Do Bank Depositors Need To Worry about FRDI?

At every financial literacy seminar of Moneylife Foundation (an NGO engaged in advocacy and financial literacy), I have made it a point to say that we, Indians, are lucky that public sector banks (PSBs) comprise 63% of our banking system. This means that there is an implicit sovereign guarantee that protects our deposits no matter how badly government-owned banks perform. This is why depositors could happily keep all their savings in term deposits with a United Bank of India (UBI) and United Commercial Bank when their net worth was badly eroded, without worrying about the bank going bust or the fact that only Rs1 lakh per depositor was guaranteed by deposit insurance.

Moreover, seven years before the global financial crisis and collapse of Lehman, India’s Reserve Bank of India (RBI) had followed the ‘too big to fail’ principle. It force-merged Global Trust Bank with Oriental Bank of Commerce to prevent widespread losses to depositors, doesn’t matter that the decision may have been motivated by a need to avoid a close scrutiny of how it was sleeping on its job. In fact, over the past several decades, the only payments made out of deposit insurance is on account of failed cooperative banks, which are under dual regulation (RBI and registrar of cooperatives) and completely controlled and manipulated by politicians across the spectrum. Hence, as consumer activists, we had argued that deposit insurance must remain at Rs1 lakh, because a higher insurance will be an incentive for crooked politicians to use public money to make good their loot of cooperative bank funds. Moreover, seven years before the global financial crisis and collapse of Lehman, India’s Reserve Bank of India (RBI) had followed the ‘too big to fail’ principle. It force-merged Global Trust Bank with Oriental Bank of Commerce to prevent widespread losses to depositors, doesn’t matter that the decision may have been motivated by a need to avoid a close scrutiny of how it was sleeping on its job. In fact, over the past several decades, the only payments made out of deposit insurance is on account of failed cooperative banks, which are under dual regulation (RBI and registrar of cooperatives) and completely controlled and manipulated by politicians across the spectrum. Hence, as consumer activists, we had argued that deposit insurance must remain at Rs1 lakh, because a higher insurance will be an incentive for crooked politicians to use public money to make good their loot of cooperative bank funds.

Suddenly, all this is set to change. The government has introduced the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) in parliament this June which has evoked strong opposition by all trade unions. The FRDI Bill aims to limit the use of public money to bail out distressed organisations in the event of a financial crisis, by providing a resolution framework to handle the failure of banks, insurance companies and financial sector entities. Bank unions, however, believe that it will give the government sweeping powers to wind up public sector banks. Meanwhile, depositors have another reason to panic.

A WhatsApp message (provocatively titled “This Tsunami will wipe out your money lying in the Banks” and ostensibly written by a chartered accountant) is going viral with a link to an article in The Hindu, which suggests that our bank deposits are no longer safe; they can be appropriated by the government and converted into equity to bail out banks. The culprit is, apparently, a ‘bail-in’ clause in the FRDI Bill that allows the government to convert your deposits into equity in order to recapitalise and bail out banks that are facing bankruptcy.

Depositors, who have gone through enormous hardships to access their own savings during the currency demonetisation of 2016, find it is easy to believe that the government may appropriate their hard-earned savings to bailout banks. Most Indians hold the bulk of their savings in property or bank deposits and there is already a gnawing worry over the government’s inability to deal with the mammoth bad loans of banks, which are in excess of Rs10 lakh crore. So, let’s examine whether we really need to panic.

The FRDI Bill is based on a 2014 working paper of RBI. It is in line with a global move to create statutory structures to contain the contagion effect of the kind that shook the world in 2008 by the failure of large financial institutions. In November 2014, India, as part of the G20 nations, had agreed to create a legal structure which includes a ‘bail-in provision’ to recapitalise banks. But such a contingency is a matter of last resort. In fact, most global banks, including those in India (State Bank of India, ICICI Bank and Bank of Baroda had done this), have been asked to work on the concept of a ‘living will’, where they put in place a disaster management plan, if you will, on what is to be done in the event of a massive melt down. The FRDI Bill’s bail-in provisions that are a source of panic, will kick-in only if the organisation is facing bankruptcy.

What is a bail-in? It is the opposite of a bailout, where governments use taxpayers’ money to save large institutions. A bail-in gives statutory powers to a resolution authority to convert existing creditors (including depositors) into shareholders in order to recapitalise the bank. The FRDI Bill creates the statutory basis for such action by replacing the current deposit insurance guarantee corporation (or converting it) with a Resolution Corporation that will cover banks, financial institutions and insurance companies.

The FRDI Bill also envisages a ‘Corporation Insurance Fund’ that will insure a part of the deposits. The extent of deposits insured is likely to be substantially higher than Rs1 lakh insured today. These insured deposits will be out of the purview of appropriation for a ‘bail-in’. We understand that, in the US, 100% of the deposits are insured; hence, the bail-in, if it happens, will primarily affect bondholders and other unsecured creditors. While it is important to remember that a bail-in is envisaged only as a last resort, it is also a fact that Cyprus has already invoked this clause to bailout banks. The FRDI Bill also envisages a ‘Corporation Insurance Fund’ that will insure a part of the deposits. The extent of deposits insured is likely to be substantially higher than Rs1 lakh insured today. These insured deposits will be out of the purview of appropriation for a ‘bail-in’. We understand that, in the US, 100% of the deposits are insured; hence, the bail-in, if it happens, will primarily affect bondholders and other unsecured creditors. While it is important to remember that a bail-in is envisaged only as a last resort, it is also a fact that Cyprus has already invoked this clause to bailout banks.

Bank unions are correctly worried about sweeping powers in the hands of a government that rushes statutory changes through parliament as money bills, without proper discussion or explanation. On the other hand, those who were part of the RBI working group are less worried, because any hasty action that takes away the implicit safety and guarantee of deposits associated with public sector banks would only cause a run on deposits and no government in its right mind would dare do this.

Indian banks are also more tightly regulated and do not have the same exposure to derivative products as those in the US and other countries. The flip side to this is that we have a massive bad loan problem that remains unresolved. Bad loans of banks spiralled from Rs39,030 crore in 2008 to Rs2,16,739 crore in 2014—all under the incredibly corrupt coalition called the United Progressive Alliance (UPA). Consequently, even Opposition leaders have been reluctant to question government policies too closely, probably fearing it would boomerang on them.

I believe that the government ought to be speaking to the people to allay their fears, instead of orchestrating discussions on business channels to counter the meeting of bank unions. The finance ministry must realise that people want to be assured that 100% of their deposits would be safe and bankers will be made accountable for their loans. Merely raising deposit insurance under the FRDI Bill is cold comfort to millions of retirees whose entire savings are in low yield, taxable, bank fixed deposits, only because they safe.

Secondly, the FRDI Bill intends to keep out cooperative banks, which go belly-up with monotonous regularity. Then, again, this government has been very soft of cooperative banks, whether it is re-capitalising them in 2014 or giving up its tough initial stance against allowing them to exchange demonetised currency. If political compulsions will bring cooperative banks under FRDI Bill it will be a cause for concern.

Thirdly, we need clarity on where non-banking finance companies, micro-finance companies and payment banks fit into this equation. While none of these are yet in a position to create systemic issues if they go bankrupt, we do have the example of the Ponzi-like deposit collection companies (Sahara, PACL and Saradha) destroying the savings of ordinary, disempowered people.

It appears that FRDI Bill is part of a piecemeal response to a problem that afflicts countries that are either heavily indebted or have allowed banks to make risky bets. We don’t have that problem. We have other problems. If we have to put this law in action, we need a holistic thinking about the entire financial sector.