[Apoorv Madan and Rushil Anand are fourth year B.B.A. LL.B. (Hons.) students at Jindal Global Law School in Sonipat]
Background
It may be considered common knowledge, at this time, that failure of some financial institutions can have far-reaching implications on economies, sometimes resulting in full-blown financial crises. Further, because of the increasingly interconnected and globalised world, the reverberations of the failures are lot more pronounced and widespread. Despite positive developments and overall economic growth, the financial sector in India is facing tremendous pressure. This is in major part due to bad loans and other structural problems, whereby the Non-Performing Assets reached an alarming level, and the Reserve Bank of India (RBI) recently expressed concern that the problem may be getting worse. To tackle this pressing issue, the Government proposed, among other measures, the promulgation of a separate law, the Financial Resolution and Deposit Insurance Bill 2017 (“FRDI”), for governing the resolution of insolvent financial companies. Other attempts to resolve the crisis have included the introduction of a Bank Recapitalisation Plan, which envisages the infusion of Rs. 80,000 crore via recapitalisation bonds and Rs. 8,139 crore as budgetary support.
Present Regime for Resolution of Financial Companies
Presently, the resolution of stressed assets in the financial sector is largely governed by the Insolvency and Bankruptcy Code, 2016 (“IBC”), and regulations of the RBI. In February 2018, the RBI issued a revised framework for resolution of stressed assets, applicable to scheduled commercial banks and all-India financial institutions. It mandated implementing a mechanism for early identification of stress in the loan accounts. According to this, banks are obligated to classify stressed accounts into the three categories of ‘Special Mention Accounts’ (“SMAs”), depending on the days since the amount is overdue. In addition, they have to report these SMAs to the Central Repository of Information on Large Credits (“CRILC”) on a monthly basis. Other important stipulations include the requirement to put in place a board-approved resolution plan and a stringent qualifying criterion for what constitutes implementation of the resolution plan. In case the plan is not successful, it requires the lender to initiate insolvency proceedings against the borrower under the IBC within 15 days of the failure.
At this point, the revised framework is definitely a welcome step and should likely prevent more trouble for the sector. Nevertheless, it remains to be seen if it would be effective in getting the struggling sector out of this massive crisis.
Need for a Separate Resolution Framework for Banks?
A press release by the Ministry of Finance issued on 2 January 2018 explained that presently there is a regulatory lacuna as far as a detailed and integrated legal framework for resolution of financial firms is concerned. The powers and responsibilities regarding resolution of financial services are dispersed among different public institutions, and this scenario is not conducive to an efficient resolution of financial conglomerates. The Financial Resolution and Deposit Insurance Bill aimed to create a unified framework to oversee health of financial institutions including non-banking finance companies (“NBFCs”) and insurance companies.
The Bill
Over a year ago, in August 2017, the Government tabled the Financial Resolution and Deposit Insurance Bill (“the Bill”) in Parliament. The Bill proposed to prevent the failure of banks, and to ensure that “in the rare event of failure of a financial service provider, there is a system of quick, orderly and efficient resolution in favour of depositors.” The Bill is in the nature of an insolvency legislation, albeit specifically tailored for financial companies.
The most crucial feature of the Bill was its proposal to create a “Resolution Corporation” to look after functioning of the financial institutions and ensure that they do not go bankrupt. Similar to a common feature in many nations’ financial sectors, the corporation was intended to mainly monitor and flag situations where a particular firm is in danger of bankruptcy and, in certain cases, to take over the resolution of the firm.
The Bill required the Corporation to monitor and classify a financial institution’s health under five categories in order of how close the firm is to bankruptcy: (1) Low, (2) Moderate, (3) Material, (4) Imminent and (5) Critical. It empowered the Corporation to direct an institution to take measures to protect its financial health. In case where an institution was placed under “Imminent” or “Critical” category, the Bill required the firm to provide a restoration plan to the regulatorand a resolution plan to the Corporation, detailing as to how the institution plans to improve its risk status as well as containing information of its assets and liabilities. Furthermore, it empowered the Corporation to take over the resolution of a firm where the corporation was identified under the “Critical” category. The Bill required the resolution of the financial institution to be completed in a year from it being declared critical, with an option to extend the period to another year.
The Bill envisaged special designation viz. Systematically Important Financial Institutions (“SIFIs”), for firms that are ‘too big to fail’ – that are major players in the economy owing to their sheer size and interconnectedness with the economy, whose fall will adversely affect the economy. The Bill required the firms to provide information as required by the Corporation, to monitor their functioning and financial health.
