Crisis that will hurt bank resolution law

It is a crisis of confidence — and that too in a sector that inspires the highest expectation of an intensity of promise by a regulated institution. What was in recent weeks a crisis involving the state of health of state-owned banks, is now threatening to spiral into an expanded crisis involving the state of affairs in private sector banks. With this environment, politically, one can kiss goodbye to the proposed law on resolution of failing banks.

The biggest part of the solution to a problem is to acknowledge there is one. Consider the symptoms:  

• The break-down of systems at Punjab National Bank that led to the discovery of the alleged Rs 110-billion scam involving issuance of guarantee-like instruments raised serious concerns about how vulnerable any bank could be;
   
• The public spat between the Reserve Bank of India and the central government with each pointing fingers at the other about duality of control and the regulator not having teeth over appointments of key personnel in banks;
   
• The absence of clarity of purpose for the Bank Boards Bureau and the publicly-evident communication breakdown between the bureau and the government, with speculation about whether the bureau would continue having any role at all;
   
• The chief executives of ICICI Bank and Axis Bank, both in the private sector staying on the front-page news headlines for days on end – the first about an alleged conflict of interest and insinuated corruption and the other about alleged non-performance and absence of sanction for it; and 
   
• The growing allegations of abuse of powers by creditors in the resolution process under the newly-minted Insolvency and Bankruptcy Code – allegations range from approving related party contracts by resolution professionals, a lack of transparency in evaluation of resolution applicants, and monetising decision-making powers in selection of winners.

Illustration by Binay Sinha

One of the fundamental assumptions across all laws is that banks conduct themselves with utmost honesty and good faith. This is why records kept by banks are given an on-the-face-of-it validity as “prima facie” evidence of facts. Bankers are second only to lawyers as keepers of clients’ confidence (with a lawyer, the relationship is privileged by law to allow for a sacred space of interaction to enable clients to avail of the protections under the law — that concept is itself being tested severely but should be the subject of a different edition of this column.

With banks’ ownership and governance being closely regulated, the intensity of promise held out by banks is of the highest order. A bank once formed, is next to impossible to wipe out. Legislation governing public sector banks prohibit proceedings by their promisees to wind them up. The government keeps infusing taxpayers’ funds into these banks to keep them afloat. The United Bank of India lived through years of uncertainty about its real core strength. A series of exemption orders are being passed by the Sebi, the capital market regulator, exempting the government from having to make an open offer to shareholders, when it infuses more funds into banks’ capital to shore them up — a luxury that is never accorded to other listed companies.

Private sector banks are like normal companies but are never wound up. Global Trust Bank was force-merged into Oriental Bank of Commerce. Centurion Bank was revived by RBI-supervised induction of private equity. Bank of Punjab and Lord Krishna Bank were merged into Centurion Bank in succession over the years, and this merged entity of stressed banks eventually merged into HDFC Bank. Times Bank, another struggling bank merged into HDFC Bank. To begin with, public sector banks came into existence only because private sector banks were nationalised, many of them amid concerns about them being run to ground. 

In short, banks are special. Literally and for all practical purposes, a bank once formed, is indelible and cannot be obliterated. The man on the street trusts his savings with the banks on the foundation of this promise. A bank that becomes “systemically important” (substantially, determined by scale and size of its operations) would get covered by the proposed resolution law. Under this law, to “resolve” and save such an institution, the obligations of the banks can be altered and varied by law. The layman thinks that banks that are not covered by this law would protect his deposits, but once such a law is in, those not covered by such law may (at least theoretically) would not be considered to be “too big to fail”.

The proposed Financial Resolution and Deposit Insurance Bill is with a Parliamentary Committee for now. The environment in the banking sector is hardly conducive for this important and material reform to see the light of day. If banks are not seen living up to the honesty presumed of them (in India, bankers still carry a reputation despite the history of the United States and United Kingdom in the last decade) even the common man is bound to question how is savings are squandered on cronies of bankers and how he would lose out even more when a weak bank is resolved, or how money from the taxes paid by him would go back into the very same banks to keep them afloat. Without serious confidence building measures being taken, and articulated well to the common man, the environment appears ominous.

The author is an advocate and independent counsel. Tweets @SomasekharS