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
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). 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.
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. 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. 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.
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 One of the rare
instances was in 2013, when bail-in was used to resolve a bank in Cyprus.
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