You may have heard that the cabinet has approved the Financial Resolution and Deposit Insurance (FRDI) bill and tabled it in the Lok Sabha. The bill was referred to a joint parliamentary committee without any discussion in the Lok Sabha. The committee is expected to place their report on the bill in the Lok Sabha in 2018. If passed, in my view the implementation of the bill will destabilize the already worrying situation in our country :'
1. The bill refers to a bail in by depositors – that means that a bank which is short of cash by having given away our money in massive loans that the promotors refuse to pay back (like Vijay Mallya), may recoup some of its losses by refusing to return part of or all of our money in the bank. That money may be converted to shares in the loss-making bank. Until the bank becomes profitable again, if at all, and the shares appreciate greatly in value, we will be unable to have our money that was in the bank, back.
2. The money covered by insurance paid by the banks amounts to only Rs. 1 lakh per account holder in one bank. Yes, if you have another account in another bank that is separately insured for 1 lakh rupees also. Ofcourse some 67 % of the account holders in our public-sector banks have deposits amounting to less than 1 lakh so they are covered by this insurance. But the remaining 33 % presumably lower middle class and above will have their entire life savings in banks amounting to tens of lakhs possibly, especially soon after retirement.
3. Atleast 12 % of all loans given by public sector banks have become unviable – wont be paid back by the loan takers. In terms of amount of money in loans that have become bad, figures ranging from 10 – 20 lakh crore rs. are being quoted in the media. For perspective, total amount of deposits in public sector banks are 111 lakh crores. The money loaned out is 81 lakh crores. The banks have borrowed money from other sources to the tune of 12 lakh crores. Whatever the math, it is being said by all concerned that the public-sector banks have become short of cash and are unable to make new loans to industry and agriculture in keeping with demand. This has badly hit economic growth in our country, but even more seriously, it puts our money in the bank at risk should the bank fail.
4. For decades, the government has not gone far enough to improve the functioning of our public-sector banks. Instead, politicians have focused on milking the banks for large loans to their own enterprises and to the companies that fund them for elections – enterprises which have no intention of paying the loan back fully. So farmers owing a few thousands or lakhs to the banks are hounded and their land confiscated while companies with thousands of crores in outstanding loans are given more and more loans. So some of our money given for safe custody in banks has already disappeared in this loot. The amount of this lost money has become so large lately that it is affecting the giving of new loans and perhaps may eventually one day lead to the bank being unable to pay us back fully when we want to withdraw our cash.
5. We have even earlier been aware of all this, but taken comfort in the implicit sovereign guarantee that our government will not let any commercial bank fail. And it has not. When some bank has been in trouble, RBI and Government have stepped in and merged it with another bank and so on. Cash injections have been made by Governments into public sector banks to help them meet their obligations. But with this proposed FRDI Bill, that sovereign guarantee appears to be a thing of the past – the govt. says in this bill that if your bank is in trouble, it is your money that should be used to help it stabilize.
6. If this comes to pass with one or more banks, what of the depositors dependent for their living expenses on their bank account or on cash reserves to run their business ? What is their fault in this looting ? If it is essentially a fault of careless or corrupt governance, the government should be bailing out banks and setting right their governance. Of course Government should not be misusing our hard-earned taxes and bank deposits to first loot from deposits (and taxes) and then use some of those taxes to keep bailing out banks who keep giving loans to looters, and so on. It should be taking many corrective steps to minimize this loot and to make more loans possible to those genuinely putting up businesses and industries, and to help make agriculture more profitable by helping improve farm productivity.
7. So has the government been taking any of the steps suggested by many committees ? The main supervision of banks is by the governing bodies of those banks.. these are stuffed full of government appointees, who perhaps use their positions to extract more loans for cronies. Many reforms such as having separate MDs and Chairmen of Banks, carefully making new appointments to bank governing bodies, making available better credit rating systems, and so on have been repeatedly mooted. But many positions on bank governing boards even now wait for months and years for government to approve of names suggested by RBI. Naming willful defaulters (those who have capacity to pay back loans but are choosing not to pay them) has been asked for repeatedly by courts in response to PILs but was resisted by government as well as RBI. Critics rightfully say that those borrowing thousands of crores from banks – our money, should be transparently rated, their project proposals put in the public domain, and their loan payback performance also publicly available. But this is far from being implemented.
