Money in the bank, or for it?

Last week, this paper’s sister publication, The Hindu Business Line, published a series of stories, based on information sourced from people close to the matter, on what the various institutional stakeholders who are likely to be impacted by the Financial Resolution and Deposit Insurance Bill 2017 (FRDI Bill) actually think about it. These range from the Reserve Bank of India (RBI) to state-owned and private banks. The Bill was introduced in Parliament last August but is still being vetted by a parliamentary standing committee.

The elephant in the room

To no one’s surprise, it emerges that all of them — behind closed doors and protected by parliamentary privilege — have strong reservations about it. Most want major clauses changed or dropped; some even argued for a rethink on the Bill itself. But all this was to protect their own turfs. The RBI was worried about ‘dual oversight’ and who will actually take the call on when a bank is failing. Public sector undertaking (PSU) banks wanted to protect their bailiwick. And so on. No one talked about the one provision in the FRDI Bill which has caused alarm and despondency amongst millions of bank depositors, mostly India’s much-neglected poor, and the middle class: the infamous ‘bail-in’ clause.

This is the clause that empowers the Resolution Corporation (which will be created to handle cases of bank failure if the Bill becomes law) to either cancel, alter or modify the liability owed by a service provider. Simply put, your money in the bank — whether in a savings account or in a fixed deposit — is a liability owed by the ‘service provider’, i.e., the bank. If the bank is going belly-up, the Resolution Corporation is empowered to either use your deposit money to shore up the bank’s finances and make you suffer the losses, or convert your deposit into bonds or equity.

Faced with mass panic and a massive social media backlash, the government has been at pains to point out that the existing protection for depositors is not being touched and that the Bill provides “enhanced protection” for depositors. This includes a clause which says that no depositor will receive less than what he/she would have got if the bank had been liquidated and its assets distributed among creditors. Further, your deposit can be cancelled or converted only if you have agreed to do so in the contract governing such debt.

Loss to depositors

Quite apart from the fact that no one reads the fine print on fixed deposit forms, and even if they read them, no one but a trained lawyer would understand what it is they are agreeing to, the bigger issue is that the entire issue of deposit insurance is taken as read. In other words, the government just assumes that the status quo is fine and everyone will be happy if it remains unchanged.

Wrong. Indian depositors are woefully undercovered if banks in which they are putting their money fail. The Deposit Insurance and Credit and Guarantee Corporation (DICGC), an RBI arm, insures deposits only up to ₹1 lakh — a sum unchanged since 1993. Less than a third of the deposits with banks (by value) are covered by insurance.

The government and the RBI point out that the global average is 20-30% of deposits in the system (which India meets), but what they don’t tell you is that the quantum of cover is among the lowest in the world. In the U.S., deposits up to $250,000 are covered. Even Brazil offers coverage of over $75,000, while in India, this is a measly $1,500. Furthermore, a whopping 85% of deposits are higher than the cover limit of ₹1 lakh. So, if banks do fail, an overwhelming majority of depositors will suffer massive losses.

Here’s another factoid — virtually every penny of the payouts that the DICGC has made so far has gone to co-operative banks. No PSU bank has failed or been liquidated so far, since the RBI has insured mergers or takeovers and thus protected depositors. The handful of private bank failures have been tiny and their impact muted.

Meanwhile, banks are understandably reluctant to pay more premium to DICGC, since they see that as funding co-op bank failures.

What can be done

This needs to be fixed first before tackling any major restructuring. There are multiple options for this. Co-op banks can be excluded from this (let their regulator, the Registrar of Co-operatives, figure it out). Second, deposits above a certain limit — say, ₹50 lakh, given current inflation levels — can be kept out of insurance cover, or have the option for a voluntary opt-in at a higher premium. And third, the amount of cover should be increased substantially, to at least half the average value of deposits, excluding high-value deposits of, say, above ₹5 crore.

All this requires substantial political will. The co-op bank bit will be a hot potato, since most of the political class has a vested interest in them. Likewise, forcing higher insurance premiums on banks will only worsen their already precarious situation. But the alternative — of doing nothing, or worse, letting a loosely worded FRDI Bill with no clear-cut provisions become law — will only make the situation much, much worse.


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