As part of a host of banking reforms, the Central government has approved a bill in June 2017 to enact a new law framing rules for the resolution of failing banks, whose details that surfaced on social media made all bank depositors a worried lot. If the government goes ahead with this move, it will give enormous “bail-in” powers to a proposed rescuing body called Resolution Corporation. The corporation will be set up under the Financial Resolution and Deposit Insurance Bill and can invoke bail-in provisions for saving a bank which is on the verge of collapse.
For those uninitiated with the financial lexicon, the bail-in is a method used for rescuing a financial institution, which is on the brink of failure by making its creditors and depositors take a loss on their shareholdings or deposits. A bail-in is the opposite of a bail-out, which involves the rescue of a financial institution by external parties, typically governments using taxpayers’ money. Typically, bail-outs have been far more common than bail-ins, but in recent years after massive bail-outs, some governments now require the investors and depositors in the bank to take a loss before taxpayers.
However, the Narendra Modi government has incorporated the bail-in provision under the proposed Financial Resolution and Depo-sit Insurance (FRDI) Bill, 2017. Currently, the Bill is under examination of a select Parliamentary committee. The government plans to introduce the Bill in the Winter Session of Parliament. Under Section 52 of the FRDI Bill, the powers of the Resolution Corporation are so extensive that it can cancel a liability of a bank — which means that it can declare the bank doesn’t owe you any money though you have deposited your hard earned money with it. Under the same section, it can modify or change the form of liability — the import of it is that if you have deposited say Rs 10 lakh for 5 years intending to use the money for your child’s graduation or marriage, the corporation can convert it into a locked-in deposit of 20 year tenure without your consent. The Bill also has a provision that allows the RC to exempt the failing bank for fulfilling its obligations under a contract or an agreement.
In simple words, it means that your savings account balance of Rs 15 lakh can be reduced to Rs 1 lakh, the maximum covered by the 1961 deposit insurance law. Or they can convert your SB balance of Rs 15 lakh to a fixed deposit, repayable after five years, giving you of five per cent annual interest. And you can do nothing about it. No courts can intervene into it unless you challenge the very law itself. The bail-in provision was used in Cyprus in 2013. As a result, the uninsured depositors (those with deposits larger than €100,000) in the Bank of Cyprus lost almost half of their deposits. In return they received stocks in the bank, however, the value of these stocks were nowhere near most depositor’s losses. Uninsured depositors in Laiki, the nation’s second-largest bank, lost everything as the bank failed.
Typically, banks come under pressure when the economy is in downturn as large corporations do not repay money on time, leading to stress. The problems faced by banks could be due to economic downturn, or lack of regulatory oversight that allowed banks reckless lending, or mismanagement of the bank. Therefore, it is criminal to ask depositors to bail-in a mismanaged bank. As per the normal banking prudence, lenders insist on 150 per cent collateral security from the borrower in form an asset for granting a secured loan. For example, if a borrower wants Rs.100 as loan, he has to provide security worth '150 before availing the loan. In such a case, the question arises as to why the bank needs the depositor’s money for save a bank. If the bank managements know that they would anyways be saved, would that not lead to further corruption and slackness in banks?
If the bail-in is essential, should the government change the wording of the Bill to first countermand the money of big companies in a top-to-bottom approach. As the banks tweak rules to lend big companies, it must be the deposits of the companies that must be used for bail-in. India never had such bail-in provision. The government had established Depositor Insurance and Credit Guarantee Corporation in 1978 to insure at least Rs 1 lakh of the depositors’ money. Though the insured threshold was never raised, Rs 1 lakh in 1978 equals to the current Rs 13 lakh after adjusting the inflation.
It is illogical for the government to expect depositors to bail out the banks, when they don’t get any share in profits. This goes against the very norms of natural justice whereby rights and duties ought to be equal and corresponding. The Union Cabinet, however, went ahead with approving a Bill having such a monstrous provision. If it is approved by Parliament, people, more so the senior citizens would be left high and dry. Let’s hope some sense dawns amongst the powers-that-be and the bail-in provision is thrown into the dust bin.
The writer is a Navi Mumbai-based CA and management consultant. He could be reached at [email protected]
Read a detailed analysis here: The Central Govt Has Introduced The Bail-In Clause And The Reason Why We Need To Talk About It