The controversial FRDI bill is a much-needed financial system reform. It will only make Indian banks stronger and deposits safer.
Hours after the BJP scraped through to a hard-fought victory in the Gujarat assembly elections Monday, an emotional Prime Minister Narendra Modi told his party colleagues in Delhi that the results were a green signal for his reform agenda. “Support for the BJP shows the nation is ready for the reform agenda… every citizen wants India transformed,” he said.
It seems he ended up speaking a bit too soon. Earlier the same day, Lok Sabha Speaker Sumitra Mahajan had informed the house that the Financial Resolution and Deposit Insurance (FRDI) bill may not be introduced in Parliament even during the budget session, let alone the ongoing winter session as originally scheduled. The joint committee looking into the bill, Mahajan said, had been given an extension until the last day of the budget session next year.
The speaker couldn’t obviously be expected to say it, but for all practical purposes, the government had postponed dealing with its new financial reform headache that was fast threatening to turn into a serious migraine.
While the government cannot be faulted for turning overcautious in the light of its experience with demonetisation and GST, the growing controversy over the FRDI bill once again underlines the challenge of pursuing financial reform in the face of large-scale financial illiteracy that critics and political rivals are eager to exploit.
The FRDI bill is part of a series of steps being taken by the NDA government to strengthen India’s financial sector. It follows the insolvency and bankruptcy code, and the move to recapitalise public sector banks sinking under the burden of non-performing assets.
The crux of the controversy over the FRDI bill is the safety of the money deposited in banks. As it stands, depositors have an insurance cover of up to Rs 1 lakh against their deposits in banks under the Deposit Insurance and Credit Guarantee Corporation Act of 1961.
The FRDI bill proposes to replace this corporation with the Resolution Corporation, which will decide on the insurance that can be paid to depositors in the event of a bank failing. The limit of Rs 1 lakh was set in 1993 and an increase is long overdue.
The Resolution Corporation will also keep a close watch on the functioning of banks and other financial institutions – non-banking financial companies, insurance companies, mutual funds, stock exchanges, among others – and warn customers about the risk of dealing with them by grading or rating them based on their performance and other financial health parameters.
If a financial institution (FI) starts slipping and its risk profile crosses a threshold, the Resolution Corporation activates norms to stop the FI from failing. If this fails to prevent the FI from sinking, frameworks will be in place to facilitate the merger or takeover of the failing/failed FI. When none of this works, liquidation becomes the only option for the bank or FI.
Policymakers and financial experts have commended this clear framework that monitors, regulates and puts in place a system to ensure a healthy financial services system as opposed to the current arbitrary method dependent on the Reserve Bank of India and the central government.
FRDI has, however, sparked outrage with its so-called ‘bail-in’ clause. This clause allows a failing bank to ‘bail-in’ into its assets and holdings to prevent itself from going bankrupt, as opposed to a bail-out, when external entities step in to save the bank. This has been interpreted as banks being allowed to dip into the funds of their depositors to shield themselves – a possibility that has been portrayed as the imminent doom of all bank deposits.
What started a few months back as WhatsApp forwards that warned people about the proposal moved to social media, before grabbing the attention of bank employees’ unions. Now we have none other than the feisty West Bengal chief minister Mamata Banerjee warning the central government against the move.
Such scare-mongering is not new to India though. The country has been witness to this during the introduction of computers at work, signing of the WTO treaty, or even the adoption of genetically modified seeds, among others.
Call it the upside of a maximum government hovering above banks, particularly public sector banks, and the RBI also watching from the sidelines, India has not seen a bank slipping to the extent it needed liquidation. In 2004, for instance, when the private Global Trust Bank was in deep distress, the RBI stepped in and got the public sector Oriental Bank of Commerce to acquire it.
India is also a signatory to the Basel norms, a global regulatory pact that has put in place reforms designed to improve the regulation, supervision and risk management of the banking sector.
To be sure, successive governments have taken advantage of public sector banks, be it for loan melas, loan waivers, or lending to businesses friendly with the party in power – practices that have contributed to the NPA mess. But it is also the government that has jumped in with a PSU bank recapitalisation plan worth Rs 2.11 lakh crore – fiscally imprudent but politically critical, as it breathes oxygen into PSU banks.
In fact, the political imperative of ensuring a stable financial services sector is the biggest insurance of bank deposits. More so for the NDA government, which has made financial inclusion and formalisation of the economy one of its key goals. Besides, the NDA government has also burnt its fingers on demonetisation and the implementation of GST, and the hasty retreat on the FRDI bill is a clear indication that the government has no stomach for more damage to its financial management image.
The government has reassured depositors that insurance will take care of their deposits even under the new system, and that a consent clause will ensure banks cannot act unilaterally and bail-in or dip into deposits during a crisis. Finance minister Arun Jaitley has also assured the government will fully protect deposits and indicated a willingness to amend the bill.
All of this points to a strong possibility that the government will tinker with the bail-in provision. It has shown it is adept at tinkering when it did so with GST slabs and rules after the new tax system was implemented. So, just like GST, there is no need to throw the entire FRDI bill out with the bail-in clause.
With inputs from Subrata Panda.