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- The Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) seeks to establish a Resolution Corporation under the Finance Ministry to monitor all financial firms, and handle any financial failure in any F.I. (including PSBs) including liquidation and insurance matter of depositors and creditors to the F.I. These tasks are presently handled by the RBI. The Clause #52 of “Bail-in” has created a nationwide depositor panic, fearing retail haircut also.
- What is the FRDI, 2017: It is a bill that proposes the creation of a “Resolution Corporation”. The draft bill and its clauses 52 and 53 carry the details of a bail-in provision, which is the source of panic.
- Bail-in versus Bail-outs: The global financial crisis 2008 saw American government forced to offer bailouts to the failed (and failing) financial firms (banks, insurance companies etc.) That was through taxpayer money, hence a BAILOUT. The other is BAIL-IN which is done using internal resources (not external) – like the depositor money lying with you.
- India versus the West: It is important to note that in the West, most of the deposits mobilised by Banks are from the wholesale markets (money market MFs etc.). But in India, crores of small “retail depositors” invest their life’s savings in banks (FDs and Saving Accounts). For Indian banks, retail deposits are the mainstay of their liquidity.
- No “security” for our savings: When an Indian puts her money in a Bank, she does not get any security from the Bank in return. It is pure trust. We become the “unsecured creditors” to the Bank, unlike the institutional secured creditors (who may have invested in Banks’ bonds or debentures etc.) That is why, the GoI and RBI ensures no big Bank ever fails.
- How much is insured, really? Today, only upto Rs.1 lac of depositor money is secured (insured). If the F.I. goes insolvent (broke), then anything above this may be lost by the depositor. This limit, fixed in 1993, is due for a major revision (say, to Rs.2 lacs / 3 lacs).
- Numbers of insured: Using the Rs.1 lac standard, today nearly 81% depositors are secured (insured), and 32% of deposits are insured. So actually not many would be affected – but panic is panic {Globally 21-30% is the standard}
- Will any big bank go bust? In India, the GoI and RBI together have ensured that through mergers and acquisitions, any bank collapse is always prevented.
- The crisis in the West: The huge sub-prime lending in the American housing market from 2000-2007 led to the housing market collapse – and the consequent global recession. It was a fire that was doused by huge doses of bailouts by the US govt, using the TARP funds.
- FSB and G-20: As a result of the mayhem, the FSB (Financial Stability Board) was formed in 2009, and tasked with monitoring the global financial system and forming policies to avoid a similar collapse anytime soon (or again).
- Western Capitalist Model: The capitalist model in West is under tremendous pressure. There is a raging debate on the 1% versus the 99%. Wealth inequity is at an all time high, with every Oxfam Report indicating a growing chasm of wealth in the world.
- Government and Private Sector: There is a significant inter-movement between the government and the private sector in the US. It is not uncommon to see chiefs of big private banks become high government functionaries.
- G-20 at the forefront: What was purely a central banker platform initially turned into the powerful political CEOs platform to handle the crisis post-2007. The problem with India is “to be seen in sync with them, as our ratings and EODB ranks depend on it”.
- The pressures in Indian Banking: The truth is that most of the PSBs are nearly bankrupt, as their net worth is totally eroded due to the bad debts. The overall NPA level was Rs.10 lac crores in the system by end 2017.
- How did we get into this ditch? The years from 2002 onwards were marked by irrational exuberance worldwide. Everywhere was a sense of financial success, and “risk being tamed” through quantitative models. But the US failed first. Raghuram Rajan was among the first to hint this in 2005 (was ridiculed).
- Huge loans to infra: This exuberance led to huge loans made out to infra companies (by PSBs, under political pressure, in India), many of which went bad.
- Asset – Liability mismatch: The deposits are banks’ liabilities, and loans are assets. If your deposits are short-term (or mid-term) and assets long-term, then there is a clear mismatch. Indian banks have paid a heavy price for it.
- Insolvency Resolution a nightmare! The new IBC law (Insolvency and Bankruptcy Code) was passed in 2016, to finally stop “kicking the NPA can down the road” and make promoters and bankers finally face the truth. But the resolution process has turned into a near nightmare with huge haircuts for the Banks.
- Rs.2.11 lac crore recapitalisation: In Nov. 2017, this Recap plan for PSBs was announced. Welcomed.
- The FRDI came in parallel: Now if you see the whole situation in parallel, it becomes clear that a lot is happening. People’s fear, in the remote case, may actually turn out to be true (unless there is an unequivocal rejection of the clause # 52 etc.)
- What next? The road ahead for India is clear (1) Do not allow direct impounding of deposits for any kind of “bail-ins” (2) Increase deposit insurance to at least Rs.3 lacs (3) Do not create any confusion with the word “securities” – make it explicitly clear (4) Avoid any mixing of Western models in our reality, which is totally different
- Questions for your practice:
- Explain the complete dynamics of the 2007 global recession.
- Explain how Indian banking system accumulated so much of bad debts.
- Is a separation of governance and regulation desirable in banking? Why?
- What is likely to be the final outcome of this entire debate? Speculate.
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