FRDI Bill: Why India’s Attempt To Bring In A Resolution Framework For Financial Firms Failed

India's decision to bring in an Insolvency and Bankruptcy Code for non-financial corporations has been widely appreciated. It pushed up India in the ‘Ease of Doing Business' rankings and was cited as one of the reasons for a rating upgrade by Moody's Investors Service.

But when the government tried to put a bankruptcy and resolution framework for financial firms in place, the plan crashed and burned.

The Financial Resolution and Deposit Insurance (FRDI) Bill was intended to provide a mechanism for resolution of distressed financial firms. Among its many provisions were two – the setting up of a resolution corporation and the ‘bail-in' of certain categories of deposits – which became troublesome and eventually led to the withdrawal of the bill.

While moving the motion to withdraw the bill, the interim finance minister Piyush Goyal said stakeholders had raised apprehensions relating to the provisions of the bill, like the bail-in clause to resolve a failing bank. Some had also questioned the adequacy of the deposit insurance cover, the need to revise insurance limit substantially and application of resolution framework for public sector banks. “Resolution of these issues would require a comprehensive examination and reconsideration,” Goyal said in his statement.

Controversy Over Deposit Bail-Ins

The FRDI Bill introduced a provision that would allow certain categories of deposits to be ‘bailed-in'. But this specifically excluded insured deposits. The concept of a ‘bail-in' is one under which creditors and depositors absorb some of the losses when a financial institution fails.

The provisions of the bill suggested that deposits to a certain extent would continue to be insured just like in the current regime. The decision on the amount of deposits to be insured is in the hands of a regulator.

Currently, under the Deposit Insurance Corporation Act, each depositor of a bank can be only protected up to a limit of Rs 1 lakh by the guarantee of the Deposit Insurance and Credit Guarantee Corporation.

However, the provision generated much debate and controversy and was one key reason for the withdrawal of the FRDI Bill.

The bill could have removed the ‘bail-in' clause, and revised the deposit insurance cap to Rs 5 lakh through which almost all deposits would have been covered, said Ila Patnaik, a professor at National Institute of Public Finance and Policy (NIPFP).

The Resolution Corporation

The proposal to set up a separate ‘resolution corporation', which would be responsible for resolution of distressed financial firms also proved to be contentious.

Views expressed by regulators at the meetings of the Joint Committee of the FRDI Bill—which was constituted to suggest changes in the bill— show that the banking regulator was uncomfortable with the lack of clarity on the role of the resolution corporation.

Reserve Bank of India Governor Urjit Patel suggested making changes in the bill to allow appropriate regulator to carry out classification of risks in consultation with the Resolution Corporation, instead of empowering the Resolution Corporation to do this task in consultation with appropriate regulator, according to minutes of the meeting of Joint Committee.

BloombergQuint has accessed a copy of the minutes. Business Standard newspaper first reported these concerns earlier this week.

According to the minutes of the committee meetings, the RBI governor also raised concerns regarding the search and seizure powers being given to the Resolution Corporation.

Patnaik feels the RBI's concerns are not justified.

The bill had provisions for the RBI to regulate financial firms that are healthy, and gave powers to the resolution corporation to inspect financial firms that become unhealthy or stressed, Patnaik told BloombergQuint. “The resolution corporation should be given powers to look into the books of all financial firms, healthy or stressed,” said Patnaik.

Regulatory Overlap

The RBI was not the only existing regulator concerned about overlaps.

The Insolvency and Bankruptcy Board of India emphasized on the need for clear cut division of jurisdiction between Resolution Corporation and IBBI, according to the minutes of the meeting accessed by BloombergQuin.

The IBC puts in place a mechanism for resolution of non financial firms, so there is no overlapping of powers there, said Patnaik from NIPFP.

Separately, the National Housing Bank—regulator of the housing finance companies—sought its inclusion as an appropriate regulator in the bill, according to the minutes of the meeting.