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Sunday, 7 January 2018

Bail-in needs rethink

Recently officials of Ministry of Finance have assured that there is no likelihood of bail-in for over 98% of depositors. FM also stated in Rajya Sabha that Bail-in provision most certainly will not be used in case of a public sector bank as such a contingency is not likely to arise. There have been many assurances from government side but doubts of depositors persist.

Bail-in clause is mentioned in proposed Financial Resolution & Deposit Insurance ( FRDI ) Bill 2017 which was introduced in August 2017 in Lok Sabha. Presently the proposed bill is with Joint Committee of members of Parliament ( JPC ) & the consultations on various provisions are on with stakeholders. Recommendations of JPC might make government to revise or rephrase some of the provisions. Draft of the said bill is available on & can be downloaded from the following address on internet. For ease of reference Clause 52 on Bail-in is copy-pasted below.

http://dea.gov.in/sites/default/files/FRDI%20Bill-27092016_1.pdf

Clause 52 Bail-in
(1) Notwithstanding anything contained in section 49, any action taken by the Corporation pursuant to this section may be through a bail-in instrument or a scheme under section 48 the form and manner of which shall be specified.
(2) The bail-in instrument may contain:
(a) a bail-in provision; or
(b) a provision for the purposes of, or in connection with, any bail-in provision made by that or another instrument.
(3) A bail-in provision means any or a combination of the following: –
(a) a provision cancelling a liability owed by a covered service provider;
(b) a provision modifying, or changing the form of, a COMMITTEE DRAFT 63 liability owed by a covered service provider
(c) a provision that a contract or agreement under which a covered service provider has a liability is to have effect as if a specified right had been exercised under it.
(4) (a) for the purposes of clause (a) of sub-section (3) of this section cancelling a liability owed by the covered service provider includes cancelling a contract under which the covered service provider has a liability.
(b) for the purposes of clause (b) of sub-section (3) of this section, (i) modifying a liability owed by covered service provider includes modifying the terms or the effect of the terms of a contract under which the covered service provider has a liability. (ii) changing the form of, a liability includes, (a) converting an instrument under which the covered service provider owes a liability from one form or class to another, (b) replacing such an instrument with another instrument of a different form or class, (c) creating a new security, of any form or class, in connection with the modification of such an instrument.
(5) The Corporation may specify the liabilities, or classes of liabilities of a covered service provider, which may be subject to bail-in.
(6) In addition to the actions enumerated in sub-section (3), for Central Counter parties, the Board may, in consultation with the Appropriate Regulator also take the following actions:
(a) direct the haircutting of the collaterals and margins;
(b) direct the issuance of equity to the creditors. Explanation: For the purpose of this section, haircut shall have the same meaning as assigned to it in section 45 of this Act. COMMITTEE DRAFT 64
(7) An instrument for the purposes of this section shall not affect -
(a) any liability owed by a covered service provider to the depositors to the extent that deposits are covered by Deposit Insurance;
(b) any liability that the covered service provider has by virtue of holding client assets;
(c) any liability of original maturities upto seven days;
(d) any obligation to a central counter party;
(e) any liability, so far as it is secured;
(f) any liability owed to employees or workmen including pension liabilities of the covered service provider except for liabilities designated as performance based incentive under section 51;
(g) any transaction covered under section 47; and
(h) such other liabilities as may be specified by the Appropriate Regulator in consultation with the Corporation and the Central Government.
(8) Whenever the Corporation makes a bail-in instrument under this section it must forward such bail-in instrument along with a report to the Central Government in such form and manner as may be prescribed and such report must contain –
(a) the reasons why a bail-in instrument under this section was made;
(b) the effect of the bail-in instrument;
(c) if the bail-in instrument deviates from the requirements of section (3), then the reasons for such deviation.
(9) A copy of the report received under sub-section (8) shall be, as soon as may be after it is received by the Central Government, be laid before each House of Parliament. (10) The provisions of sub-sections (3), and (6) of section 49 shall apply to this section mutatis mutandis. Explanation I: In this section, “client assets” shall have such meaning as may be specified. COMMITTEE DRAFT 65 Explanation II: The purpose of bail-in is to absorb the losses incurred, or reasonably expected to be incurred, by the covered service provider and to provide a measure of capital for it so as to enable it to carry on business for a reasonable period and maintain market confidence in it.

