Various surveys point out that the majority of households prefer to park their money in bank deposits, with less than 10 per cent opting for investing in mutual funds or stocks. Why? Because consumers believe that investing in bank fixed deposits is one of the safest and oldest (hence tried and tested) ways to park their surplus funds and thereby earn regular interest income. In fact, now is perhaps a good time to invest in bank fixed deposits, as the rates are going upwards. With Reserve Bank of India (RBI) needing to reduce liquidity and money supply in the banking/monetary system, the last few months of 2018 have seen banks revising the deposit interest rates upwards to tap into the excess liquidity. But what if the financial situation of a bank deteriorates so much that it becomes unable to repay the deposits it holds? What guarantee does the customer have in such a situation?
All banks that are members of Deposit Insurance & Credit Guarantee Corporation (DICGC) enjoy a degree of protection – there is insurance coverage against the bank winding up and/or liquidation of the bank, for which the bank needs to pay a nominal insurance premium at regular intervals. The bank depositors thereby enjoy DICGC cover up to Rs 100,000 per deposit account in each bank, in the event of an unfortunate event.
Now, with the proposed introduction of Financial Resolution & Deposit Insurance (FRDI) Bill (pending passage in Lok Sabha and Rajya Sabha before becoming an Act of Parliament), there may soon be a replacement for the existing DICGC. When incorporated, the Act will provide deposit insurance up to a certain limit (unconfirmed sources indicate a higher deposit limit of up to Rs 300,000) in the event of bank failure.
The new Bill is being incorporated to deal with issues that can arise when companies operating in the financial sector (such as banks, insurance companies and stock exchanges) go bust. It may be noted that the Insolvency and Bankruptcy Code (IBC) is already in place to deal with situations where companies (incorporated under The Companies Act) go bankrupt or insolvent.
The FRDI Bill has a provision that has caused some grief among bank depositors. Apparently it allows merger/acquisition, bail-in, transfer of a sick entity’s assets and liabilities to a third party (so as to form a bridge company to control these assets and liabilities), and liquidation. In other words, it allows failing banks to use depositors’ money to cut losses.
The bill has suggested that the use of the ‘bail in’ provision may result in cancellation of a liability, which could extend to bank deposits or could lead to modification of the terms or changing the form of the asset class. This provision would be last in the line for payments in case of liquidation.
To assuage the anxiety of depositors, the government has said that public sector banks are well out of the radar as such emergencies are not likely to arise in them, the reason being that the government takes care of the capital needs of these banks. On the other hand, this tool will serve as the last resort in private sector banks only when a merger/acquisition is not viable.
The Bail-in Provision
Bail-in has been proposed as one of the resolution mechanisms in one of the clauses (52) for sustainability of a failing financial firm. The Bill provides for the establishment of a resolution corporation with the power to liquidate depositors’ money in case of bankruptcy.
Bail-in can also be invoked if the depositor had given prior consent at the time of signing the deposit application/forms.