While it is accepted that governments in general are not as methodical or as strategic as private corporations, it is galling to see method and deliberateness applied for the wrong ends, even if the intent is not to malign and the apparent method and deliberateness happen to be accidental consequences of forces that have already been in motion. Let me explain. As though the dislocation unleashed by demonetisation and the introduction of the goods and services tax (GST) were not enough, the government is moving ahead with a Financial Resolution and Deposit Insurance Bill. The FRDI Bill has raised anxieties in the minds of senior citizens and to-be senior citizens who have the bulk of their savings in bank deposits. Another round of economic uncertainty is the last thing that this government should be unleashing before 2019.

The concerns are legitimate and the government’s clarifications are deliberately vague. That sows doubt and distrust. If one were to steer clear of attributing malign and sinister motives, then it would be safe to describe the proposed legislation as a context-free “copy and paste" job from other countries. Plainly, it is sloppiness. What the depositors need to hear in simple English (that is because the language of law in India is English) is that their deposits are safe and will not be part of the “bail-in". It should be part of the provisions of the Bill. There is more than one good reason to offer this clarification.

The idea behind resolving the failure of a financial institution is to ensure that it does not bring economic activity to a grinding halt, endanger the rest of the financial system and affect the innocent bystander, the taxpayer. For the most part, the resolution mechanisms in India have satisfied two of these three criteria despite periodic epidemics of non-performing assets in the banking system, the most recent of which is still untamed.

That the taxpayer shall not be on the hook to bail out failed financial institutions and the costs, if any, should be first borne by insider-stakeholders is sound, in principle. But, in any resolution, when the market value of the liabilities of the failed institution exceed the market value of its assets, the first hit is to the current equity-holders of the institution. In terms of the hierarchy of claims, they are the most junior. In the case of the Indian banking system, the predominant owner is the government and hence, the taxpayer. Hence, in the Indian context, the taxpayer is the first to be bailed in! In other words, the principle that the resolution mechanism shall protect the taxpayer is a non-starter. Therefore, before bailing in depositors, the government must climb down from its occupation of the commanding heights of the banking system. The idea that one can apply a so-called market-economy solution to a government-owned banking system is risible. The sequencing is wrong.

The second principle is that those who stood to gain from the banks’ profitable expansion of assets and operations should be prepared to lose from its failures. That is why equity-holders are first in the list of those to be bailed in. Then come bondholders. To a degree, they participate in the upside. If banks perform well, their bond prices rise and they gain from trading them for higher prices and from the higher coupons they get for accepting junior and subordinated claims compared to secured and senior bondholders. The depositor is already short-changed by the high average inflation rate in the Indian economy. Second, banks are willing to cut deposit rates faster than they cut lending rates when interest rates go down. Finally, bank depositors have no participation in the upside. Hence, to bail them in is against fairness and natural justice.

Third, for creditors to bear the consequences of bank assets performing well, they should have a say in the creation of those assets through participation in the banks’ governance.

Fourth, financial repression and the casino-like nature of stock markets (not just an Indian phenomenon) ensure that senior citizens and others unschooled (God bless them) in the ways of the capital market have limited options for safe financial savings. To induce doubts about the safety of deposits when financial systems are rigged against the unsuspecting investor is not fair either.

Fifth, the stated goal of the government to encourage the public to use banking channels for commercial transactions flies in the face of the anxiety that the Bill creates in the minds of depositors. How would the deposits of micro and small enterprises be treated? Will Jan Dhan Yojana become Jan Dead Yojana?

So, what should the government do? Resolution schemes and corporations are non-starters as long as the taxpayer is the dominant shareholder in the banking system. Fix that before considering this Bill. In the meantime, redraft clauses 52 and 53 of the proposed Bill. Make their provisions prospective and, even then, exclude depositors. If depositors have to be bailed in, the deposit insurance limit must be raised substantially.

In 2014, Bare Talk advised the then new finance minister (“The Fourth Challenge For The Finance Minister", 26 May 2014 and “Stop The Task Forces, Mr Jaitley", 6 October 2014) to constitute a new Financial Sector Legislative Reforms Commission with terms of reference that do not allow market fundamentalism to determine the fate of the Indian banking and capital markets. It is not too late.

V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns here.

Comments are welcome at baretalk@livemint.com

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