What is Bail-in?
Bail-in is defined as rescuing a financial institution on the brink of failure by making its creditors and depositors take a loss on their holdings.
A bail-in is opposite of bail-out. In bail-out process, failing institution is rescued by government funds.

Bail-in by default?
Government has shown its intent that by passing FRDI Bill 2017 they will not support any failing financial service provider. And for sure they shall pass the FRDI Bill by brute majority in parliament soon. Supposing the bill gets enacted as proposed, in that case bail-in becomes a process of default. A failing financial service provider may say that all the remedies have been exhausted & still more funds are needed therefore we may now be allowed to use part of the uninsured deposits of customers! 
Of course insured deposits shall not be touched. As of now deposits of Rs. one lakh is insured by DICGC which they propose to increase this insurance now. Residual uninsured amount may be at risk. This risk may be nil, some percentage or of full uninsured amount.
An example may perhaps clarify the position: if I have deposits of say 17 lakhs in bank & insurance is say 10 lakhs then residual amount of 7 lakhs is at risk. Further this residual amount may not be touched or some percentage of 7 lakhs may be taken or full amount may be taken to bail-in the failing financial institution. Amount so taken may be compensated by issuing equity in lieu thereof, or by issuing interest bearing bonds or not at all. 
It may be mentioned that our deposits with financial institution is liability of that institution. Please pay due attention to Clause 52 article 3 which read as under:
(a) "a provision cancelling a liability owed by a covered service provider" and
(b) a provision modifying, or changing the form of, liability owed by a covered service provider.    

Is bail-in applicable to banks only?
Proposed provisions are applicable not only to banks but all 'financial service providers' meaning thereby insurance companies, NBFCs, mutual funds etc. 

What about other countries?
During last recession of 2008 a large number of governments helped banks with funds for bail-out to avoid panic like situation. However in 2013 bail-in was tried in Cyprus a member of EU. In European Union deposits up to euro one lakh was insured. Up to 48% of uninsured deposits of customers & investment of bondholders were used by failing bank to cover losses. In lieu thereof shares were issued & you can imagine value of these shares. Uninsured deposits of second largest bank Laiki of Cyprus were lost. 
The G-20 group of nations have already discussed the bail-in & the plan for passing law is at various stages in many countries. 
However the Indian financial landscape is different from that prevailing in developed world. PSBs seem safe bet now as the government holds majority shares in all of them. It needs to be done with caution.

Why the bail-in bill now?
Banking system in India is under tremendous stress of spiralling growth of NPAs. The bad assets of the banks are now in the range of nine lakh crores. To tackle this government has offered capital infusion of 2.1 lakh crores in stages to PSBs. The gap of nearly seven lakh crores remains uncovered. Where from this gap shall be covered? May be by issuing shares, by issuing bonds, by selling some assets and if it is not sufficient to mitigate losses then? Request government for funds? And in case government says no? Why not use deposits of customers to wipe out losses?
By placing the bill in Lok Sabha government is clear that henceforth they shall not provide any funds to any failing financial institution.

What about assurances?
Officials have assured that the bail-in shall be sparingly used. What is 'sparingly used' is not clear. FM has said that it may not be used in case of public sector banks. It has also been hinted that present limit of insurance of deposits which is one lakh shall be increased etc.
Elaborate procedure is proposed to be followed before any financial service provider seeks bail-in. Resolution Corporation shall be set up to oversee the bail-in & related matters.  
Increasing insurance of deposits to say 10-15 lakhs from present level of one lakh helps one feel assured.
Taking part of or full uninsured deposit for bail-in does not help one feel assured, & instruments in lieu of deposits taken like shares or bonds does not help one feel assured.
Not knowing future rates of shares thus handed over, not knowing period of repayment & rates of interest on bonds thus handed over does not help one feel assured. 

Why depositors be made to pay for losses of financial institution? Very idea of bail-in is non assuring. 

not assured 



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