Investor’s Query: There is a lot of talk and news going around bail in issue could you please share your understanding on this and ease my mind with regards to bank deposits and mutual fund investments?
Mr. Gerard Colaco: A lot of clients and others have asked for our opinion about the FRDI bill. However, stop panicking at everything you read in the press or receive through idiotic WhatsApp ‘viral’ messages. The FRDI is a good move. It does not affect mutual funds.
Here is my opinion about the Financial Resolution and Deposit Insurance Bill, 2017, commonly referred to as FRDI. There is a lot of uninformed and unenlightened loose talk about the FRDI. Viral internet massages do not improve the situation either, because they are almost entirely all noise and no signal.
India is a member of the G-20 group of countries. These countries resolved to implement bail-in provisions in the aftermath of the global financial crisis of 2008. Right now, the FRDI is not law. It is a bill which was tabled in the Lok Sabha. It was referred to a joint parliamentary committee for its suggestions.
So it has some way to go before it becomes law. I will take action, if any, only after I know what the final legal provisions look like. Also, FRDI does not apply to mutual fund investments. It is mainly applicable to banks, insurance companies and some other credit institutions, especially those considered too big to fail.
Several countries have implemented similar laws pertaining to robust resolution of issues relating to troubled financial institutions. Essentially, the FRDI bill aims for an orderly winding up of a financial institution. To that extent, it is a good, preemptive move.
The FRDI provides for the establishment of a resolution corporation (RC). The RC will identify early warning signs of distress at financial institutions, including banks, non-banking financial companies, insurance companies, stock exchanges, etc.
If any financial institution falls under the ‘critical risk’ category, the RC will immediately take over, while the sector regulator would continue to attempt to resolve the crises. For example, if a bank reaches critical risk, the RC will step in. Simultaneously, the RBI, which is the sector regulator, will continue with attempts to resolve the problem.
If the sector regulator fails, or, even as the regulator’s rescue attempts are ongoing, if the RC feels that drastic and speedy action is required, it will exercise the powers and take the necessary steps it is legally authorised to. The weapons at the RC’s disposal shall be transfer of assets and/or liabilities to another firm, forced mergers, liquidation, bail-ins and temporarily running the firm under a different management or entity. Bail-ins are not the only options available to the RC.
The basic objective here is resolution. This is now an accepted fact in developed markets. The Indian FRDI follows their example. It must also be borne in mind that that FRDI does not do away with bailouts. A bailout is a sovereign right of the government. No law needs to provide for it. No law can take it away. The bailout option will always remain with the government.
Finally, if any bank is allowed to go into liquidation and depositors actually lose money, politicians will lose votes. That would be political suicide. That is why, some 16 years back, even a relatively insignificant bank like Global Trust Bank was not allowed to go bankrupt when it imploded, mainly because of bad loans given to business.
The RBI stepped in and ordered Global Trust Bank to be merged with Oriental Bank of Commerce. Shareholders lost everything. Account holders and depositors lost nothing. The politically and electorally disastrous fallout of depositors losing money because of the failure of any reasonably large bank remains the rest protection that a depositor could have. This protection is infinitely more potent than bail-outs, bail-ins and deposit insurance combine.
So, what should a normal individual or a small business do? First, wait for FRDI to become law. Then study is provisions. If they cause discomfort, ensure that you have 2 or 3 bank accounts, say, taking care to choose at least one leading public sector bank and one leading private sector bank. Distribute your money between these banks. Diversification always helps. All banks are not likely to go into bankruptcy simultaneously. Ditto for business accounts.
I would also ensure that the banks I deal with have their shares listed on the stock exchanges. Stock prices can often sound an early warning about a company’s or bank’s financial health.