Bank insolvency Bill has safeguards for depositors

Amount insured to be notified later, uninsured deposits get higher priority

Contrary to fears, the much contested Financial Resolution and Deposit Insurance Bill (FRDI) seeks to provide protection to deposits under deposit insurance. But the amount payable will be specified by the resolution corporation in consultation with the Reserve Bank of India (RBI).

 
The bill also seeks to place claims of uninsured deposits higher on the priority list than under the existing structure. Further, in the case of a bail-in, only those liabilities can be cancelled where all parties agree to the bail-in clause.
 
The FRDI Bill, 2017, was presented in the Lok Sabha in August and was referred to a Joint Committee of Parliament. The bill deals with the insolvency of financial service providers such as banks. It entails the creation of a resolution corporation bestowed with powers of monitoring weak banks and to take steps to ensure orderly liquidation.
 
Under the existing system, uninsured depositors are treated at par with claims of unsecured creditors. Their claims rank even lower than preferential payments which include government claims.
 
But the bill proposes to overhaul the priority list, putting claims of uninsured depositors on a higher level.
 
Section 80 of the bill says that uninsured deposits are placed above those of unsecured creditors, government claims, secured creditor for any amount unpaid following the enforcement of security interest; any remaining debts and dues, preference shareholders and equity shareholders, giving depositors an extra layer of protection.
 
One issue that has been widely debated is that of amount of deposit insured under the new architecture.
 
Now, under the Deposit Insurance and Credit Guarantee Corporation (DICGS) Act, 1961, deposits were insured up to Rs 1,500. This amount was subsequently increased on five occasions to Rs 1 lakh in 1993 via notifications.
 
This insurance cover is enough to protect 92 per cent of accounts (of the total 1884.8 million accounts 1737.2 million accounts are fully protected) according to the annual report of DICGC.
 
The new bill continues to provide protection under the deposit insurance mechanism, though the exact amount will be specified by the corporation in consultation with the RBI according to section 29.
 
The bill also contains a provision for a bail-in.
 
A bail-in essentially involves writing down of liabilities or its conversion into equity to the extent required to recapitalize the bank. Currently, there is no such provision in the laws. If a bank fails it may either be merged with another bank or liquidated.
 
But post the financial crisis of 2008, the Financial Stability Board, an international body comprising G20 countries (including India), recommended that countries should allow resolution of firms by bail-in under their jurisdiction, notes PRS in a blogpost.
 
Some have expressed reservations over this clause.
 
But a closer look at the FRDI bill reveals that several safeguards have been put in place in the event this route is used.
 
First, section 55 says that only those liabilities can be cancelled where the contract for creating the liability contains a provision that the parties to the contract agree to the liability being eligible for a bail-in. This implies that creditors would have to agree to these terms before-hand.
 
Second, it is also possible that regulations may not include deposits at all in the bail-in securities. Under section 52, the corporation will have to specify the liabilities that can be bailed in.
 
Third, the bill further states that the bail-in shall not affect any liability to the extent such deposits are covered by deposit insurance.
 
Further, under section 55, the bail-in is to be exercised according to the hierarchy of claims, in which depositors are placed higher than they are currently.
 
Then there is also a clause for compensation.
 
Under section 55, if the bail-in clause is exercised, then no creditor (including depositor) of a bank must be left in a worse position than they would have been in the event of its liquidation.
 
In case any party is aggrieved, then he/she can approach the tribunal within 60 days of completion of resolution for compensation. The tribunal will then have to appoint an independent valuer within 15 days of receipt of application.
 
And if there is a case for higher compensation, then the National Company Law Tribunal may direct Resolution Corporation to pay compensation.

About the Bill

• The Bill deals with the insolvency of financial services providers such as banks
• It entails the creation of a resolution corporation with the power to monitor weak banks and take steps to ensure orderly liquidation
• The Bill was presented in the Lok Sabha and was referred to a Joint Committee of Parliament
• At present, up to Rs 1 lakh of deposits of a person are insured in case of meltdown
• The Bill seeks to place claims of uninsured deposits higher on the priority list than under the existing structure
• The Bill allows bail-ins, which involve writing down liabilities or their conversion into equity to recapitalise banks