The Financial Resolution and Deposit Insurance Bill, 2017 was introduced in Lok Sabha during Monsoon Session 2017.  The Bill is currently being examined by a Joint Committee of the two Houses of Parliament.  It seeks to establish a Resolution Corporation which will monitor the risk faced by financial firms such as banks and insurance companies, and resolve them in case of failure.  For FAQs explaining the regulatory framework under the Bill, please see here.

Over the last few days, there has been some discussion around provisions of the Bill which allow for cancellation or writing down of liabilities of a financial firm (known as bail-in).[1]^,[2]  There are concerns that these provisions may put depositors in an unfavourable position in case a bank fails. In this context, we explain the bail-in process below.

What is bail-in?

The Bill specifies various tools to resolve a failing financial firm which include transferring its assets and liabilities, merging it with another firm, or liquidating it.  One of these methods allows for a financial firm on the verge of failure to be rescued by internally restructuring its debt.  This method is known as bail-in.

Bail-in differs from a bail-out which involves funds being infused by external sources to resolve a firm.  This includes a failing firm being rescued by the government.

How does it work?

Under bail-in, the Resolution Corporation can internally restructure the firm’s debt by: (i) cancelling liabilities that the firm owes to its creditors, or (ii) converting its liabilities into any other instrument (e.g., converting debt into equity), among others.[3]

Bail-in may be used in cases where it is necessary to continue the services of the firm, but the option of selling it is not feasible.[4]  This method allows for losses to be absorbed and consequently enables the firm to carry on business for a reasonable time period while maintaining market confidence.³  The Bill allows the Resolution Corporation to either resolve a firm by only using bail-in, or use bail-in as part of a larger resolution scheme in combination with other resolution methods like a merger or acquisition.

Do the current laws in India allow for bail-in? What happens to bank deposits in case of failure?

Current laws governing resolution of financial firms do not contain provisions for a bail in.  If a bank fails, it may either be merged with another bank or liquidated.

In case of bank deposits, amounts up to one lakh rupees are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC).  In the absence of the bank having sufficient resources to repay deposits above this amount, depositors will lose their money.  The DICGC Act, 1961 originally insured deposits up to Rs 1,500 and permitted the DICGC to increase this amount with the approval of the central government.  The current insured amount of one lakh rupees was fixed in May 1993.[5]  The Bill has a similar provision which allows the Resolution Corporation to set the insured amount in consultation with the RBI.

Does the Bill specify safeguards for creditors, including depositors?

The Bill specifies that the power of the Corporation while using bail-in to resolve a firm will be limited.  There are certain safeguards which seek to protect creditors and ensure continuity of critical functions of the firm. 

When resolving a firm through bail-in, the Corporation will have to ensure that none of the creditors (including bank depositors) receive less than what they would have been entitled to receive if the firm was to be liquidated.[6]^,[7]

Further, the Bill allows a liability to be cancelled or converted under bail-in only if the creditor has given his consent to do so in the contract governing such debt.  The terms and conditions of bank deposits will determine whether the bail-in clause can be applied to them.

Do other countries contain similar provisions?

After the global financial crisis in 2008, several countries such as the US and those across Europe developed specialised resolution capabilities.  This was aimed at preventing another crisis and sought to strengthen mechanisms for monitoring and resolving sick financial firms.

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.  The European Union also issued a directive proposing a structure for member countries to follow while framing their respective resolution laws.  This directive suggested that countries should include bail-in among their resolution tools.  Countries such as UK and Germany have provided for bail-in under their laws.  However, this method has rarely been used.^7,[8]  One of the rare instances was in 2013, when bail-in was used to resolve a bank in Cyprus.

———————————————–

[1] ‘Modi government’s FRDI bill may take away all your hard-earned money’, India Today, December  5, 2017, http://indiatoday.intoday.in/story/frdi-bill-banking-reforms-modi-government-india-parliament/1/1103422.html.

[2] ‘Bail-in doubts — on financial resolution legislation’, The Hindu, December 5, 2017, http://www.thehindu.com/opinion/editorial/bail-in-doubts/article21261606.ece.

[3] Section 52, The Financial Resolution and Deposit Insurance Bill, 2017.

[4] Report of the Committee to Draft Code on Resolution of Financial Firms, September 2016, http://www.prsindia.org/uploads/media/Financial%20Resolution%20Bill,%202017/FRDI%20Bill%20Drafting%20Committee%20Report.pdf.

[5] The Deposit Insurance and Credit Guarantee Corporation Act, 1961, https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/dicgc_act.pdf.  s

[6] Section 55, The Financial Resolution and Deposit Insurance Bill, 2017.

[7] The Bank of England’s approach to resolution, October 2014, Bank of England.

[8] Recovery and resolution, BaFin, Federal Financial Supervisory Authority of Germany, https://www.bafin.de/EN/Aufsicht/BankenFinanzdienstleister/Massnahmen/SanierungAbwicklung/sanierung_abwicklung_artikel_en.html.