The Financial Resolution and Deposit Insurance Bill, 2017 was introduced in Parliament during Monsoon Session 2017.[1] The Bill proposes to create a framework for monitoring financial firms such as banks, insurance companies, and stock exchanges; pre-empt risk to their financial position; and resolve them if they fail to honour their obligations (such as repaying depositors). To ensure continuity of a failing firm, it may be resolved by merging it with another firm, transferring its assets and liabilities, or reducing its debt. If resolution is found to be unviable, the firm may be liquidated, and its assets sold to repay its creditors.
After introduction, the Bill was referred to a Joint Committee of Parliament for examination, and the Committee’s report is expected in the Winter Session 2017. The Committee has been inviting stakeholders to give their inputs on the Bill, consulting experts, and undertaking study tours. In this context, we discuss the provisions of the Bill and some issues for consideration.
What are financial firms?
Financial firms include banks, insurance companies, and stock exchanges, among others. These firms accept deposits from consumers, channel these deposits into investments, provide loans, and manage payment systems that facilitate transactions in the country. These firms are an integral part of the financial system, and since they transact with each other, their failure may have an adverse impact on financial stability and result in consumers losing their deposits and investments.
As witnessed in 2008, the failure of a firm (Lehman Brothers) impacted the financial system across the world, and triggered a global financial crisis. After the crisis, various countries have sought to consolidate their laws to develop specialised capabilities for resolving failure of financial firms and to prevent the occurrence of another crisis. [2]
What is the current framework to resolve financial firms? What does the Bill propose?
Currently, there is no specialised law for the resolution of financial firms in India. Provisions to resolve failure of financial firms are found scattered across different laws.2 Resolution or winding up of firms is managed by the regulators for various kinds of financial firms (i.e. the Reserve Bank of India (RBI) for banks, the Insurance Regulatory and Development Authority (IRDA) for insurance companies, and the Securities and Exchange Board of India (SEBI) for stock exchanges.) However, under the current framework, powers of these regulators to resolve similar entities may vary (e.g. RBI has powers to wind-up or merge scheduled commercial banks, but not co-operative banks.)
The Bill seeks to create a consolidated framework for the resolution of financial firms by creating a Resolution Corporation. The Resolution Corporation will include representatives from all financial sector regulators and the ministry of finance, among others. The Corporation will monitor these firms to pre-empt failure, and resolve or liquidate them in case of such failure.
How does the Resolution Corporation monitor and prevent failure of financial firms?
Risk based classification: The Resolution Corporation or the regulators (such as the RBI for banks, IRDA for insurance companies or SEBI for the stock exchanges) will classify financial firms under five categories, based on their risk of failure (see Figure 1). This classification will be based on adequacy of capital, assets and liabilities, and capability of management, among other criteria. The Bill proposes to allow both, the regulator and the Corporation, to monitor and classify firms based on their risk to failure.
Corrective Action: Based on the risk to failure, the Resolution Corporation or regulators may direct the firms to take certain corrective action. For example, if the firm is at a higher risk to failure (under ‘material’ or ‘imminent’ categories), the Resolution Corporation or the regulator may: (i) prevent it from accepting deposits from consumers, (ii) prohibit the firm from acquiring other businesses, or (iii) require it to increase its capital. Further, these firms will formulate resolution and restoration plans to prepare a strategy for improving their financial position and resolving the firm in case it fails.
While the Bill specifies that the financial firms will be classified based on risk, it does not provide a mechanism for these firms to appeal this decision. One argument to not allow an appeal may be that certain decisions of the Corporation may require urgent action to prevent the financial firm from failing. However, this may leave aggrieved persons without a recourse to challenge the decision of the Corporation if they are unsatisfied.
Figure 1: Monitoring and resolution of financial firms
How will the Resolution Corporation resolve financial firms that have failed?
The Resolution Corporation will take over the administration of a financial firm from the date of its classification as ‘critical’ (i.e. if it is on the verge of failure.) The Resolution Corporation will resolve the firm using any of the methods specified in the Bill, within one year. This time limit may be extended by another year (i.e. maximum limit of two years). During this period, the firm will be immune against all legal actions.
The Resolution Corporation can resolve a financial firm using any of the following methods: (i) transferring the assets and liabilities of the firm to another firm, (ii) merger or acquisition of the firm, (iii) creating a bridge financial firm (where a new company is created to take over the assets, liabilities and management of the failing firm), (iv) bail-in (internally transferring or converting the debt of the firm), or (v) liquidate the firm to repay its creditors.
If the Resolution Corporation fails to resolve the firm within a maximum period of two years, the firm will automatically go in for liquidation. The Bill specifies the order of priority in which creditors will be repaid in case of liquidation, with the amount paid to depositors as deposit insurance getting preference over other creditors.
