Let me begin today’s column with a significant statement of the President of India Droupadi Murmu. While speaking at a banking event yesterday she asked the banks to strike the right balance between creation of assets and protecting people’s money to ensure economic progress.
“The first responsibility of banks is to protect people’s money. The other important aspect of banks is creation of assets. This balance has to be maintained, and if disturbed, there will be an economic problem,” the President said.
In the given global banking scenario, the statement of the President of India is of utmost importance. Global banking industry is shaking like jelly. Bank failures continue to hit global economies, sending shivers down the spine of common bank customers. Even as the banking crisis unfolded in the West, the banking industry in other parts of the world has got engaged in getting the act together to brave any sort of spillover of the crisis into their territories.
Amid these concerns over banks’ health in the US and Europe, the Indian banking industry too is gearing up to avert any impact of the crisis. The government has already asked the banks to present a scenario-based risk plan in two weeks, along with a communication strategy to handle any situations that may arise. The government has already given indications that they are having an eagle’s eye on the crisis and have increased vigilance so that depositors’ worries are addressed.
Pertinently, since the collapse of Silicon Valley Bank and Signature Bank in the US, unrest brewed up among bank depositors globally as they started fearing for their money. In India, the safety of depositors’ money instantly became a subject of debate. However, experts were quick to state that the crisis is unlikely to impact the Indian banking sector as Indian banks have high capital adequacy and a very large share of assets under management.
Notably, Finance Minister Nirmala Sitharaman took a review of the preparedness of public sector banks in wake of the stress in banking systems in the US and Europe. The review focused on PSBs’ preparedness along with due diligence through adherence to the regulatory framework by focusing on risk management, diversification of deposits and asset base.
The Finance Minister asked the banks to capitalize on the global banking crisis and have a close look at their business models to locate stress points, including concentration risks and adverse exposures.
Even as banks assured their continued focus on robust asset-liability and risk management practices and putting all possible safeguards in place to brave any eventuality, the unrest in bank customers for safety of their hard earned money is only brewing up. In fact, the preparedness signal given by none other than the Finance Minister to the banks to take any shock head-on has been taken as an indication that Indian banks are not fully insulated against the ongoing global banking turmoil.
Banking crisis is not a new phenomenon. These have been happening at regular intervals and will continue to happen in future. In fact, in the prevalent banking scenario when advanced technology is ruling the roost, risk of banking failures has not been fully mitigated. In other words, modern technology-driven banking practices do not guarantee that a bank won’t fail. The risks will continue to loom large, but in new form.
Amid this scenario, the banks, regulators and the government have to remain focused and leave no room for complacency. The level of vigilance mechanism overseeing the operations of banks needs to be taken to the next level so that depositors’ money is protected at all costs.
In the meantime, there is a need to create a Resolution Corporation and the situation demands reintroduction of the Financial Resolution and Deposit Insurance (FRDI) Bill.
The FRDI Bill was tabled in the Lok Sabha in August 2017, following which it was referred to the joint parliamentary committee. Then the Government was forced to withdraw it on August 7, 2018 following widespread criticism of its controversial provisions, including a “bail-in” clause that suggests depositors’ money could be used by failing banks and financial institutions to stay afloat. The Bill contains a proposal for setting up a Resolution Corporation.
Pertinently, for banks and other financial institutions, traditionally the approach has been to merge a failed bank with a larger bank. According to the RBI governor, while that definitely protects the depositors’ interest, it also tends to pull down the balance sheet of the larger bank to which the failed bank is merged. A Resolution Corporation is projected as a way to ensure that a bank is resolved rather than liquidated, as depositors are expected to get a much higher value in resolution of the bank as a going concern than in liquidation.
Now, let’s revisit the contours of the FRDI Bill which I have shared on a couple of occasions in this column, as none other than the regulator has in the past pitched for the need of a Resolution Corporation, a vital part of the Bill. The Bill exclusively revolves around a situation gripped in financial distress and envisages protection to customers of financial service providers in times of financial distress; and preaches lessons of financial discipline among financial service providers in the event of financial crises, by limiting the use of public money to bail out distressed entities.
As far as setting up a Resolution Corporation, it will monitor the health of the financial entities like banks and in case of their failure; will come into play to try and resolve the issues confronting them.
However, there is a need to remove controversies around this entity. First and foremost thing is that the ‘Resolution Corporation’ once comes into being should not have adverse impact on the functioning of the financial regulators. Relevant amendments should be done so that the regulators don’t lose teeth. The banks, insurance and other financial companies should not be left at the mercy of this Corporation.
The provision of ‘bail-in’ option in the ‘Resolution Corporation’ should not be used to eat up the portion of depositors’ money in the event of a bank failure.
‘Bail-in’ is one under which creditors and depositors absorb some of the losses in case a financial institution fails. In case of a ‘bail-in’ the depositor rather than a borrower is likely to lose a portion of money deposited in the bank account.
In other words, while exercising the ‘bail-in’ option, the Resolution Corporation will lay hand on liabilities (deposits) of the financial entity to cover the losses and restart its business. More precisely, invoking the ‘bail-in’ option can lead to cancellation of repayment of various kinds of deposits. The deposits in a failed financial entity can also be converted into long term bonds or equity.
So, this controversial ‘bail-in’ option needs to be taken care of in a way that depositors are not burdened and their hard earned money is not used to cover the losses of a failed bank.
Remarkably, the Finance Minister Nirmala Sitharaman in her Budget 2020 speech among other things had stated that the Government was working on the Financial Resolution and Deposit Insurance (FRDI) Bill. Why not to work on the Bill and reintroduce it with removal of controversial clauses for the safety of money deposited in banks.
(The views are of the author & not the institution he works for)
DISCLAIMER: The views and opinions expressed in this article are the personal opinions of the author.
The facts, analysis, assumptions and perspective appearing in the article do not reflect the views of GK.