8. Instead, the agencies which can help monitor, investigate and stem the loot are more and more staffed with corrupt or lackadaisical people, or the positions are simply not filled for years, especially by the present government – CBI, central vigilance commission, central information commissioner, lokayukta, and so on..
9. The FRDI bill envisages the creation of a Resolution Corporation that will rate the sickness of banks and take them over as required. It will manage their affairs and try to make them solvent if possible, or else sell their assets. These functions have been performed by the Reserve Bank of India (RBI) all along. To many commentators there is no justification for creating the Resolution Corporation to take over functions of the RBI. The only advantage to the government appears to be that the resolution corporation will have appointees made by the finance ministry and thus more directly controlled by it compared with the RBI which is an independent statutory body. And it is such government / political control itself which has brought the banks to their present pass !
10. I have sent a mail to Lok sabha and Rajya sabha MPs of my area asking them to desist from voting for this bill when it is put to discussion and voting. I used this well drafted mail at this link - http://www.repealfrdi.net/ they send you a mail to your id (can take 2-3 hours) and you press the link to send it to the MPs. I have heard there is a petition ongoing at change.org to repeal this bill and I will find and sign it too.
11. Some people wrote back to say they shared some of these concerns and had been trying to read up more. one person wrote back : ‘The Govt has issued a series of ads in the newspapers that deposits are safe. This was started during the Guj elections. I checked my known sources & have been told that this kind of thing cannot be done in India which is a savings oriented economy.’ Another person wrote back : ‘But last week finance minister Mr Jaitly cleared these same points on India TV and said that it's not true, all is fake and created by opposition. The government going to make law for more secure the money of depositers in bank.’
12. Here is the background on how the FRDI bill came to be drafted in its present form : Post 2008 bail out of American banks, the US govt. felt they cannot do this again. So they proposed to the G-7 group of countries the bail in clause that money from the depositors of the failing bank be used to make it solvent again. (in contrast, bail out means some external party – usually the government gives money to the bank to make it solvent again). The G-7 group of countries accepted that clause and further proposed it to the G-20 group of countries – India among them. This clause was accepted by this group as well, and several countries have reportedly now made similar laws as in india – reportedly they include Canada, UK and the EU. The Financial Stability Board which was created to guide this process internationally has apparently a model law that india has copied more or less verbatim.
13. But these countries offer much more security to their citizens compared to in our country. To begin with the deposit insurance in the UK and Germany is 3 times that of the average yearly wage in those countries. In Canada and the US, it is 5 times the average yearly wage in those countries. In India the average yearly wage is 1.25 lakh rupees, so our deposit insurance does not even cover one year’s wage. I guess it should be raised to atleast 4 lakh rupees to be equivalent to the UK norm, but would entail more payments for this insurance by the banks and therefore more payments by us as fees to our banks. Secondly, these countries offer a fantastic level of health care to all their citizens, old age pensions (which in Germany is 3000 euros a month – 2.25 lakh rupees !), and many other support systems. In India these systems and services are very inadequate. Especially the middle class onwards, everyone save government servants, are critically dependant on their savings in banks.
14. Experts say that another difference between these countries and ours is that most deposits in their banks are by wholesalers – i.e. large institutions, credit unions, insurance companies and so on. These large institutions are better able to protect themselves. In our country most deposits are retail – i.e. by the end customer. So India should never have copied this bill from an international model which is totally unsuited for our country.
