FRDI ‘Hajamat’: Don’t Worry I Won’t Shoot,
Then Why the Gun ?
Finance Ministry’s assurances are illusory
The Financial Resolution and Deposit Insurance (FRDI) Bill 2017, is intended to resolve the financial distress that may develop in financial institutions (called “financial service providers”), specifically in banks.
It is also intended to provide a basis for providing depositors in banks with a degree of assurance that a specified minimum of deposits will be secure in the event of a financial crisis in the bank. The method of doing this is by raising a Resolution Corporation (RC) with appropriate powers.
RBI’s Financial Stability Report, 2016, mentions that by forming a Resolution Corporation (RC), India would be adhering to the Financial Stability Board’s (FSB) “Key Attributes of Effective Resolution Regimes for Financial Institutions” published in October 2014. FSB is an international organization established in 2009, to regulate international financial reform. So apparently, the FRDI Bill is intended to comply with international best practices in our national financial management.
Since this is about banks and their financial stability, it is well to note that banks survive by providing loans and earning interest on the loans provided. The capital for providing loans is from institutional and individual depositors, both small and large, who as creditors, earn interest on their deposits from the bank.
The bank uses its capital to provide loans. Simplistically put, when interest is not paid by a borrower, the bank takes measures to recover the interest and the principal. These measures include recovering the security based upon which the loan was provided, issuing legal notice to the guarantor to pay up, legally auctioning the borrower’s property to realise the moneys due, and taking civil or criminal action against the borrower.
If the amount due is not fully realised after auctioning the assets of the defaulting borrower, the unobtainable balance is “written-off” from the books with the concurrence of Ministry of Finance (MoF) and RBI. These methods are in use, but when the amounts are very large and the borrowers are politically very powerful, and in particular for public sector banks (PSBs), Government of India (GoI) provides money to the PSBs from public funds to “bail out” the bank. This is not unlike the case of a person arrested by police being bailed out of judicial custody by a friend who pays the bail money.
According to one estimate, GoI has been providing the big corporations tax holidays by excusing corporate income tax and excise and customs duties of around Rs.90 lakh-crores in the 11-years period 2005-2016, reflected as “Revenue foregone” in successive budgets. That is, revenue which would have been available for use in the health, education and social welfare sectors including MNREGA has been foregone, even while GoI rues lack of funds for these very sectors. To be fair, this is a legacy problem, but the present government has done little different from its predecessors.
Benefit to the corporate sector through “Revenue foregone” is merely one half of the dodgy benefit to the corporate world. The other half of the dodge is providing enormous loans to the beneficiaries of “Revenue foregone” in the name of boosting the industrial sector in pursuit of the Holy Grail of economic growth. And when these loans are not serviced, the bank either declares the loan as a non-performing asset (NPA) or else proffers another loan which is used to pay back the earlier loan (this is termed “re-financing”), so that the NPA is taken off the books.
Of course, the names of corporates which avail the holiday on corporate tax and excise and customs duties may not all figure among the names of defaulting borrowers, but many really big corporates benefit by tax holidays and also borrowing money which become NPAs which are then written-off. Impeccably smart footwork by successive finance ministers in consultation with their prime ministers, to keep the corporates in good spirits, using public money! Today, PSBs are finding it difficult to lend because around 40 large corporate groups owe around Rs.10 lakh-crore rupees.
That borrowings from PSBs are used by big corporates to finance mega-projects which cause population displacement, impinge adversely on the environment, and exacerbate global warming and climate change, is another dimension which is outside the scope of the present article.
With this mode of financial operation within the oversight of MoF and RBI, PSBs have NPAs which are treated as “losses incurred” and are a significantly dangerous proportion of their balance sheets. Thus, PSBs are in a position of precarious financial stability. These same PSBs are where you and me and umpteen others have invested our life savings as deposits, which are entered as liabilities in the balance sheet of the bank.
And so we come to the matter of resolution of financial crises and insurance for the deposits made in banks by members of the public, which is the reason for the FRDI Bill, 2017.