The Contentious Provisions
The Bill was criticised on various grounds, largely owing to an incomplete reading of the Bill. Other than the inclusion of the sensationalised ‘bail-in’ clause, other criticisms include conflicting jurisdiction of the proposed Resolution Corporation with that of Insolvency and Bankruptcy Board of India (“IBBI”), a lack of clarity in RBI’s powers regarding resolution of financial firms after promulgation of this law, and the exclusion of the National Housing Bank.
1. Banks’ Liability towards Depositors:The Bill provided ‘bail-in’ as one of the tools that can be utilised in case a firm is close to bankruptcy.[1]Unlike ‘bail-outs’ where there is an external agency that helps a firm under the risk of bankruptcy, ‘bail-in’ gives power to utilize the money deposited with banks to recapitalize by converting depositors money into equity. Though the Financial Stability Board has recommended such clauses, it is used rarely and has created unease among public, as use of this provision may lead to private depositors money being dished out to save a firm. In effect, the Bill empowered the Government to shift its burden to the depositors. This may discourage depositing money in the bank and could possibly force people to explore alternative sources such as investment in gold or properties. However, it is imperative to note that this clause can only be applied with the depositor’s consent. In two news release (available here and here), the Government attempted to reassure, perhaps reasonably, that the provisions are not detrimental to the depositors. It maintained that they do not affect the existing protections at all, and rather, further their interests and provide additional protections. Regarding the bail-in clause, the Government stated that it shall be used sparingly. There is some force in the Government’s contention that the now lapsed Bill is lot more depositor friendly, when compared to many other jurisdictions that provide for compulsory ‘bail-in’ without the consent of the depositors. The Bill had indeed inserted sufficient safeguards to ensure that the provision is used in a reasonable and judicious manner, and is subject to the oversight of Parliament. It also argued that if used in unreasonable manner, the depositors would be entitled to claim compensation before the National Company Law Tribunal.
2. No Clause relating to Insured Amount: Notwithstanding the provision of safeguards relating to use of ‘bail-in’ clause, the Bill did not have a clause concerning maximum deposit insurance amount. The Deposit Insurance and Credit Guarantee Corporation (“DICGC”), which the Corporation would have replaced, insured all bank deposits up to Rs. 1 lakh. Banks mandatorily had to pay an insurance premium to DICGC and, in case a bank is liquidated, these premiums would be utilised by DICGC to pay the depositors. While the proposed Bill allots these duties to the Resolution Corporation, it does not specify the insured amount that would be paid to depositors in case a bank liquidates.
3. Jurisdiction Issues: The Bill also faced opposition from the RBI primarily because of the possibility of conflict of its jurisdiction with that of the proposed Financial Corporation. Various provisions of the Bill have already been incorporated by RBI in its guidelines and revised framework. There was also a lack of clarity on role of IBBI after the promulgation of the law. The National Housing Bank also stressed upon the need of its inclusion as a regulator under the Bill.
4. No Appeal Mechanism:The Bill has no appeal mechanism to challenge the Corporation’s decision. One of the reasons is to ensure that the resolution process goes unhindered, but this leaves an aggrieved person with no recourse. Furthermore, section 133 prevented matters relating to Corporation’s decisions to be challenged in court.
Conclusion and the Way Ahead
The current Government came to the power with the promise of radically restructuring the Indian economy, achieving double-digit growth and improving the ease of doing business. While there have been major reforms in the economy, the process has been rather complex. The failure of the FRDI has been latest in the series of setback. While the Bill had promised to bring in some important reforms to the financial sector, the failure to assuage public concern regarding the bail- in provision led to its eventual withdrawal.
However, this is not the end of this saga as some of the reforms the Bill intended to introduce are crucial for further development of the Indian economy as a whole. As of now the banking sector, already suffering from the Non-Performing Asset crisis, does not have a systematic resolution structure in case banks come close to bankruptcy. The Bill would have placed resolution measures to ensure early detection and prevention of such bankruptcy risks, in accordance with the recommendations of Financial Stability Board.
One possible way around the issue can be removal of the ‘bail-in’ provision. This would not only help remove concerns regarding the provision, but also pave the way for introduction of other crucial reforms such as the Resolution Corporation. According to the latest media reports, the Government intends to introduce the Bill in its ‘new form’. While there are no details about this new form of the Bill, the reforms it intends to bring are necessary to enhance the resilience of the economy and help it achieve further growth.
– Apoorv Madan & Rushil Anand
[1] Section 52, The Financial Resolution and Deposit Insurance Bill, 2017.