Here’s why bail-in in India is an impossibility

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Germany’s first chancellor Otto von Bismarck was particularly known for his terse comments, among other things. One such comment was when he said that if you like laws and sausages you should not watch either one being made.

Even 120 years after Bismarck’s death, the comment still makes sense, especially in the Indian context where the government of the day typically fights a never-ending perception battle when it tries introducing a new law or a change in policy.

The introduction of the Handling of the Financial Resolution and Deposit Insurance Bill (FRDI), 2017, by the government is a textbook case of how not to introduce a bill to the public. With the dark days of demonetisation still fresh in their mind, the people of India are wary of any steps taken by the government as money is concerned.

Though the bill has been sent to the joint parliamentary committee, which is studying the bill and is expected to submit its report in the winter session, some media reports fuelled by social media messages are causing panic among investors and depositors. But rather than clarifying its position on the bill as soon as the first reports were out, the government waited for social media to go absolutely berserk before the Finance Minister came out with a pacifier.

A common fear among the public with respect to the bill is that the money deposited by a customer in his or her bank account can be used to ‘bail-in’ these banks. The other concerns expressed by people ranged from the money in the bank being converted into a fixed deposit or shares of the bank. A few messages and commentaries revealed that people were also worried about their whole deposits getting lost.

Before addressing some of these fears, let us first look at what the existing rules mean for depositors and then deliberate on the changes that are expected if and when FRDI is implemented in its current form.

India has historically been a country where not only bank accounts, but even mutual funds are considered safe places to park one’s money. No depositor has ever lost his or her money despite the Deposit Insurance Corporation providing a cover of only Rs 1 lakh for both the principal amount and interest earned. The cover was only Rs 1,500 in 1962, when the corporation was incorporated, but was increased to Rs 1 lakh in May 1993.

However, the insurance company did not have much work to do as depositors of banks going under were taken care of by merging the failed banks with bigger banks.

Coming to FRDI, here is what section 52 – the section of the FRDI bill that deals with ‘bail-in’, has to say:

“…the Corporation may, in consultation with the appropriate regulator, if it is satisfied that it is necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider and to provide a measure of capital so as to enable it to carry on business for a reasonable period and maintain market confidence, take an action under this section by a bail-in instrument or a scheme to be made under section 48”.

Section 48 details the method and time of resolution and provides for all possible means to ensuring that the depositor’s money is safe. It calls for transferring the whole or part of the assets and liabilities of a specified service provider, or creating a bridge service provider, or merger or amalgamation of the specified service provider, as well as the acquisition of the specified service provider, in whole or in part.

In other words, the bill talks of ensuring that the depositor is insured and protected by the relevant regulator in all possible ways, as is the case even now. Although FRDI details the processes for how the depositors’ money is protected, what is not spelled out yet is the cover provided on the loss of one’s deposit and interest.

Given the path the government has chosen in the case of smaller banks, where they are being asked to merge with bigger ones, the cover amount is not so much of an issue as the government allowing a bank to collapse. Still, the government should have made a reference to it in the bill to allay public fear.

In any case, depositors need not worry as subsection (7) of Section 52, which talks of the bail-in instrument or scheme, clearly states that this section shall not affect any liability owed by a specified service provider to depositors to the extent such deposits are covered by deposit insurance. It also talks of not affecting any liability that the specified service provider has by virtue of holding client assets.

Subsection (7)(e) of Section 52 talks of not affecting any liability any liability, so far as it is secured – thus covering all secured deposits. Subsection (7)(f) takes care of the liability owed to employees or workmen including pension liabilities of the specified service provider, except for liabilities designated as performance based incentive.

Depositors have little to worry about in India as even failed mutual funds, as was seen in the case of Unit Trust of India, have been bailed out by the government using taxpayer money. All the depositor has to ensure is that they are part of a bigger entity. After all, if the political damage is big enough, all depositors are bound to get paid, irrespective of the bank or financial entity involved.

A classic case is the Saradha Chit fund, where the state government repaid the depositors with taxpayer money. Political capital outweighs financial capital by a mile, particularly in a country like ours. One look at farm loan waivers, where even borrowers have been taken care of, should be enough to dismiss any worries one might have about the bill.