FRDI Bill Are depositors going to pay for bank failures?

Sajjad Bazaz
A week after presenting Budget 2020, the Finance Minister Nirmala Sitharaman disclosed that the Government is working on the contentious Financial Resolution and Deposit Insurance (FRDI) Bill, but didn’t mention the timeline for reintroducing it in the parliament.
Notably, the FRDI Bill, 2017 was tabled in the Lok Sabha in August 2017, following which it was referred to the joint parliamentary committee. Then the Government was forced to withdraw it on August 7, 2018 following widespread criticism of its controversial provisions, including a “bail-in” clause that suggests depositors’ money could be used by failing banks and financial institutions to stay afloat.
Before deliberating upon the Financial Resolution Deposit Insurance (FRDI) Bill, which many fear will be detrimental to depositors, let me first briefly share two global stories of political and financial meltdown of two nations – Greece and Cyprus.
In 2015 Greece defaulted on its debt. It missed payment of €1.6 billion to the International Monetary Fund (IMF). It was for the first time in history that a developed nation missed such a payment. Even as Greece’s economic crisis is attributed to joining the Eurozone, the fact remains its economy was already plagued by structural problems like soaring inflation rates, high fiscal and trade deficits, low growth rates and several exchange rate crises. To fulfill eligibility criteria for entry into Eurozone, the Greek Government had doctored its budget figures. The move didn’t rescue the country from deep economic meltdown with impact on general public.
A lot of commentary is still going on about the Greece crisis. However, one move that has shook the confidence of its citizen was shuttered banks and limits on the cash withdrawals through Automated Teller Machines (ATMs).
Greece citizens have witnessed decade long deprivation and unemployment, angry and exhausted senior citizens facing five years of pension cuts and mounting tax burden. The country witnessed the pensioners queuing up at the bank gates to claim their retirement benefits, only to leave empty-handed.
The shuttered banks, denial of retirement benefits and cut in pensions raised doubts in common man’s mind about the stability of banking system in the present global financial order. When banks in a developed country like Greece can succumb to financial crisis, how banks and financial institutions in a developing country like India can remain stable to shivering financial world order?
Now a brief about another crisis. Some six years back Cyprus became an epicenter of market anxiety. The country’s banks collapsed amid the integrity of the eurozone hanging in the balance. A “bail-in” was brokered and bank depositors were forced to pay for a eurozone rescue.
In simpler terms, as a part of plan to pull the Cyprus out of the financial anxiety, among other things a portion of the bank depositors’ money in Cyprus banks was seized to cover bank losses. The Cypriots during the mid March 2013 were astonished to wake up to discover that their government had seized up to 10% of everyone’s savings from their bank accounts without warning. Even as Cyprus has recovered from the banking crisis, deep scars still remain as a constant reminder to its citizens, especially bank depositors, who had lost their hard earned money for none of their faults to bail out the country from the financial crisis.
Now, when our Finance Minister spoke about the FRDI Bill making a comeback in the Parliament, revisiting these two global incidents of financial crisis makes sense and that too when the country is going through ‘worst’ phase of economic slowdown.
Here understanding the contours of the FRDI Bill is of utmost importance for financial service providers as well as the customers availing their services. The Bill exclusively revolves around a situation gripped in financial distress and envisages protection to customers of financial service providers in times of financial distress; and preaches lessons of financial discipline among financial service providers in the event of financial crises, by limiting the use of public money to bail out distressed entities. Among other things, it also aims to strengthen and streamline the current framework of deposit insurance, which the Budget 2020 has proposed to be hiked to Rs. 5 lakh from the existing Rs. 1 lakh, for the benefit of retail depositors. Further, it seeks to decrease the time and costs involved in resolving distressed financial entities.
The Bill also envisages closure of the so far rarely tested “Deposit Insurance and Credit Guarantee Corporation” (DICGC) established in 1961 and replace it by a ‘Corporation Insurance Fund’.
What all these ‘offers’ envisaged in the Bill mean? The Bill is simply loaded with dangers with serious consequences both for financial companies like banks and insurance companies and their customers. As envisaged in the Bill, any financial distress would see amalgamation, merger, liquidation and acquisition of any bank, and any insurance company. As contained in the Bill, even discontinuation of service of employees or transfer of their employment or reduction of their remuneration is also an option to overcome any financial distress of a bank or an insurance company.
The FRDI Bill also contains setting up a Resolution Corporation. The Resolution Corporation will monitor the health of the financial entities like banks and in case of their failure; the newly created corporation will come into play to try and resolve the issues confronting them. The ‘Resolution Corporation’ once comes into being will have adverse impact on the functioning of the financial regulators. These regulators would be losing teeth as banks, insurance and other financial companies would be left at the mercy of this Corporation, which in turn will be subservient to the Finance Ministry.
In the name of deposit insurance also, the Bill goes against the interest of small depositors through its provision of ‘bail-in’. Bail-in’ is one under which creditors and depositors absorb some of the losses in case a financial institution fails. In case of a ‘bail-in’ the depositor rather than a borrower is likely to lose a portion of money deposited in the bank account.
Notably, while exercising ‘bail-in’ option, the Resolution Corporation will lay hand on liabilities (deposits) of the financial entity to cover the losses and restart its business. More precisely, invoking ‘bail-in’ option can lead to cancellation of repayment of various kinds of deposits. The deposits in a failed financial entity can also be converted into long term bonds or equity.
The kind of turmoil we have witnessed in our banking system through large magnitude frauds through high profile personalities and the mountain of non performing assets in the last few years seems to have led the Government to reintroduce the FRDI Bill. However, the government should revisit controversial clauses like ‘bail-in’ clause to safeguard the interest of public and prevent prudential risks from spilling over into a systematic concern. At least, the revised Bill should see modification in the ‘Bail-in’ clause to ensure that depositors are not forced to absorb losses of a failed financial entity.
In succinct, any financial reform should protect interests of financial consumers during the time of crisis, not rob them of their hard earned money.