In order to deal with insolvency of firms in the financial sector, the Finance Ministry has recently sought views of the Reserve Bank of India (RBI) on drafting a modified version of the FRDI Bill which was withdrawn in 2018.
About FRDI BILL-
- The Parliament had passed FRDI Bill in 2017, however, it was withdrawn in 2018.
- The bill was meant to address the issue of insolvency of firms in the financial sector — so that if a bank, NBFC, an insurance company, a pension fund or a mutual fund-run by an asset management company fails, a quick solution is available to either sell that firm, merge it with another firm, or close it down, with the least disruption to the system and other stakeholders.
- The Bill was withdrawn due to concerns among the public over safety of deposits despite assurances by the Central government.
- The bill empowers the Central government to establish a Resolution Corporation with a head office at Mumbai. It will have 11 members including a Chairperson, three whole time members, two independent members and five ex-officio members (nominated by RBI, SEBI, IRDAI, PFRDAI and one officer from Ministry of Finance)
- Notwithstanding anything in any other law for the time being in force, while exercising its powers, the Corporation shall have the same powers as are vested in a civil court under the Code of Civil Procedure, 1908, while trying a suit.
- The Resolution Corporation has the following functions:
- provide deposit insurance to banking institutions;
- specify the criteria for the classification of a specified service provider into one of the categories of risk to viability;
- act as an administrator for the specified service provider which has been classified in the category of critical risk to viability;
- exercise powers in relation to certain termination rights in respect of specified service providers;
- resolve a specified service provider which has been classified in the category of critical risk to viability;
- act as a liquidator for a specified service provider against which an order of liquidation has been made;
- any other powers and functions as may be prescribed
- The financial firms will be classified into five categories on the basis of financial risk. to ensure that there is a clear mechanism for assessment, monitoring, and dealing with imminent failures before they occur. These categories in increasing order are : Low Moderate Material Imminent Critical
- If an institution has been classified as critical, its management will be taken over by the Resolution Firm for restoration and resolution. It will resolve the firm within one year (may be extended by another year, if needed).
- Resolution may be undertaken using methods including (i) merger or acquisition, (ii) transferring the assets, liabilities and management to a temporary firm, or (iii) liquidation (iv) Bail-in. If the resolution is not completed within a maximum period of two years, the firm will be liquidated. The Bill also specifies the order of distributing liquidation proceeds.
- The Corporation shall constitute the following funds for the purposes of this Act, namely :
- A fund for deposit insurance provided by the Corporation to the insured service providers called the Corporation Insurance Fund;
- A fund for meeting the expenses of carrying out resolution of specified service providers called the Corporation Resolution Fund;
- A fund for all other functions of the Corporation called the Corporation General Fund.
- As is the process till now, the banks will pay the premium on the deposit insurance. This amount is not mentioned in the bill. However, it says that the government in consultation with regulator (RBI) will specify the total amount payable by the corporation with respect to any depositor.
What are the concerns?
- It has been criticised that people’s money was being used to bail out banks that made bad lending decisions.
- It is also apprehended to be compromising on the interests of the depositors.
- Power – The bill proposes the setting up of a Resolution Corporation.
- The direction and management of the corporation vests with the Board, subject to the terms and conditions of the Act.
- Six of the 11 members of the Board will be nominated by the government, giving it the final say in decision-making.
- The greater representation in the Resolution Corporation gives the government overweening powers.
- Notably, debt restructuring and ensuring the robustness of financial institutions was previously the domain of the RBI.
- Bail-in clause – This clause gives banks the authority to issue securities in lieu of the money deposited.
- The insurance option covers only Rs.1,00,000 of the principal.
- The remainder of the sum deposited with a bank will be converted to tradable financial assets which can be redeemed.
- The contention is that their value will not be immediately commensurate with the deposit amount.
- As the bank has filed for bankruptcy, the value of assets held would have also eroded.
- Notably, other countries that have experimented with a bail-in clause have not fared well.
- E.g. In Cyprus, depositors lost almost 50% of their savings when a “bail-in” was implemented by the resolution corporation.
Prompt Corrective Action (PCA) framework-
- RBI has come out with a Prompt Corrective Action (PCA) framework for NBFCs (non-banking financial companies).
- The objective of the PCA Framework is to enable Supervisory intervention at appropriate time and require the Supervised Entity to initiate and implement remedial measures in a timely manner, so as to restore its financial health.
- The central bank has defined three risk thresholds for applying prompt corrective action to NBFCs.
- The PCA Framework is also intended to act as a tool for effective market discipline.
- The decision on the PCA framework came after four big finance firms — IL&FS, DHFL, SREI and Reliance Capital — which collected public funds through fixed deposits and non-convertible debentures collapsed in the last three years despite the tight monitoring in the financial sector.
Source: Indian Express