Journalist P.Sainath says: “A large part of the trillions in NPAs ... was run up by the wealthy who can’t be named due to ‘secrecy laws’ ”. Hence in the past, to resolve the problem of financial stability, GoI has bailed out banks, re-financing them by pumping in tax payers’ money. But that is not deemed sufficient in the present precarious financial condition of financial institutions, and hence the need for a bail-in option, described in FRDI Bill Section 52, to “absorb the losses incurred or reasonably expected to be incurred”.
The FRDI Bill caused fears among depositors principally due to the implications of the bail-in option available to the Resolution Corporation. However, Government made an attempt to allay these fears. [“Fears over FRDI Bill misplaced, says Government”; January 3, 2018; The Hindu;http://www.thehindu.com/news/
It is also intended to provide a basis for providing depositors in banks with a degree of assurance that a specified minimum of deposits will be secure in the event of a financial crisis in the bank. The method of doing this is by raising a Resolution Corporation (RC) with appropriate powers.
RBI’s Financial Stability Report, 2016, mentions that by forming a Resolution Corporation (RC), India would be adhering to the Financial Stability Board’s (FSB) “Key Attributes of Effective Resolution Regimes for Financial Institutions” published in October 2014. FSB is an international organization established in 2009, to regulate international financial reform. So apparently, the FRDI Bill is intended to comply with international best practices in our national financial management.
Since this is about banks and their financial stability, it is well to note that banks survive by providing loans and earning interest on the loans provided. The capital for providing loans is from institutional and individual depositors, both small and large, who as creditors, earn interest on their deposits from the bank.
The bank uses its capital to provide loans. Simplistically put, when interest is not paid by a borrower, the bank takes measures to recover the interest and the principal. These measures include recovering the security based upon which the loan was provided, issuing legal notice to the guarantor to pay up, legally auctioning the borrower’s property to realise the moneys due, and taking civil or criminal action against the borrower.
If the amount due is not fully realised after auctioning the assets of the defaulting borrower, the unobtainable balance is “written-off” from the books with the concurrence of Ministry of Finance (MoF) and RBI. These methods are in use, but when the amounts are very large and the borrowers are politically very powerful, and in particular for public sector banks (PSBs), Government of India (GoI) provides money to the PSBs from public funds to “bail out” the bank. This is not unlike the case of a person arrested by police being bailed out of judicial custody by a friend who pays the bail money.
According to one estimate, GoI has been providing the big corporations tax holidays by excusing corporate income tax and excise and customs duties of around Rs.90 lakh-crores in the 11-years period 2005-2016, reflected as “Revenue foregone” in successive budgets. That is, revenue which would have been available for use in the health, education and social welfare sectors including MNREGA has been foregone, even while GoI rues lack of funds for these very sectors. To be fair, this is a legacy problem, but the present government has done little different from its predecessors.
Benefit to the corporate sector through “Revenue foregone” is merely one half of the dodgy benefit to the corporate world. The other half of the dodge is providing enormous loans to the beneficiaries of “Revenue foregone” in the name of boosting the industrial sector in pursuit of the Holy Grail of economic growth. And when these loans are not serviced, the bank either declares the loan as a non-performing asset (NPA) or else proffers another loan which is used to pay back the earlier loan (this is termed “re-financing”), so that the NPA is taken off the books.
Of course, the names of corporates which avail the holiday on corporate tax and excise and customs duties may not all figure among the names of defaulting borrowers, but many really big corporates benefit by tax holidays and also borrowing money which become NPAs which are then written-off. Impeccably smart footwork by successive finance ministers in consultation with their prime ministers, to keep the corporates in good spirits, using public money! Today, PSBs are finding it difficult to lend because around 40 large corporate groups owe around Rs.10 lakh-crore rupees.
That borrowings from PSBs are used by big corporates to finance mega-projects which cause population displacement, impinge adversely on the environment, and exacerbate global warming and climate change, is another dimension which is outside the scope of the present article.
