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. Order of priority under liquidation

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.

Petroleum Secretary S Sundareshan, while addressing a press Conference on Friday, announced the government’s decision to deregulate prices of petrol. Petrol prices shall now be subject to periodic revisions based on fluctuations in market prices. An immediate hike of Rs. 3.50 per litre has already been affected. Prices of diesel shall be deregulated in stages while those of kerosene and LPG shall continue to be regulated by the government. For the moment, diesel has been hiked by Rs. 2 per litre, kerosene by Rs. 3 per litre and LPG by Rs. 35 per cylinder. Crude to retail: Pricing and under-recoveries India imports about 80% of its crude oil requirement.  Therefore, the cost of petroleum products in India is linked to international prices. The Indian barrel of crude cost $78 in March 2010. Once crude is refined, it is ready for retail. This retail product, is then taxed by the government (both Centre and State) before it is sold to consumers. Taxes are levied primarily for two reasons: to discourage consumption and as a source of revenue. Taxes in India are in line with several developed nations, with the notable exception of the US (See Note 1) Before the current hike, taxes and duties in Delhi accounted for around 48% of the retail price of petrol and 24% of the retail price of diesel. (Click Here for details) Ideally, the retail prices of petroleum products should then be determined as: Retail prices = Cost of production + taxes + profit margins However, in practice, the government indicates the price at which PSU oil companies sell petroleum products. Since these oil companies cannot control the cost of crude (the primary driver of the cost of production) or the taxes, the net result is an effect on their profit margins. In cases where the cost of production and taxes exceeds the prescribed retail price, the profit margins become negative. These negative profit margins are called ‘under-recoveries’. When international crude prices rose above $130 in 2008, under-recoveries reached an all-time high of Rs. 103,292 crore. Even at much lower prices in 2009-10 (averaging at $70 per barrel), under-recoveries totalled Rs. 46,051 crore. (See Note 2) The latest move is an effort to reduce these under-recoveries. The government cited the recommendations of the Kirit Parkih Committee while announcing its decision (Summary - Kirit Parikh Committee report). Any alternatives to price hike? As is evident from above, under-recoveries can also be reduced by decreasing taxes. In fact, one might argue that by both taxing the product and offering a subsidy, the government is complicating the situation. Usually whenever subsidization coexists with taxation, it serves the purpose of redistribution. For example, taxes might be collected universally but subsidy be granted to the weaker sections only. However, this is not the case in the current situation. What needs to be noted here is that these taxes are a very significant source of revenue. In fact, the total taxes paid by the oil sector to the central and state governments were around 3% of GDP in 2008-09 (See Note 3). Reducing taxes now might make it difficult for successive governments to raise taxation rates on petroleum products again. Moreover, though taxes are levied both by the Centre and the States, the subsidy is borne only by the Centre. Hence, the current arrangement is beneficial to the States. Possible future scenarios The opposition has voiced concerns that the hike in prices is likely to lead to even higher inflation and will further burden the consumer. The Chief Economic Advisor to the Finance Ministry, Dr. Kaushik Basu, however, told the media that these changes would have a beneficial effect on the economy. According to him,

"The (decontrol of petrol prices), coupled with price increase for LPG (cooking gas) and kerosene, will have an immediate positive impact on inflation. I expect an increase of 0.9 percentage points in the monthly Wholesale Price Index (WPI) inflation".

 

However, he added, that since the hike in fuel prices would push down fiscal and revenue deficit,

"they will exert a downward pressure on prices… More importantly, from now on, if there is a global shortage and the international price of crude rises, this signal will be transmitted to the Indian consumer. It will rationalise the way we spend money, the kinds and amount of energy we use, and the cars we manufacture. It is an important step in making India a more efficient, global player”.

It remains to be seen how the actual situation pans out. Notes 1) Share of tax in retail price (%)

Country Petrol Diesel
France 61% 46%
Germany 63% 47%
Italy 59% 43%
Spain 52% 38%
UK 64% 57%
Japan 48% 34%
Canada 32% 25%
USA 14% 16%
India (Del) 48% 24%

Source:  Petroleum Planning and Analysis Cell, PRS (Data as of Feb, 2010) 2) Under-recoveries by oil companies (Rs Crore)

Year Petrol Diesel PDS Kerosene Domestic LPG Total
2004-05 150 2,154 9,480 8,362 20,146
2005-06 2,723 12,647 14,384 10,246 40,000
2006-07 2,027 18,776 17,883 10,701 49,387
2007-08 7,332 35,166 19,102 15,523 77,123
2008-09 5,181 52,286 28,225 17,600 103,292
2008-09 5,151 9,279 17,364 14,257 46,051

Source:  Petroleum Planning and Analysis Cell, PRS 3) Contribution to Central and State taxes by Oil Sector (2008-09)

Category Rs (crore)
Sales tax 63,349
Excise duty 60,875
Corporate tax 12,031
Customs duty 6,299
Others (Centre) 5,093
Other (State) 4,937
Profit petroleum 4,710
Dividend 4,504
Total 1,61,798

Source:  Petroleum Planning and Analysis Cell