MUMBAI : When it comes to their savings, a majority of Indians like to play it safe. They like to park their money in banks. As of September 2019, the total deposits of scheduled commercial banks in India stood at ₹130.4 trillion. Of this ₹81.6 lakh crore, or 62.5% of the total deposits, were with public sector banks. In smaller cities and rural areas, the proportion of deposits with public sector banks (PSBs) is higher.
But this confidence in bank deposits has taken a knock over the past few years, especially after demonetization, which increased insecurity around money. This feeling has been fuelled by recent troubles at the Punjab and Maharashtra Cooperative (PMC) Bank and Sri Guru Raghavendra Sahakara Bank in Karnataka.
Late last year, hours after the Reserve Bank of India (RBI) limited withdrawals from PMC, the news was all over social media. A fake message—claiming that after PMC Bank, the RBI and the government planned to shut down nine PSBs—went viral on WhatsApp. The RBI even had to put out a press release stating no such plan was on the anvil.
Soon, videos showing panicky PMC depositors started doing the rounds. One viral video featured a schoolteacher who had put her life savings in PMC Bank, but lost access to her money, and hence, couldn’t get her daughter married. Another news item that went viral was about a depositor who died of cardiac arrest even though he had a good amount of money in the bank. Such videos have created a sense of panic among depositors across the country.
There’s another factor that has been fuelling doubts about bank deposits. Over the last few years, the entire banking system in general and the state-owned in particular, have faced a lot of trouble.
A lot of loans given by these banks have gone bad. A bad loan is essentially a loan which hasn’t been repaid for a period of 90 days or more. The bad loans of the public sector banks peaked at ₹8.95 trillion as of March 2018. Since then they have fallen to around ₹7.79 trillion as of September 2019.
The bail-in concept
In August 2017, the government introduced the Financial Resolution and Deposit Insurance (FRDI) Bill, 2017. This Bill was referred to a Joint Committee formed by members of the Lok Sabha and the Rajya Sabha. One year after it was introduced, the Bill was quietly dropped in August 2018. That’s because there was widespread ere apprehension about the controversial ‘bail-in’ clause in the Bill.
What exactly is a ‘bail-in’? The FRDI Bill essentially envisaged the setting up of a resolution corporation (RC). The RC was supposed to monitor the health of financial firms like banks, insurance companies, mutual funds, non-banking finance companies, etc. In case of failure of any of these firms, the RC had the mandate to resolve the failure.
The term bail-in first appeared in clause 52 of the FRDI Bill. This clause basically empowered the RC “in consultation with the appropriate regulator, if it is satisfied that it is necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider."
Simply put, in case of the failure of any financial firm, be it a bank or any other firm, it can be rescued through a bail-in.
Over the last few years, the word bailout has been extensively used in the context of banks. Between April 2017 and March 2020, the government will have ended up investing ₹2.66 trillion in PSBs. With the massive losses that these banks incurred thanks to their bad loans, the capital of these banks was eroded and the government had to invest more money in these banks to keep them going. In short, it had to bail them out.
A bail-in is basically the opposite of a bailout. In a bail-in, a financial firm is rescued by restructuring its liabilities. What does that mean? Any bank deposit is a liability for a bank, given that it has to be repaid and a regular interest has to be paid on it. The Clause 52 of the FRDI Bill allowed the RC to cancel a liability or even modify its form.
So, it allowed the RC to cancel the repayment of any kind of deposit that individuals or firms had invested in. It also allowed the RC to impose a haircut. A haircut is a situation in which the bank would have negotiated with the deposit holders and repaid only a portion of the deposit and not the entire amount. The Clause 52 also allowed the RC to convert the deposits into long-term bonds or into equity as well.
Not surprisingly, the concept of bail-in created a lot of upheaval on WhatsApp. But curiously there was one devil in the detail that was not red-flagged enough: deposit insurance.
Deposit insurance
The bail-in was supposed to only impact the amount of deposit over and above what was insured through deposit insurance. The Deposit Insurance and Credit Guarantee Corporation (DICGC) essentially insures deposit amounts up to ₹1 lakh.
What this means is that if you have deposits of, say, ₹2.5 lakh with a bank that is failing, the RC has three options. It can cancel the repayment of ₹1.5 lakh ( ₹2.5 lakh minus ₹1 lakh of insured amount); or negotiate a haircut and not repay the entire amount above ₹1 lakh; or simply convert ₹1.5 lakh into long-term bonds or stocks of the failing bank (irrespective of whether you want it or not).
That’s scary, right? It’s not surprising the government had to do away with the FRDI Bill.
Recent media reports suggest that FRDI Bill now seems to be making a comeback, albeit in a new avatar. Financial journalist Sucheta Dalal reports in Moneylife that there’s a new form of the FRDI Bill doing the rounds. It’s called the Financial Sector Development and Regulation (Resolution) (FSDR) Bill, 2019.
According to Dalal, this new Bill does away with using the term bail-in. Having said that, it does allow the RC to cancel or modify the liabilities of a failing financial firm. This basically means that deposits can still be cancelled or modified into equity, with the deposit holder ending up with stocks of the bank.
It seems the Bill also talks about increasing the deposit insurance limit from the current ₹1 lakh, which has been in place since 1993. So, in that sense there isn’t much of a difference between the FRDI Bill and the new FSDR Bill. Both Bills envisage a situation where if the RC wants it may not return the deposit amount above the insured amount.