BackOrderly failure options will help Indian financial firms flourish
A modified FRDI bill is on its way that ought to address a few deficiencies in the previous draft
PremiumThe New Year seems to have brought a new ray of hope for the insolvency regime in India. The government has started discussions to put in place a resolution mechanism to deal with the insolvency of firms in the financial sector. It aims to modify and re-introduce the Financial Resolution and Deposit Insurance (FRDI) Bill.
This bill was earlier introduced in 2016 and withdrawn in 2018 primarily due to its controversial provision of a ‘bail-in’. This offered a distressed financial service provider the option to restructure its debt internally by either writing off its uninsured debt or converting deposits to other instruments such as equity. This was perceived as antithetical to the public interest, as it was alleged to put depositors’ money at huge risk. In reality, however, that bail-in clause was in the interest of depositors and also in sync with global standards. There are, however, other concerns with the framework that was proposed earlier.
The first one is of ambiguity over its scope. It has been unclear whether FRDI provisions would be applicable to pension funds and housing finance companies (HFCs), as they were not explicitly mentioned in the FRDI bill. This could have led to litigation in the future.
Further, global templates should be taken into account. The Key Attributes set by the Financial Stability Board (FSB), an international body that monitors and makes recommendations for the global financial system, emphasize time-bound payments to insured depositors. This requires that the monitoring authority for resolution cases involving financial service providers should ensure the timely pay-out or transfer of insured deposits and prompt access to transaction accounts as well as segregated client funds, irrespective of a part or whole sale of the entity. This aspect should be addressed in the revised bill.
The ‘core principles for effective deposit insurance systems’ laid out by the International Association for Deposit Insurance (IADI) find reference in the FSB’s Key Attributes for ensuring timely pay-outs. These suggest that pay-outs be made to depositors within seven working days, and, if not, then a credible plan must be in place in the jurisdiction to reach this seven-day pay-out target within two years. India’s FRDI bill had no mention of any such timeline, and only spoke about prompt pay-outs to depositors in the event of a financial firm’s liquidation. Given the experience with the Indian court system and our limitations of institutional infrastructure, promptness should be defined in line with FSB recommendations, and it should not be left to the wisdom of regulators to determine what “prompt" would be for each case.
There has also been unease in India over the coverage limit of insured deposits. At ₹5 lakh per account, it was raised last August by an amendment of the Deposit Insurance and Credit Guarantee Corporation Act, but it’s abysmally low compared to the coverage limit of insured deposits of about ₹1.84 crore in the US and ₹1.5 crore in Australia. India has the lowest limit among all G-20 jurisdictions. As deposits up to that limit are excluded from the purview of a bail-in, since that money is secure, a low coverage limit worries people who see deposits above that cap at risk because of such a provision.
Moreover, the previous FRDI bill’s provisions were silent on any immunity accorded to the directors and officers of the firm under resolution for complying with decisions of the designated resolution authority. In the absence of such immunity, challenges could arise in implementing resolution orders.
The operational independence of the resolution body that would look after the insolvency resolution of failed financial firms also needs a look-in. Given the resolution corporation’s dual role in the resolution process as well as deposit insurance of insured service providers, conflicts of interest may arise. Hence, the new bill should provide for adequate governance arrangements to manage any such conflict.
Lastly, the earlier bill did not provide for reverse-transfer powers to ‘bridge institutions’, as available across the world. Resolution authorities, as per the law in Singapore, the UK and EU, have reverse asset and liability transfer powers. India should provide for such a resolution method under its new framework. This would assist in resolving the entirety of the business, as opposed to just the ‘good’ part of the business that would have been transferred to a bridge institution, allowing the latter to manage and curb the erosion in value of key businesses. Such a mechanism would also afford more flexibility in resolving insolvencies of financial institutions while minimizing systemic damage to the financial ecosystem.
The latest Financial Stability Report issued by the Reserve Bank of India indicates that bank non-performing assets may go beyond 8% by September. Creating the legal framework to encourage quick resolution of stress and insolvency should be the government’s top priority. India can flourish politically and economically only if financial institutions that form the backbone of the economy are supported by strong regulatory pillars that allow them to flourish as well as fail.
These are the authors’ personal views.
Neeti Shikha and Urvashi Shahi are, respectively, associate dean, Indian School of Public Policy, New Delhi; and a PhD candidate at Jindal Global Law University
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