Following closely on the heels of the controversy over GST implementation and allegations over the motives behind demonetization comes another salvo in the guise of the FRDI from finance minister Arun Jaitley and it seems the woes of the middle class Indian taxpayer will just not cease.
So what is the FRDI bill?
The Financial Regulation and Deposit Insurance Bill that is being studied by a Parliamentary Standing Committee aims to “establish a framework to carry out the resolution of certain categories of financial service providers in distress” and “to provide deposit insurance to consumers” of these services. Thus reads the Preamble to the Bill.
It also seeks to set up a Resolution Council to monitor, classify and identify institutions at risk of failure. Banks, insurance firms with high NPAs and bad debts, will now be pulled up based on accounting red flags. This roadmap was forced as a compulsion following international negotiations at the WTO and other forums after the global financial crisis of 2008.
Such monitoring is welcome because banks and insurance firms have been underperforming for a long time now and the respective regulators had no coherent law to deal with errant organisations.
Why should an ordinary Taxpayer be worried?
At the heart of the controversy regarding this bill is Section 52, which provides a “bail-in” clause to recover debts owed by a failing financial institution by appropriating the deposits of account holders.
What is the Bail-in clause in the FRDI?
A bail-in clause, unlike a bail-out clause used to fund recovery and nursing back to health of a failed financial institution by using tax revenue collected through contributions of income tax, Goods and Services tax, municipal taxes and so on, allows the institution to use the money deposited by its savings and fixed deposit account holders to pay for restructuring the business.
According to Section 48, a failing bank or other financial service provider has five options to help it recover:
- Transfer of the whole or part of its assets and liabilities to another healthy entity.
- Creation of a bridge service provider to oversee eventual sale or resolution.
- Bail-in as provided in Section 52.
- Merger/amalgamation or acquisition by a viable entity.
- Liquidation/ winding down of the business.
The proposed method may also be a combination of the above.
How does Section 52 affect me?
For the purposes of financial bookkeeping, all deposits with your bank are liabilities to them though they may be assets from your point of view. By virtue of Section 52, the Resolution Council may direct the bank to either cancel a liability or modify or change the form of the debt, the means for which may include cancellation of the contract empowering its recovery.
To be fair, there are exceptions to the list of debts that the bank can change in this manner. These include the deposit amounts which are covered by insurance of up to Rupees 1 lakh by the Deposit Insurance and Credit Guarantee Corporation (now an arm of the RBI). Also exempted are client assets held by the bank such as mortgaged property and short term deposits maturing within a week.
The section goes on to say that the purpose of such a clause is to “absorb losses” and enable “a measure of capital” for the firm so that it can “carry on business for a reasonable period and maintain market confidence in it.”
Experts have said that the chance of such a huge financial failure which would be the trigger for the bail-in clause, is unlikely to occur, that about 90% of bank depositors hold less than Rupees 1 lakh in their Savings Bank accounts and that the failure of banking and insurance institutions have always been contingent to market risks.
Does that mean that honest taxpayers must choose healthy banks of their own incomplete knowledge to maintain financial stability and security? Did we miss some fine print in our bank account opening forms? Perhaps, a higher power must answer.
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