FRDI BILL IS A BAD IDEA AND SHOULD BE MODIFIED..

FRDI BILL IS A BAD IDEA AND SHOULD BE MODIFIED..

[ A view expressed by CONSUMER PROTECTION SERVICE COUNCIL – regd. NGO].

Since the last one month, people have been getting WhatsApp forwards essentially saying that the Modi government is planning to use their bank deposits to rescue all the banks that are in trouble. As is usually the case with WhatsApp, this is not true. The truth is a lot more subtle.

Let's try and understand this.

Where did the idea of fixed deposits being used to rescue troubled banks come from?

The government had introduced The Financial Resolution and Deposit Insurance (FRDI) Bill, 2017, in August 2017. This Bill is currently being studied in detail by a Joint Committee of members belonging to the Lok Sabha as well as the Rajya Sabha.

The basic idea behind the FRDI Bill is essentially to set up a resolution corporation which will monitor the health of the financial firms like banks, insurance companies, mutual funds, etc., and in case of failure try and resolve them.

The Clause 52 of the FRDI Bill uses a term called "bail-in". This clause essentially empowers the Resolution Corporation "in consultation with the appropriate regulator, if it is satisfied that it necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider."

It basically means that financial firms or a bank on the verge of a failure can be rescued through a bail-in. Typically, the word bailout is used more often and refers to a situation where money is brought in from the outside to rescue a bank. In case of a bail-in, the rescue is carried out internally by restructuring the liabilities of the bank.

Banks pay interest on their deposits, therefore a deposit is a liability for any bank. The Clause 52 of FRDI essentially allows the resolution corporation to cancel a liability owed by a specified service provider or to modify or change the form of a liability owed by a specified service provider.

What does this mean? Clause 52 allows the resolution corporation to cancel the repayment of various kinds of deposits. It also allows it to convert deposits into long term bonds or equity for that matter. Haircuts can also be imposed on firms to which the bank owes money. A haircut basically refers to a situation where the borrower negotiates a fresh deal and does not payback the entire amount that it owes to the creditor.

But there are conditions to this...

The bail-in will not impact any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance. This basically means that the bail-in will impact only the amount of deposits above the insured amount. As of now, in case of bank deposits, an amount of up to Rs 1 lakh is insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). This amount hasn't been revised since 1993.

Typically, anyone who has deposits in a bank tends to assume that they are 100 per cent guaranteed. But that is clearly not the case. Over the years, the government has prevented the depositors from taking a hit by merging any bank which is in trouble with another bigger bank.

So, to that extent the situation post FRDI Bill is passed, is not very different from the one that prevails currently. It's just that the government has come to the rescue every time a bank is in trouble and we don't see any reason for that to change, given the pressure on the government when such a situation arises and the risk of the amount of bad press it would generate, if any government allowed a bank to fail.

Over and above this, Clause 55 of the FRDI Bill essentially states that "no creditor of the specified service provider is left in a worse position as a result of application of any method of resolution, than such creditor would have been in the event of its liquidation."

This basically means that no depositors after the bail-in clause is implemented should get an amount of money which is lesser than what he would have got if the firm were to be liquidated and sold.

While, this sounds very simple, it will not be so straightforward to implement this clause.

So why is the government doing this?

If governments and taxpayers keep rescuing banks what is the signal they are sending out to bank managers and borrowers? That it is okay to lend money irresponsibly given that governments and taxpayers will inevitably come to their rescue.

In late 2008 and early 2009, governments and taxpayers all over the world bailed out a whole host of financial institutions which were deemed too big to fail. In the process, they ended up creating a huge moral hazard.

In order to correct for this moral hazard, in November 2008, the G20, of which India is a member, expanded the Financial Stability Forum and created the Financial Stability Board. The Board came up with a proposal titled "Key Attributes of Effective Resolution Regimes for Financial Institutions". This proposal suggested to "carry out bail-in within resolution as a means to achieve or help achieve continuity of essential functions". India has endorsed this proposal. Hence, unlike what WhatsApp forwards have been claiming, this proposal is not a new thing and has been functional world wide for quite some time.

But does this really prevent moral hazard?

Substantial of the banking sector in India is controlled by the government owned public sector banks. As of September 30, 2017, these banks had NPAs of 12.6 per cent (for private banks it is at 4.3 per cent).

NPAs or bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. The bad loans rate when it comes to lending to industry is even higher. In case of some banks it is close to 40 per cent.

This is primarily because banks have been, under pressure from politicians and bureaucrats, lending a lot of money to businessmen like Vijay Mallya, who either siphoned off this money or over borrowed and are now not in a position to repay. This is a risk that will remain until the banking sector continues to primarily remain government owned in India.

The rate of recovery of bad loans of banks in 2015-2016, stood at 10.3 per cent.

This does not inspire much confidence. In this scenario, having a clause which allows the resolution corporation to get depositors to pay for the losses that banks incur, is really not fair. The moral hazard does not really go away. The bankers, politicians and crony businessmen, can now look at these bank deposits to rescue banks. As of now, the government and the taxpayers have kept rescuing public sector banks, by infusing more and more capital into them. Now the onus to do so will shift to public deposits, if FRDI Bill becomes an Act.

It is necessary to mention here that the other G20 countries which have signed this proposal have some sort of a social security system in place, while India does not have one Also, deposits are the major form of savings and earnings for India's senior citizens and clearly, they should not be exposed to be a part of any such risk.

The FRDI Bill has raised anxieties in the minds of senior citizens and to-be senior citizens who have the bulk of their savings in bank deposits. The concerns are legitimate and the government’s clarifications are vague.

That sows doubt and distrust. If one were to steer clear of attributing malign and sinister motives, then it would be safe to describe the proposed legislation as a context-free “copy and paste” job from other countries. Plainly, it is sloppiness.

What the depositors need to hear in simple English (that is because the language of law in India is English) is that their deposits are safe and will not be part of the “bail-in”. It should be part of the provisions of the Bill.

Agreed that any government will think twice before using depositor money to rescue a bank, this is not an option that should be made available to governments or bureaucrats in India. It is a bad idea – an unnecessary hazard. It needs to be rejected.

For Consumer Protection Service Council,

Ganesh Joshi ( National President), Dayanand Nene ( National Secretary)