exclude the constitutional mandate of the Supreme Court and High Court to examine the constitutional validity of the orders so passed by the body.²²

Way forward and conclusion

The author thinks that the fear of buy-in is significantly exaggerated. The Bill not only provides checks in the exercise of this power but also ensures that it is a method to be adopted as the last resort.²³ It can only be employed by the FRDIC in consultation with the relevant financial sector regulator–Reserve Bank, in the case of banks. Only that liability can be cancelled, which has contractual terms permitting it, can be converted. Further, the whole process is supposed to be based on the process of consultation with the stakeholders. Crucial liabilities like depositors’ money and workmen’s wages have been excluded from the process. The corporate would also have to explain the reason behind adopting the process in a detailed submission to Parliament. Finally, it is more appropriate to use this provision instead of the bail-out option (even though the Bill does not take away the power of the Central Government to provide any form of financial support to anybody). The people who deposit money in financial institutes take a risk on capital for which they make gains, therefore, it is more prudent for them to pay the bill instead of the whole taxpayer class.

The necessity for a holistic overhaul has been flagged time and again due to the growing distress in the Indian financial sector. The ever-growing instance of fraud and the precarious risk of NBFCs collapsing like IL&FS group, Dewan Housing Finance Corporation Limited (DHFL), and Srei Infrastructure Finance, etc., spreading a contagion only goes on to put the onus on the Central Government to work towards the revival of the Bill in any form possible. We cannot work on the assumption that we will never face any event like the 2008 financial crisis.²⁴ We need to be prudent and have at least a holistic framework in place to deal with black swarm events. The argument that the Indian system will never allow this to happen due to Government intervention in the financial sector overestimates the ability of the Government to deal with all situations. Therefore, having an over-encompassing monitoring body is essential, and cannot be shelved because of certain objections.