15. The bail in clause has already been used in Cyprus in 2013. Cyprus is one of the EU countries, albeit a small one. The banks in that country had bought a lot of bonds from Greek Banks as investments. When the Greek economy started sinking those bonds became worthless and the Cyprus banks had no money to transact normal business with their customers. The bail in clause was invoked and customers could only have access to 1 lakh euros – the amount covered by their deposit guarantee. Some 40 % of the deposits above that amount were converted to shares of those failed banks. Another 20 % were kept in reserve for more conversion to shares if the bank needed to do so. Another 30 % was put in compulsory FDs for periods ranging from 3 months to 1 year. So one presumes the customers of those banks got only 10 % of their deposits back immediately, apart from 1 lakh euros, and another 50 % after a period of time when the situation had stabilized. But 40 % of every deposit was gone for a long time until the banks would be profitable and their share prices rose.
16. The bail in clause was also used by the Iceland Government in 2009 (the term may not actually have existed then but the same strategy was employed). This is another small country in the Eurozone. The banks there raised money from Europe by offering crazy interest rates to the tune of 15 % and so on. The Iceland banks then went shopping for equally crazy assets all over the world, including sports teams and so on. The banks crashed after a few years. The government fully guaranteed (after the bank crash) the full amounts of deposits of the DOMESTIC customers. But it refused to honour the deposits of lakhs of customers who had transacted with those bank branches in countries such as the UK, Denmark and others. Those governments were agile enough to quickly freeze the assets of the failed banks in their countries, and thus retrieve for their citizens atleast some of their money.
17. So obviously this bill should be repealed in full – rejected by parliament or withdrawn by the Government. It is not enough in my view to delete just 1-2 offending clauses – because they can easily be inserted back in after a few years by a majority single party led government. But that is not the end of our troubles with our banks – which can still fail and cause us grief. Government spokespersons and people who drafted the bill have said that therefore the bill does not really make things worse than they already are. But I think they are obfuscating the reality – today a bank may fail and may end up losing the money of some of its depositors. But depending on the losses, some or most may get their money back. But a bail in provision as per the FRDI bill would lock in the money of all depositors so that the bank may continue to survive.
18. I have tried to study what positive steps can be taken so these must be the focus of what we demand that the Government do in this matter. The last RBI Governor’s tenure was from Sep 2013 to Aug 2016. Early on, he got RBI to minutely study the actual asset position of banks – i.e. how many loans had actually gone bad (as the banks were not declaring them and were hiding their actual financial position). With that report in hand by early 2015, RBI constituted a Banks Board Bureau with many eminent persons on board who set about to find talented people of integrity to head the banks or serve in their boards. Sadly, the Government has not worked in tandem with the Bureau to quickly fill bank boards with appropriate appointees.
19. RBI and the Banks Board Bureau also worked on many other measures to recover some of these bad loans called NPAs (Non Performing Assets). From selling off some of the assets of failed companies, to restructuring the loans to giving an emergency cash injection in a few cases where the company could be helped to continue its business and return the funds by and by. But the RBI Governor, Raghuram Rajan, who was in the thick of this process of bad loans cleanup was not given another term after his 3-year term was over. This was a delicate task he was doing and many people felt he should have been allowed to complete it.
20. In fact, there have been 24 Governors since the inception of the Reserve Bank and 12 of them have served terms of 4-7 years each. In previous regimes, the governor appointed by Congress Party was given an extension by the then BJP government, and that appointed by the BJP government was given an extension by the Congress Government. That must have been because the work they were then doing was felt to be more important than which regime appointed the Governor. But this BJP government not only did not extend the term of the RBI Governor appointed by the Congress Government before them, it allowed Subramaniam Swamy to endlessly belittle the RBI governor publicly with unfounded trivia. This was a new low in independent india, for the RBI and its Governors have been widely respected throughout its history not only in india but internationally too.