With this mode of financial operation within the oversight of MoF and RBI, PSBs have NPAs which are treated as “losses incurred” and are a significantly dangerous proportion of their balance sheets. Thus, PSBs are in a position of precarious financial stability. These same PSBs are where you and me and umpteen others have invested our life savings as deposits, which are entered as liabilities in the balance sheet of the bank.
And so we come to the matter of resolution of financial crises and insurance for the deposits made in banks by members of the public, which is the reason for the FRDI Bill, 2017.
Journalist P.Sainath says: “A large part of the trillions in NPAs ... was run up by the wealthy who can’t be named due to ‘secrecy laws’ ”. Hence in the past, to resolve the problem of financial stability, GoI has bailed out banks, re-financing them by pumping in tax payers’ money. But that is not deemed sufficient in the present precarious financial condition of financial institutions, and hence the need for a bail-in option, described in FRDI Bill Section 52, to “absorb the losses incurred or reasonably expected to be incurred”.
The FRDI Bill caused fears among depositors principally due to the implications of the bail-in option available to the Resolution Corporation. However, Government made an attempt to allay these fears. [“Fears over FRDI Bill misplaced, says Government”; January 3, 2018; The Hindu;http://www.thehindu.com/news/
MoF is reported to have made the following statements to allay fears:
1. “Most certainly, it [bail-in] will not be used in case of a public sector bank as such a contingency is not likely to arise”.
2. “The implicit guarantee for solvency of public sector banks remains unaffected as the government remains committed to adequately capitalise them and improve their financial health.”
3. “Cancellation of the liability of the depositor beyond insured amount will be possible only with the prior consent of the depositor”.
4. “In case of injudicious and unreasonable exercise of bail-in power by the Resolution Corporation, for example, where the depositors of a bank get less value than in liquidation, such affected depositors will have the right to get compensation from the Resolution Corporation on an order of the National Company Law Tribunal”.
Basically, Government assures depositors that
- Depositors’ misgivings regarding the depositor protection in the context of the bail-in provisions, are entirely misplaced,
- bail-in has been proposed as merely one of the resolution tools in the event a financial firm is sought to be sustained by resolution,
- the bail-in clause will only be implemented with the consent of depositors, and
- it reiterates its implicit guarantee for the solvency of PSBs.
Let us consider these assurances together with the quoted statements of MoF. First off, the depositors concern is precisely why at all the bail-in provision should be made available – at least in the case of PSBs – when the cause for resolution is primarily NPAs, mostly due to default of the big borrowers, possibly in collusion or connivance with bank officials and MoF officials. Assuring a depositor that bail-in will not be used as such a contingency is not likely to arise, is akin to holding a gun to a depositor’s head and assuring the depositor, “Don’t worry, I won’t shoot”.
1. “Most certainly, it [bail-in] will not be used in case of a public sector bank as such a contingency is not likely to arise”.
2. “The implicit guarantee for solvency of public sector banks remains unaffected as the government remains committed to adequately capitalise them and improve their financial health.”
3. “Cancellation of the liability of the depositor beyond insured amount will be possible only with the prior consent of the depositor”.
4. “In case of injudicious and unreasonable exercise of bail-in power by the Resolution Corporation, for example, where the depositors of a bank get less value than in liquidation, such affected depositors will have the right to get compensation from the Resolution Corporation on an order of the National Company Law Tribunal”.
Basically, Government assures depositors that
- Depositors’ misgivings regarding the depositor protection in the context of the bail-in provisions, are entirely misplaced,
- bail-in has been proposed as merely one of the resolution tools in the event a financial firm is sought to be sustained by resolution,
- the bail-in clause will only be implemented with the consent of depositors, and
- it reiterates its implicit guarantee for the solvency of PSBs.
Let us consider these assurances together with the quoted statements of MoF. First off, the depositors concern is precisely why at all the bail-in provision should be made available – at least in the case of PSBs – when the cause for resolution is primarily NPAs, mostly due to default of the big borrowers, possibly in collusion or connivance with bank officials and MoF officials. Assuring a depositor that bail-in will not be used as such a contingency is not likely to arise, is akin to holding a gun to a depositor’s head and assuring the depositor, “Don’t worry, I won’t shoot”.
