Monday, 30th October 2017

E- paper

Concern over bail-in

Provision on bank depositors

By Jayanta Roy Chowdhury
  • Published 30.11.17

New Delhi: Politicians of various stripes have started to raise red flags about a provision in a bill that the Narendra Modi government intends to move in the Lok Sabha in the upcoming winter session, which could theoretically allow beleaguered banks and financial institutions to scoop up depositors' money to stop them from going bust.

It is called a "bail-in" - a concept coined during the European banking crisis of 2008-09 - which has been wormed into the Financial Resolution and Deposit Insurance (FRDI) Bill.

When a bail-in is triggered, a bank's depositors run the risk of being forced to bear a part of the burden of recapitalising the entity. In effect, a part of their deposits may have to be written off. That is what happened to bondholders and depositors in Cyprus banks with more than 100,000 euros in their accounts.

Finance ministry officials have said there is no cause for alarm and the provision is meant to ensure emergency capital for banks. They pointed out that banks in India have been fairly well regulated and there have been very few bank failures since 1969 when banks were nationalised.

The Congress and the CPM have started voicing deep concern about Section 52 of the bill that could in certain circumstances allow a "specified service provider" - read a bank - to cancel, modify or change the liability that it owes.

But this will have to be done in consultation with the Resolution Corporation, to be set up under the legislation, which will have the power to provide deposit insurance to banking institutions, find ways to haul a failing bank back from the brink, or act as a liquidator in the event that a liquidation order is given.

"This is a serious issue," says Nilotpal Basu, former MP and CPM central committee member. "The Modi government seems to be surreptitiously sneaking in a measure to institute 'hair-cuts' on depositors' money in a manner that is similar to what we have seen in Greece, Cyprus and other European countries which have gone through an economic crisis."

A note posted by the Congress on Wednesday said: "If the draft bill gets the nod of Parliament, it will empower the Resolution Corporation to cancel a bank's liability or alter it to another security."

The bail-in instrument may "convert any securities from one class to another, including the creation of a new security in modification of an existing security", the legislation says.

Before a bail-in instrument is to be activated, the Resolution Corporation will have to inform the central government about the reasons for issuing it in the first place and the effects it will have. A copy of that report will have to be immediately placed before each House of Parliament.

Finance ministry officials, however, played down the campaign against the bail-in provision in the bill.

"The purpose of the 'bail-in' is to help bring in emergency capital for banks. It does not mean that this clause will be used and certainly cannot be invoked for PSU banks which are covered fully by the state's sovereign guarantee," said a ministry official.

Safety of deposits

At present, a depositor in a bank can draw partial comfort from the fact that his deposit is insured to the extent of Rs 1 lakh with the Deposit Insurance and Credit Guarantee Corporation which was set up under an act of Parliament in 1961.

The Rs 1 lakh cover is meant for all deposits of an individual parked in savings bank and current bank accounts and held as fixed deposits, irrespective of how much is parked in these accounts.

The FRDI legislation will change that significantly. The bill empowers the Resolution Corporation to decide the amount insured for each depositor. Theoretically, it is possible that the insured amount will vary for customers across different banks. It could also vary for different categories of customers within the same bank.

A corporation insurance fund will be created that will serve as the vehicle through which the deposit insurance will flow.

The corporation, in consultation with the appropriate regulator, shall specify the total amount payable by the corporation to any one depositor.

The decision on how much the insured amount should be will have to be decided by the regulator, which in the case of the banking industry is the Reserve Bank of India. It would be fair to assume that once the bill is passed, the regulator will clarify the amount to be insured. It has not given any such indication yet whether the sum would be higher or lower than the existing level of Rs 1 lakh.

Stable banks

Very few bank failures have taken place since the nationalisation drive of 1969.

One recent instance was when Global Trust Bank (GTB) almost went belly up after taking an exposure to capital markets that breached regulatory caps. GTB was eventually merged with Oriental Bank of Commerce and none of its 1 million depositors lost any money. GTB shareholders, however, had to take a hit.

The FRDI legislation, however, introduces the idea of systemically important financial institutions, which became a buzz phrase after the global economic crisis of 2008.

Basically, it creates the notion of banks that are perceived as "too big to fail" and therefore forces regulators to step in with a bailout plan.

The theory suggests that some financial institutions are so large and so interconnected that their failure would be disastrous to the economic system with the potential of having knock-on effects.

India has already embraced this concept and has designated three banks - State Bank of India, ICICI Bank and HDFC Bank - as systemically important, which subjects them to higher levels of compliance with tough prudential standards.

India's banking sector is currently in the throes of distress as a bad loans problem has erupted in the wake of several years of slow industrial growth.

According to the RBI's Financial Stability Report released in June 2017, the gross non-performing advances (NPAs) or bad loans to total deposits ratio of all banks stood at 9.6 per cent as of March 2017. State-run banks currently have an even higher bad loans ratio of 13.69 per cent.

The RBI had recommended that banks initiate insolvency proceedings for 12 large defaulters, constituting some 25 per cent of the system's NPAs.