While the Bill specifies that resolution will commence upon classification as ‘critical’, the point at which this process will end may not be evident in certain cases. For example, in case of transfer, merger or liquidation, the end of the process may be inferred from when the operations are transferred or liquidation is completed, but for some other methods such as bail-in, the point at which the resolution process will be completed may be unclear.
Does the Bill guarantee the repayment of bank deposits?
The Resolution Corporation will provide deposit insurance to banks up to a certain limit. This implies, that the Corporation will guarantee the repayment of a certain amount to each depositor in case the bank fails. Currently, the Deposit Insurance and Credit Guarantee Corporation (DICGC) provides deposit insurance for bank deposits up to 1 lakh rupees per depositor.[3] The Bill proposes to subsume the functions of the DICGC under the Resolution Corporation.
[1]. The Financial Resolution and Deposit Insurance Bill, 2017, http://www.prsindia.org/uploads/media/Financial%20Resolution%20Bill,%202017/Financial%20Resolution%20Bill,%202017.pdf
[2]. 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
[3]. The Deposit Insurance and Credit Guarantee Corporation Act, 1961, http://www.prsindia.org/uploads/media/Financial%20Resolution%20Bill,%202017/DICGC%20Act,%
In today's Opinion piece, in the Indian Express, we discuss how enacting hasty new legislation in response to public events may not be the answer. The recent spot fixing controversy in the Indian Premier League has brought the issue of betting in sports back into the limelight. As a result, public debate around betting, and steps that need to be taken to prevent the recurrence of such events, is gaining traction. The government's response to this incident has been somewhat predictable. The minister of state for sports has reportedly stated that his ministry is committed to putting in place new legislation to deal with the menace of fixing in sports. This approach to law making points towards a growing trend of initiating policy and legislative decisions as a reaction to public events. This is not something new. The Mumbai terror attack in 2008 was the catalyst for the enactment of the National Investigation Agency Act, and the brutal rape and murder of a young girl in Delhi led to the overhaul of India's penal code to ensure stricter penalties for crimes against women. Both these bills were passed without effective scrutiny, as they were not referred to a parliamentary standing committee for examination. Events in the country may, on occasion, highlight gaps in our policy and legislative framework. However, they often point out the ineffectiveness of existing laws and the lack of proper implementation. And that is not always a result of not having enough laws in the country. There are more than a 1,000 Central laws and over 15,000 state laws. The problem lies with our law-making process, which is ad hoc in nature. It is geared towards churning out legislation that is not entirely evidence based and does not take the feedback of different stakeholders into account. In its reports, the National Commission to review the working of the Constitution had observed that "our legislative enactments betray clear marks of hasty drafting and absence of Parliament scrutiny from the point of view of both the implementers and the affected persons and groups". Take, for example, the Gram Nyayalaya Act, which establishes village courts to provide people with easy access to justice and reduce the case law burden on the court system. Structured feedback from villagers, whom this act is trying to empower, prior to introducing the bill in Parliament would have given valuable insights about implementation challenges. A comprehensive study to examine the impact that village courts would have in reducing pendency in the judicial system would have provided hard numbers to substantiate what types of cases should be adjudicated by the village courts. A detailed financial analysis of the cost implications for the Central and the state governments for implementing the law would have helped policymakers decide on the scale and effectiveness of implementation. In the absence of these studies, there is no way to measure whether the law has been effective in giving villagers easy access to justice and in reducing the burden on the judicial system. The importance of stakeholder consultation was recently stressed by the parliamentary committee examining the land acquisition bill. In its report on the bill, the committee recommended that, "before bringing in any bill in future, the government should ensure wider, effective and timely consultations with all relevant and stakeholders so that all related issues are addressed adequately." Rajya Sabha MP N.K. Singh, while testifying before the parliamentary standing committee on the National Food Security Bill, had drawn the attention of the committee towards the need for an accurate financial memorandum accompanying the bill, to "avoid serious consequences in the implementation of the bill." The National Advisory Council has also suggested a process of pre-legislative scrutiny of bills and delegated legislation. In its approach paper, the Financial Sector Legislative Reforms Commission had suggested that delegated legislation should also be published in draft form to elicit feedback and that a cost benefit analysis of the delegated legislation should be appended to the draft. New laws can have a significant impact on the lives of people, so it is important that our law-makers enact "effective laws". For this to happen our law-making process needs to evolve. While there will always be public pressure for new laws, the solution lies in ensuring that the law-making process is robust, consultative and deliberative. The solution to addressing policy opportunities does not always lie in making new laws but in ensuring that whatever law is enacted is well thought out and designed to be effective.
