Real returns: Busting some bail-in myths

The government cannot whisk away your bank deposits in a jiffy

Been reading WhatsApp forwards that warn of a ‘tsunami’ wiping out your bank deposits? Don’t panic, as the bail-in clause and the Financial Resolution and Deposit Insurance (FRDI) Bill that contains it, have many hurdles to cross before they become law. Nor do you have to worry about your existing bank deposits being ‘bailed in’. We simplify the Bill to address the top-of-mind questions.

What’s the need for an FRDI Bill and why does it talk of bail-ins?

The FRDI Bill is intended to lay down the rules on how the problem should be resolved when a bank (or any other financial firm) defaults on its payments. Indian laws relating to bank failure are fragmented. This Bill unifies them and lays down a standard procedure. The Bill asks the government to set up a new Resolution Corporation (RC) to closely monitor banks, spot early signs of trouble and quickly initiate steps to resolve it, before a bank ends up in default. If this fails, the RC can try to rescue the bank through various methods. Clause 52 of the Bill authorises the RC to use a bail-in as one of the options.

What’s a bail-in?

In the past, when large financial firms failed in India, they were either rescued by the Government pumping in money (UTI’s US-64) or by the RBI merging the ailing firm with a healthy one (Global Trust Bank with Oriental Bank of Commerce). A bail-in is a solution wherein the bank’s own lenders are asked to make sacrifices to keep the bank running, instead of the Government pumping in taxpayer money.

The bail-in clause allows the RC to cancel any of the bank’s dues or modify terms. So, a loan to the bank can be partly cancelled, the interest can be slashed, or it can be converted into equity shares. Loans, here, can include money from account-holders.

When can this bail-in clause be used?

Only in extreme situations. The RBI and the RC will closely monitor all the banks registered with them for trouble signs. They must classify them into the low, moderate, material, imminent and critical risk categories. In case the bank is ‘critical’, the RC can create a temporary entity to take over its operations, merge it with another bank or invoke the bail-in against creditors.

Can the bail-in clause be used against bank account holders?

Clause 52 says that bail-ins cannot affect deposits that are covered by deposit insurance. But deposits beyond the insurance limit can be subject to bail-in. This is subject to two conditions. One, if your bank account is subject to a bail-in, the bank has to incorporate this into your contract terms at the time of signing up. Therefore, the bail-in provisions cannot affect your existing bank deposits. Two, the RC has powers to select specific instruments that will be exempted from bail in. These regulations will be framed after the FRDI Bill becomes law.

What portion of my bank deposits is covered by deposit insurance?

Presently, deposits in Indian banks are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) to the extent of ₹1 lakh per bank.

The ₹1 lakh limit includes both your principal and any accumulated interest in each account. For calculating it, savings accounts, fixed deposits and current accounts are added up. If the bank goes belly up, you are guaranteed this money during liquidation. Sums beyond this are not guaranteed.

However, the FRDI Bill plans to dissolve the DICGC and hand over the deposit insurance role to the RC. The RC will be tasked with providing the deposit insurance cover, creating a fund to finance it and making new deposit insurance rules.

Can the insurance be lower than now? Even ₹1 lakh is quite measly.

Unlikely. Given that the deposit insurance cover in India was last set in 1993, it is overdue for an upward revision. Plus, most developed and even emerging countries have far higher deposit insurance than India. The US, for instance, insures bank depositors up to $2,50,000 while the DICGC cover in India is about $1,540.

A bail-in was used against depositors in Cyprus and many developed nations have laws allowing it. As Indian banks are sitting on high NPAs, isn’t it highly likely to be used here?

Yes, governments across the developed world have been incorporating bail-in clauses after the credit crisis of 2008.

India’s decision to include the clause in the FRDI Bill is also prompted by a G20 initiative. But except for Cyprus, no other country has actually used it.

There are two reasons why India is unlikely to do a Cyprus to resolve its NPA problem. One, a major proportion of bank deposits in India are held by Government-owned banks and so are the NPAs. Any use of public sector bank deposits for bail-ins will shake public faith in the Central government.

This is why the Centre has announced a recapitalisation package of ₹2.1 lakh crore for public sector banks and has been so reluctant to allow failure in the past.

Two, when Cyprus invoked the bail-in clause against bank depositors, the country was in deep financial distress and had to seek an emergency loan from IMF, ECB and the European Commission. It was these external creditors who imposed harsh bail-in conditions on the Cypriot government and its banks.

After the balance of payments crisis in the early nineties, India has vastly improved its debt position and is nowhere close to a Cyprus-like situation.

The Finance Ministry’s latest data tells us that India’s foreign debt was at a moderate 23 per cent of national income in March 2017. The Indian government owes just $95 billion and has ample forex reserves of $400 billion to cover this.

If I hold more than ₹1 lakh in my bank accounts, what should I do now?

Nothing. The FRDI Bill is being examined by a parliamentary committee. You should wait for it to become law. Watch for the new deposit insurance limit. If you hold large sums above the new insured limit, then you can consider diversifying.

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