Domestic policy decisions cannot always be driven by international experts who provide prescriptions which do not factor country-specific concerns. A case in point is the Financial Resolution and Deposit Insurance (FRDI) Bill, 2017, which was drafted on the direction of a high-profile financial body as a solution to the mounting problem of non-performing assets (NPAs) in Indian banks. Among other provisions, the proposed legislation sought to introduce the controversial “bail in” clause whereby a substantial chunk of depositors’ money can be used to rescue banks reeling under bad loans. The Bill, announced with much fanfare as a major banking sector reform, was scrapped on July 18 by the Union Cabinet which had earlier cleared it on June 14, 2017.
Why this change of heart? According to finance ministry officials, the government suddenly seems to have woken up to the fact that the Bill had already eroded public trust in the banking system and getting it passed in this session of Parliament would be an unpopular move ahead of general elections next year. “The feedback from all quarters, including ruling party MPs, was unanimous that the legislation be scrapped. It was also impressed upon the government by bankers as well as top RBI officials that a vast population keep their savings in banks and see it as their only source of security. In such a situation it would be political as well as economic hara-kiri for a government to pass a law that would render bank deposits unsafe or vulnerable. The Bill had to be dropped—the government literally had no choice,” a ministry official told SW.
It certainly does not require an economist to understand why the proposed FRDI Bill spread public panic. Simply put, one of its crucial implications was this: if your bank is declared sick or commercially unviable then you stand to lose the monies deposited in your accounts and fixed deposits. The government or RBI will not bail out your bank as it has done in the past. Instead, your deposits will be used to rescue the bank, leaving you eligible for no more than a fixed compensation (currently Rs 1 lakh) for all your accounts. Thus, the proposed law could well turn depositors into paupers by forcing them to pay for bad business practices followed by their bank. The Bill was seen by the government as a quick fix solution to rising NPAs, particularly in PSU banks.
Interestingly, the idea of such a legislation was not mooted by the Finance Ministry. Neither was it the brainchild of any Indian expert. It was a strategy endorsed and `imported’ into the country by Prime Minister Narendra Modi in November 2014 during the G20 Summit in Brisbane. As a result, the Bill was for all practical purposes scripted by the Financial Stability Board (FSB), an international body set up in London in 2009 in the aftermath of the 2008 economic meltdown. Its mandate: to monitor and make recommendations that financial systems in developed and developing countries are expected to follow.
The FSB’s - Key Attributes of Effective Resolution Regimes for Financial Institutions - was the template that the Indian government had agreed to follow. In its recommendations, the international body had detailed the idea of a “bail in” by depositors instead of a government bail out of banks. The FSB plan also envisaged limiting the role of Central Banks (in India’s case, the RBI) to fiscal policy implementation, fixing interest rates and ensuring currency supply. Dealing with sick banks and insurance companies, it was advocated, should be the exclusive purview of an independent corporation with the mandate of ordering a bail in. The proposed FRDI Bill had made provisions for setting up of the Financial Resolution and Deposit Insurance Corporation (FRDIC) for that very purpose.
It is reliably learnt that the PMO and the Finance Ministry were very keen to push the new legislation, which the government claimed would not only reform the banking sector but also had the approval of international financial institutions like the IMF. It was Finance Minister, Arun Jaitley, who first referred to the possibility of a new legislation to resolve bad loans during his budget speech in 2016. Following that, a committee headed by Ajay Tyagi, additional secretary, department of economic affairs, Ministry of Finance, was constituted to draft the Bill. It completed its task in September 2016.
The proposed Bill was closely modelled on the FSB plan. In fact, the committee which drafted the legislation acknowledged in its introductory note that it had ensured that the Bill is “consistent with the key attributes” given in the guidelines drawn up by the international body. According to sources in the Finance Ministry, the committee borrowed substantial chunks verbatim from the FSB recommendations and the proposed legislation had no new inputs of any significance.
Says a finance ministry official: “Had the committee held discussions at the outset with various stakeholders including bank associations, RBI officials, depositors, politicians, trade union leaders and local economists then the Bill would not have been drafted. The basic pitfalls in the new legislation would have been pointed out while it was still on the drawing board. But unfortunately, no one was consulted because the government wanted the guidelines of the FSB followed to a T.”
The net result was that a Bill was drafted which did not factor in the dominant role played by PSU banks in the Indian economy. It also did not take into account the dependency of a large cross-section of the population on bank deposit interests for their sustenance. The proposed legislation was clearly not suited for India and may have had disastrous economic consequences had it been enacted. Even in the west, the ‘bail in’ formula has been tried only once in Cypress and that too in 2013 and came in for much criticism for having swallowed up depositors’ money to rescue crony capitalists.
Under the circumstances, it is surprising that the government thought it could pull off the FRDI Bill. It certainly has the numbers in the Lok Sabha to pass the legislation, but perhaps the realisation dawned that people were not ready for another economic shock after demonetisation and GST.