21. The committee set up by the Finance Ministry to prepare the FRDI bill submitted its draft just after Rajan left the post of Governor, RBI, so his comments on this bill are not available to us. The timing may have been deliberate I think, as the RBI was already fully into the very issues that are the subject matter of this bill. The bill seeks to override RBI and give all its powers in the case of failing banks to a new entity – the resolution corporation. So not only we the tax payers will be asked to pay for a whole new bureaucracy, that new entity will have zero institutional experience to begin with. It will also have highly centralized powers against which no appeal can be made to the courts or any other entity except the highly overworked company law board ! So we must ask not only for the FRDI bill to be rejected / withdrawn, we must also ask that RBI must be enabled to continue its work on cleaning up the bad assets of banks, rather than the often adversarial position the Finance Ministry takes on these issues.
22. RBI and the Finance Ministry must set up a credit rating agency which rates the credit position not only of companies that apply for loans but also of their promoters and sister concerns. The reports of this agency must be online, as also the appraisal reports by banks of the criteria they used to pass or reject specific loans. Ofcourse this may be done to begin with, for large loans. This may sound outlandish but such is the stranglehold of corruption including by bank officers, corporates, bureaucrats and politicians, that there is no other way to combat this phenomena. This suggestion has been repeatedly made by Prashant Bhushan who represented the first PIL on this subject in the 1990s. The petition was launched by H D Shourie, Arun Shourie’s father who had spearheaded a respected public organization called Common Cause. That and similar PILs also by Prashant Bhushan and Swaraj Abhiyan have continued to this day and it is a result of some of this work that the NPAs have come to light as much as they have.
23. Those who have looted our money and brought our banks (and consequently our economy) to the precipice must be prosecuted and awarded exemplary punishments. But for this the institutions who can help do this need to be staffed fully with competent people, and left alone by the Government to do their job – RBI, CVC, CIC, Loayukta and most importantly, the CBI.
24. A similar legislation to the FRDI bill has been adopted for EU as a whole, applicable to 28 Eurozone countries. Known as the Bank Recovery and Resolution Directive, the legislation is the centerpiece of efforts to avoid a repeat of the €1.6tn of taxpayer support to banks during the 2008 financial crisis. It empowers regulators to intervene quickly when a bank is weak, avoiding the panic that could arise from a messy and prolonged insolvency procedure. The law took effect in 2015, but markets were given an extra year to adjust to the most controversial measure: tougher rules imposing losses on a failing bank’s creditors, which kicked in on January 1, 2016. This stipulates that 8 per cent of a bank’s liabilities must be wiped out before any taxpayer support can be provided, placing unsecured senior bondholders and also large corporate depositors on the hook for forced losses, also known as bail-ins.
25. However the EU legislation appears to be better than the FRDI bill in these respects : It does not amalgamate insurance companies along with banks in a single bill / authority, as FRDI bill seeks to do. Secondly, insured deposits are expressly excluded from bail-ins. Thirdly, the portion of households’ and small businesses’ deposits above €100,000 also get preferential treatment These deposits sustain a loss only if all the instruments with a lower insolvency ranking are insufficient to cover the losses and restore capital adequacy. Fourth, once bail-in has involved at least 8 per cent of total liabilities, taxpayer money can be used to bail out banks. Fifthly, it does not seem to require a separate resolution corporation. For example in the UK, the Bank of England has been designated as the resolution authority so RBI could and should have been designated as the resolution authority for banks in india also.
26. A form of bail in has been implemented in Greece also. With the economy in Greece in trouble for several years, in the beginning of June 2015, it placed controls on the amount of cash that could be withdrawn from one’s account via ATMs. This limit was 60 euros when the average Greek monthly wage is 780 euros a month. That would be equivalent to withdrawing 840 rs. a day in India as our average monthly wage is 10,500 inr. After 3 weeks of being closed in june 2015, the banks opened, and the cash withdrwal limit was increased to 840 euros a fortnight which would be equivalent to 11500 rs. fortnightly withdrawal in india (in the context of the average monthly salary). That limit on withdrawals is STILL in place and is expected to be lifted at the earliest in end 2018, and only if the Greek economy does better than it is doing now, for which there is no certainty. Capital controls have also been in place through this period which means no money can be taken out of the country.
