The FRDI Bill has courted controversy since its inception. It made the news again recently. Let’s find out more.
In an attempt to deal with rising company bankruptcies, last year the Union Cabinet approved the Financial Resolution and Deposit Insurance (FRDI) Bill. The bill deals with issues that can arise when companies operating in the financial sector, like banks and insurance companies, go insolvent. Since its inception, however, the bill has been courting controversy and sparking off a major scare among the masses.
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For instance, recently, life in the two Telugu states of Andhra Pradesh and Telangana was thrown out of gear as banks complained of a severe crunch in their cash reserves with everyone preferring to withdraw cash in the wake of the FRDI Bill. Customers fear that their deposits may be used for bail-ins of banks. ATMs also downed their shutters due to non-availability of cash.
Why the bill?
The high number of high-profile bankruptcies in 2008 sparked the need for a regulation. This regulation aims to come to the rescue of distressed financial entities. With the common man engaging increasingly with the financial sector, the government felt that it is crucial to protect the interests and savings of those who’ve joined the formal economy in case a bank or insurance firm starts failing.
What are the provisions of the FRDI bill?
The FRDI Bill mandates the setting up of a Resolution Corporation. This will replace the existing Deposit Insurance and Credit Guarantee Corporation. This body will monitor financial firms, anticipating their risk of failure, taking corrective action and resolving them in case of failure.
The Corporation also has to provide deposit insurance up to a certain limit (yet to be specified), in the event of a bank failure. Classifying financial firms in terms of their risk of failure – low, moderate, material, imminent, or critical will also be the task of this body. Once deemed critical, it will take over the management of the company.
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The controversial provision in the FRDI Bill:
The FRDI bill also empowers the Corporation to bail-in a financial entity at the time of bankruptcy or insolvency. A bail-in is different from a bail-out. While a bail-out is the use of public funds to inject capital into an ailing company, a bail-in is the use of depositors’ funds to achieve these ends.
Examples of a bail-in include writing off a bank’s liabilities or converting them to other forms, such as equity.
The above-mentioned provision has given rise to major concerns among the common people, who fear losing their hard-earned savings. The government, however, has repeatedly released statements allaying the common man’s fears to this effect. According to the government, the Bill provides additional protections to depositors in a transparent manner.
Presently, the Deposit Insurance and Credit Guarantee Corporation (DICGC) guarantees bank depositors protection to a limit of Rs. 1 lakh. Remaining deposits over Rs. 1 lakh are treated at par with claims of unsecured creditors. In the event of liquidation of a bank, only after making preferential payments, depositor claims are paid.
However, if the FRDI Bill is passed, in the event of a bank failure, equity will absorb losses first. The bail-in will be then applicable to the subordinated debt. The government’s implicit guarantee for public sector banks will remain unaffected.
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Joint panel on FRDI gets more time to submit a report:
The latest with regard to the FRDI bill is that the joint parliamentary panel looking into the FRDI legislation will be getting an extension of time to submit its report on the matter. The committee got an extension in December last year and this is the second occasion that it has received additional time.
Amidst all this confusion, the government has repeatedly clarified that the bill seeks to protect and enhance the depositors’ existing rights. It will not do away with the present protections offered to them. The bail-in is only one of the several resolution tools in the FRDI Bill. It will most certainly not be used in the case of public sector banks as such contingency is likely not to arise.
The bill, however, doesn’t prevent the government from financing and offering resolution support to banks, including public sector banks.