The Financial Resolution and Deposit Insurance Bill 2017 (Bill), which was tabled in the Parliament this August, has come into increased media scrutiny over the last week. As we noted last month 1, the IRDAI and other regulatory bodies had raised objections to certain provisions of the Bill with regard to the powers vested in the proposed regulator.
The Bill is a result of India's G-20 commitment in line with the recommendations made by the Financial Stability Board in its guidance paper called "Key Attributes of Effective Resolution Regimes for Financial Institutions". The objective of the FSB was to create an effective regime for resolution of financial institutions,
"...without severe systemic disruption and without exposing taxpayers to loss, while protecting vital economic functions through mechanisms which make it possible for shareholders and unsecured and uninsured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation."
The Bill is aimed at creating a special framework for resolving bankruptcy in systemically important financial institutions such as banks, insurance companies, and stock exchanges, and resolving or liquidating them in case of failure. It provides for the setting up of a resolution corporation (Resolution Corporation) empowered to assume management of failing financial institutions and ensuring its continuity by transferring its assets and liabilities, merging it with another institution, or reducing its debt. The Resolution Corporation replaces the existing Deposit Insurance and Credit Guarantee Corporation (DICGC).
Recently, there has been increased discussion around Clause 52 of the Bill which contains a 'Bail-in' provision and has led to widespread concerns over the protection of uninsured deposits in the event of failure of financial institutions.
A Bail-in commonly refers to the restructuring of a financial institution's liabilities by either converting the debts owed to creditors into equity, or by writing off its liabilities altogether. This allows the State to use the depositor and shareholders' monies instead of absorbing such losses from the common tax payer and its own reserves.
In the present Bill, Clause 52 provides for a Bail-in provision empowering the Resolution Corporation to convert a percentage of the deposits with a bank to bank shares and other forms of security, for the purpose of debt restructuring.
At present, depositors are protected to a limit of ₹1 lakh covered under deposit insurance by the DICGC. In this regard, the Bill expressly states that the provisions of the bail-in clause shall not be applicable to the amounts insured under deposit insurance2.
However, the Bill will repeal the Deposit Insurance and Credit Guarantee Corporation Act 1962 and in doing so also removes the specified deposit insurance limit protecting these deposits. This has further added to the debate, since the Bill does not commit any particular deposit insurance amount whatsoever.
The outcry among depositors is a by-product of the Indian banking system, which is largely driven by deposits from common depositors. It is to be noted that a depositor's unsecured deposits are only exposed when the Resolution Corporation classifies such bank to be in a "critical" terms of risk of failure. However, with reports of large scale write-offs by banks due to a rising number of bad loans and non-performance assets, and an increase in new bank accounts due to the Jan Dhan Yojana, a potential exposure to a depositors' uninsured deposits has caused widespread apprehension.
As per Clause 79 of the Bill, in the event of liquidation of a failing financial institution, the proceeds from the sale of assets will be distributed in the following order of priority:
- Depositor's amounts covered by Deposit Insurance
- Costs of liquidation and resolution
- Workmen's dues, and amounts owed to secured creditors who relinquish their security
- Employee wages
- Amounts due to uninsured depositors and insurance policyholders
- Debts owed to unsecured creditors
- Amounts due to the Government and the balance owed to secured creditors
- All balance debts and dues
- Preference shareholders
- Equity shareholders/Partners
If the proceeds from liquidation are insufficient to cover all the debts owed by the financial institution, it is possible that a reduction may be applied to unsecured deposits (deposits over ₹1 lakh). It is widely reported that this may not be in the interest of the smaller depositors, as they may have to bear the losses resulting from any ill-advised decisions made by such financial institutions.
Finance Ministry Press Release
In response to the criticism faced from various stakeholders, the Ministry of Finance issued the following statement on 7th December 2017 on the Press Information Bureau website:
"The provisions contained in the FRDI Bill, as introduced in the Parliament, do not modify present protections to the depositors adversely at all. They provide rather additional protections to the depositors in a more transparent manner. The FRDI Bill is far more depositor friendly than many other jurisdictions, which provide for statutory bail-in, where consent of creditors / depositors is not required for bail-in."
However, the Ministry's statement does not elaborate on the exact nature of the 'additional protections' provided to depositors in the Bill.
In addition, it has been reported that certain Government officials have sought to reassure depositors that their existing rights remain protected, and that the National Company Law Tribunal may still direct the Resolution Corporation to pay compensation in case of any injudicious exercise of the bail-in provision.
The Bill is now at the centre of a heated public debate, with depositors on one hand raising concerns over the changes in insurance mechanism under the Bill and the extent of discretionary powers to the Resolution Corporation, while the Government reassuring depositors of the sovereign guarantee towards public sector banks.
With the report of the Joint Parliamentary Committee being due for submission in the upcoming Winter Session of the Parliament, it is still to be seen how the public concerns will be factored into the Bill.
1 http://www.internationallawoffice.com/Newsletters/Insurance/India/Tuli- Co/Insurance-regulatory-bodies-object-to-new-bankruptcy-bill
2 Clause 52 (7) of the Bill is in the following terms:
"The bail-in instrument or scheme under this section shall not affect:
(a) any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance;
(b) any liability that the specified service provider has by virtue of holding client assets..."
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