Next, MoF’s assurance that the bail-in clause will only be implemented with a depositor’s consent is patently illusory, because not a single depositor in all of India would be crazy enough to consent to MoF taking away deposits made with his hard-earned money representing his life savings, to settle the banks NPAs in the resolution process.
It is bad enough that the bail-out process using tax-payers’ money to balance the books of banks which have huge NPAs is being used, instead of recovering dues from borrowers and punishing colluders and connivers among bank staff and MoF staff.
Stating that if the RC injudiciously or unreasonably exercises its bail-in powers, the “... affected depositors will have the right to get compensation from the Resolution Corporation on an order of the National Company Law Tribunal” involves a decision concerning judiciousness and reasonableness which is outside the depositor’s control. Several questions arise at this point.
Even if the decision favours the depositor, would this apply to all the millions of depositors, how would they know the decision and demand compensation, what is the quantum and process of compensation, what is the depositor’s access to the RC and NCLT, how will the inevitable corruption in the compensation process be handled, etc.
Saying: “Most certainly, it [bail-in] will not be used in case of a public sector bank as such a contingency is not likely to arise”, containing the phrases “most certainly” and “not likely to arise” at the start and finish of the very esame sentence, bringing the “Don’t worry, I won’t shoot” message to mind. If the man with the bail-in ‘gun’ assures that he will not pull the trigger, what indeed is the need for the bail-in ‘gun’?
The statements: “The implicit guarantee for solvency of public sector banks remains unaffected as the government remains committed to adequately capitalise them and improve their financial health “(presumably by bail-out using tax-payers’ money) and also that bail-in “... will not be used in case of a public sector bank as such a contingency is not likely to arise”, do not create confidence, but on the other hand cause apprehension whether these are duplicitous statements.
In the FRDI Bill, "haircut" is one of the terms used concerning bail-in. It means a percentage reduction in the amount that is payable to the creditors (depositors) as a means of adjusting for losses due to non-recovery of NPAs. It is piquant that the word “hajamat” is Hindi for “haircut”, with the alternate meaning of fleecing somebody, with words or phrases carrying precisely the same double meaning in other Indian languages. The FRDI Bill does not inspire public confidence.
______________________________
AIM of the FRDI BILL: To provide for # the resolution of certain categories of financial service providers in distress; # the deposit insurance to consumers of certain categories of financial services; # designation of systemically important financial institutions; and # establishment of a Resolution Corporation for protection of consumers of specified service providers and of public funds for ensuring the stability and resilience of the financial system and for matters connected therewith or incidental thereto.
It is bad enough that the bail-out process using tax-payers’ money to balance the books of banks which have huge NPAs is being used, instead of recovering dues from borrowers and punishing colluders and connivers among bank staff and MoF staff.
Stating that if the RC injudiciously or unreasonably exercises its bail-in powers, the “... affected depositors will have the right to get compensation from the Resolution Corporation on an order of the National Company Law Tribunal” involves a decision concerning judiciousness and reasonableness which is outside the depositor’s control. Several questions arise at this point.
Even if the decision favours the depositor, would this apply to all the millions of depositors, how would they know the decision and demand compensation, what is the quantum and process of compensation, what is the depositor’s access to the RC and NCLT, how will the inevitable corruption in the compensation process be handled, etc.
Saying: “Most certainly, it [bail-in] will not be used in case of a public sector bank as such a contingency is not likely to arise”, containing the phrases “most certainly” and “not likely to arise” at the start and finish of the very esame sentence, bringing the “Don’t worry, I won’t shoot” message to mind. If the man with the bail-in ‘gun’ assures that he will not pull the trigger, what indeed is the need for the bail-in ‘gun’?
The statements: “The implicit guarantee for solvency of public sector banks remains unaffected as the government remains committed to adequately capitalise them and improve their financial health “(presumably by bail-out using tax-payers’ money) and also that bail-in “... will not be used in case of a public sector bank as such a contingency is not likely to arise”, do not create confidence, but on the other hand cause apprehension whether these are duplicitous statements.
