New body may settle claims if a bank fails
The proposed legislation, which aims for expeditious resolution of stressed financial institutions, including banks and insurance firms, is expected to be introduced in the Budget session of Parliament after cabinet approves it, according to an official.Updated: Jan 12, 2020 05:00 IST
A draft Cabinet note has proposed the creation of an empowered Resolution Authority (RA) for timely and orderly resolution of financial troubles at banks and financial institutions that will also decide on the quantum of money depositors will receive if a bank fails, two government officials with direct knowledge of the matter said on condition of anonymity.
“In case a bank fails, the RA could decide to pay depositors more than what they would have got in the normal course,” one of the two added. Currently, fixed deposits are protected (to some extent) by the Deposit Insurance and Credit Guarantee Corporation (DICGC) for only up to ?1 lakh per account, irrespective of the amount of the deposit.
To be sure, this could make the process discretionary. However, there have been calls to enhance the insured amount, most recently when Mumbai-based Punjab and Maharashtra Co-operative Bank ran into trouble, affecting 915,957 depositors, many of them from the middle and lower-middle class.
The proposal is part of a proposed law, which has been drafted about 17 months after the government was forced to withdraw the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI) in August 2018 because of a stiff opposition to its “bail in” clause that allowed for the utilisation of a part of depositors’ money in the revival of a failed bank.
“A draft Cabinet note on this matter is already in circulation to various stakeholders for their comments and suggestions. After scrutinising their comments and making necessary changes in the draft of the Bill, it [Cabinet note] will be brought before the Cabinet for its approval,” the second official said. The note has been initiated by the Department of Economic Affairs (DEA), an arm of the finance ministry.
According to this person, the proposed legislation, which aims for expeditious resolution of stressed financial institutions, including banks and insurance firms, is expected to be introduced in the Budget session of Parliament after cabinet approves it.
The draft Bill will replace the Deposit Insurance and Credit Guarantee Corporation (DICGC) and the idea is to create a suitable institutional mechanism under the RA, the second official said. DICGC insures all bank deposits, such as savings, fixed, current and recurring accounts. The officials declined to share more details on the matter related to the insurance of depositors’ money in a stressed bank.
The finance ministry did not respond to queries seeking details.
The two officials said the new legislation is a modification of the FRDI Bill, 2017. The RA has been introduced in the place of Resolution Corporation (RC) because a corporation cannot undertake sovereign functions, particularly because most state-owned banks are created by legislations passed by the Parliament.
The proposed RA will have representations from all financial sector regulators such as the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), the Insurance and Regulatory Development Authority of India (IRDAI), the Pension Fund Regulatory and Development Authority (PFRDA) and the Union government.
The RA is being created to develop a robust resolution system for stressed banks and financial institutions in lines with global practices, without putting any financial burden on the taxpayer, the officials explained. This need for “further strengthening of the resolution framework and framework for cyber security of the financial sector” was also discussed at the 21st meeting of the Financial Stability and Development Council (FSDC) on November 7, 2019 under the chairmanship of finance minister Nirmala Sitharaman, they said. The meeting was also attended by the RBI governor and SEBI chairman.
L Viswanathan, partner, Cyril Amarchand Mangaldas, said, “In most mature jurisdictions, the regulation function is distinct from the resolution function and accordingly, the setting up of the Resolution Authority under the [proposed] FRDI Bill to handle the resolution of large, complex, interconnected financial institutions is crucial for their timely and effective resolution.”
“Deposit insurance plays an important consumer protection function as well as has the collateral benefit of preventing runs and contagion risks to banks. Accordingly, the deposit insurance function of the Resolution Authority will be important aspect of the [proposed] FRDI [Bill],” he added.
Atul Pandey, partner, Khaitan & Co said, the proposed Bill “again highlights the government’s resolve to fix the existing regime of regulation of the financial sector which is presently plagued with multiple laws and regulations, each having their own regulatory oversight”.
“The Bill has also taken into account the views of the industry insofar as deposit Insurance is concerned, and instead of simply enhancing existing insurance limit per depositor, permits the Resolution Authority Insurance Fund to collect premiums on a risk based assessment. The RA has been granted further powers to modify liabilities of the bank to reduce their exposure (instead of the controversial bail in clause) of the existing FRDI Bill. However, this Bill will be time tested to gauge the efficiency of the RA in actively intervening on a case to case basis,” he said.