27. Singapore’s proposed resolution regime, excludes all deposits and senior debt from bail-in. The paper on APPROACH TO RESOLUTION OF FINANCIAL INSTITUTIONS IN SINGAPORE makes clear that saving them from failing is not its objective as that would make for non-accountability of the owners and managers of those financial institutions (FI). Its objective is to protect the interests of the users of the services offered by that FI. In fact, back in 2009, Iceland allowed its two leading banks to fail, suffered many negative consequences, but quickly bounced back and now has the fastest growing economy of the developed world. Ireland at the same time also suffered distress in its banking system but bailed them out. The resultant disturbed financial landscape has still not abated fully in Ireland..
28. In Singapore, as in England, there has been no need for a separate resolution corporation – the resolution function is the responsibility of the existing monetary authority in both countries, as it should be in ours.
29. As the general secretary of a bank officers’ union says, the most dangerous consequence of the proposed FRDI Bill is that it will take out the issue of existence or liquidation of a PSB (or even LIC tomorrow !) from the domain of public debate and leave it to the whims of bureaucratic dictates. Already, there are many rules and legislation in place under the existing Acts that deal with winding up of financial institutions, United Forum of Bank Unions has said in its representation to the finance minister.
30. FDRI Bill is also a poorly drafted law - think tank PRS Legislative Research demonstrates how clauses 58 and 62(1) regarding governance of a firm declared critical are inherently conflicting. There are other similarly inconsistent clauses.
31. Most professionals from the financial field simply cannot appreciate the need for this Bill. The Banking Regulation Act has worked well to help struggling banks in the past – why cant it work now ? Former Deputy governor of Reserve Bank, Chakravarty, says there is no case for a bank failure even if 25 % of the loan books of PSBs goes bad. That is reassuring ! He also gives this great idea of separating wholesale banking (for corporates and institutions) from retail banking (for individuals).
32. Chakravarty goes on to say that corporates should be funded by markets and not banks. RBI had started this process which has all of a sudden stopped, he says. On looking into what happened, we find that in Aug 2016 RBI announced a number of steps that will strengthen the corporate bond market. Thereafter it was expected that the government will nudge all stakeholders to act in order to complement RBI’s initiatives to address all outstanding issues. One of the reasons why the corporate bond market never really took off in India is because of high fiscal deficit and the government’s funding needs. The NK Singh committee was constituted to suggest new fiscal rules and it submitted its report in Feb 2017. However, the Government has chosen to not follow its recommendations for now.
33. Murlidharan, who started the whatsapp brouhaha on this bill makes this startling point – if we depositors are expected to bail in failing banks, will we also be getting our share of profit when they are making profits ? (but at present when public sector banks make profits, those go to the Government !). He also very rightly states that bank facilities are merely an essential infrastructure / service just like roads or buses that a government is required to provide to its citizens. The implication is that users of a service should not be penalized for merely using a service !
More readings / videos on this subject :
Also this video of Prashant Bhushan speaking on this subject last year : https://www.youtube.com/watch?v=LRD1cElTqTw
12. The best TV debate on FRDI bill I have seen : https://www.youtube.com/watch?v=oGXREwK26Dk
13. shows EU-wide rules for bank resolution have been framed : https://www.ft.com/content/8ad2ed98-d0a0-11e5-986a-62c79fcbcead
15. Shows Greece was considering raiding the deposits even below the insured amount as there was insufficient money in the deposit guarantee scheme : https://www.ft.com/content/9963b74c-219c-11e5-aa5a-398b2169cf79
18. This article says banks should have upto 18 % of their risk weighted assets in bonds that are clearly recognised at the time of issuance as being liable to be bailed in https://economictimes.indiatimes.com/news/economy/policy/how-frdi-bill-can-save-failing-banks-without-touching-your-deposits/articleshow/62277998.cms