In the FRDI Bill, "haircut" is one of the terms used concerning bail-in. It means a percentage reduction in the amount that is payable to the creditors (depositors) as a means of adjusting for losses due to non-recovery of NPAs. It is piquant that the word “hajamat” is Hindi for “haircut”, with the alternate meaning of fleecing somebody, with words or phrases carrying precisely the same double meaning in other Indian languages. The FRDI Bill does not inspire public confidence.
______________________________
AIM of the FRDI BILL: To provide for # the resolution of certain categories of financial service providers in distress; # the deposit insurance to consumers of certain categories of financial services; # designation of systemically important financial institutions; and # establishment of a Resolution Corporation for protection of consumers of specified service providers and of public funds for ensuring the stability and resilience of the financial system and for matters connected therewith or incidental thereto.
*********************
The bail-in clause in Sec 52 of the Financial Resolution and Deposit Insurance (FRDI) Bill, 2017, reads as follows:
52. (1) Notwithstanding anything in section 49, the Corporation may, in consultation with the appropriate regulator, if it is satisfied that it 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.
(2) The bail-in instrument or scheme referred to in sub-section (1) shall be in such form and manner as may be specified by regulations made by the Corporation, and contain—
(a) a bail-in provision; or
(b) a provision for the purposes of or in connection with any bail-in provision made by that instrument or by another instrument.
(3) Subject to sub-section (5), a bail-in provision means any or a combination of the following, namely:—
(a) a provision cancelling a liability owed by a specified service provider;
(b) a provision modifying or changing the form of a liability owed by a specified service provider; and
(c) a provision that a contract or agreement under which a specified service provider has a liability shall have effect as if a specified right had been exercised under it.
(4) The Corporation shall, by regulations, specify the liabilities or classes of liabilities of a specified service provider, which may be subject to bail-in.
(5) The appropriate regulator may, in consultation with the Corporation, require specified service providers or classes of specified service providers to maintain liabilities that may be subject to bail-in and the terms and conditions for such liabilities to contain a provision to the effect that such liabilities are subject to bail-in.
(6) In addition to the actions laid down in sub-section (3), the Corporation may, in consultation with the appropriate regulator, take the following actions in respect of a central counterparty, namely:—
(a) direct the haircutting of the collaterals and margins;
(b) direct the issuance of equity to the creditors.
Explanation.—For the purposes of this sub-section, “haircut” shall have the same meaning as assigned to it in section 44.
(7) The bail-in instrument or scheme under this section shall not affect—
(a) any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance;
(b) any liability that the specified service provider has by virtue of holding client assets.
Explanation.—In this clause, the expression, “client assets” shall include such assets as may be specified by regulations made by the appropriate regulator;
(c) any liability of original maturities upto seven days;
(d) any obligation to a central counter party;
(e) any liability, so far as it is secured;
(f) any liability owed to employees or workmen including pension liabilities of the specified service provider except for liabilities designated as performance based incentive under section 51;
(g) any transaction covered under section 47; and
(h) such other liabilities as may be specified by regulations made by the appropriate regulator in consultation with the Corporation and the Central Government.
(8) The Corporation shall forward the bail-in instrument made under this section to the Central Government together with a report in such form and manner as may be prescribed, which shall contain—
(a) the reasons why a bail-in instrument under this section was made;
(b) the effect of the bail-in instrument; and
(c) the deviations, if any, from the requirements of sub-section (3) and the reasons therefor.
(9) A copy of the report received under sub-section (8) shall, as soon as may be after it is received by the Central Government, be laid before each House of Parliament.
(10) The provisions of sub-sections (3) and (6) of section 49 shall apply, mutatis mutandis, to the bail-in instrument or scheme under this section.
Major General S.G. Vombatkere, VSM, retired as Additional DG Discipline & Vigilance in Army HQ AG's Branch. His area of interest is strategic and development-related issues.
