Bail-in Clause of the FRDI Bill—Is Its Constitutional Validity Suspect?
Ever since the Financial Resolution and Deposit Insurance Bill 2017 (FRDI Bill) was introduced in the Lok Sabha this June, it has evoked a strong response from various quarters including consumer organisations, bank employee unions and trade unions. There are also several messages doing the rounds on WhatsApp, etc, arguing for and against the provisions of the Bill that seeks to change the way in which banks and financial firms facing bankruptcy may be resolved.  The bail-in provision seeks to confer statutory powers to a Resolution Authority to convert existing creditors (including depositors) into shareholders to recapitalise ailing banks.
 
The piece in Moneylife, titled “Do Bank Depositors Need To Worry about FRDI?” by Sucheta Dalal, succinctly gave a background to the provisions of the Bill and its implications and the issues that the parliamentary standing committee will have to consider. 
 
Apart from the financial and economic considerations, there is also a legal/constitutional problem with the bail-in provision. It has to do with treating banking companies merely as financial entities without regard to the legal structure that gives each entity its basis. In law, a corporation is a business association with specified business objects with a distinct legal personhood. 
 
The association is of choice wherein members agree to be governed by the memorandum and the articles of association of such a corporation. The right to form such an association is protected by various provisions of the Constitution, particularly Article 19(1)(c) read with Article 19(1)(g).  
 
Article 19(1)(c) recognises the right to form unions and associations. Implicit in such a right is the right to form an association of one’s choice. A statutory prohibition against some associations or a statutory compulsion to become member of certain associations will necessarily, therefore, restrict such a right.  
 
Any restriction on Article 19(1)(c) will need to comply with the test in Article 19(4) of the Constitution. According to Article 19(4), the restriction will need to have statutory backing; the restriction may be imposed only for the purposes of sovereignty and integrity of India, public order, or morality; and that such a restriction must be reasonable, i.e., can be no more than what is required for such purposes.
 
The bail-in provision’s compliance with 19(4) is clearly suspect. A statutory scheme that provides for forcing depositors, without a need for taking their consent, to become members of a banking corporation is manifestly restrictive of the depositors’ right to form associations of their choice. 
 
The FRDI Bill, the purpose of which is the bankruptcy resolution of banking and insurance corporations, is not a law whose object is in line with any of the purposes mentioned in 19(4).
 
However, it doesn’t mean there is no way to provide for a statutory, consent-less, bail-in clause without violating the Constitution. 
 
One way to do it is to provide for all three methods of resolution—first, a sovereign bail-out; second, a consent-based bail-in; and third, a compulsory statutory bail-in. 
 
However, the law ought to ensure that compulsory bail-in can be invoked only when there is a manifest threat to sovereignty and integrity of India, which may be the case when the viability of big public sector banks that substantially affect India’s economic sovereignty and financial stability are threatened. 
 
In other words, when a financial emergency is in operation. Article 360 of the Constitution of India provides for a proclamation of financial emergency when the financial stability of the country is under threat.
 
A compulsory bail-in, predicated exclusively on a proclamation of financial emergency, will not only be within Constitutional bounds, but also, perhaps, be acceptable to the civil society voices that are now against the provision in its current form.
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    COMMENTS

    adimoorthy subramanyam bharath

    2 years ago

    the bail in clause if at all introduced in the final act should specifically exempt deposits opened before the effective date of the FRDI Act. Banks should expressly take the consent of the depositors for the bail in provision. It is only fair that a contract is signed after the depositor takes into account the risk to reward for getting a low yield such as 5 to 6% p.a

    senior citizen deposits should be exempted from the bail in completely

    bail in if at all enacted should exempt senior citizens

    deposits contracts entered into prior to the act should be exempted or should be expressly consented upon for closure or renewal

    exit options to existing depositors should made available

    Kamal Garg

    2 years ago

    But, that's exactly the issue. When there is no proclaimed 'financial emergency' affecting the financial stability of the country, the State cannot have such over arching powers to convert depositors money (a loan given to the Banks and essentially a relatively 'risk-free' asset) into shareholders equity (which is essentially a 'riskier' asset class). No way. People should vehemently oppose such moves by an authoritarian and power arrogant party in power.

    India at 5th position in high NPA ratio across the globe
    India’s non-performing assets (NPAs) are growing rapidly and the country is at fifth spot in terms of high NPAs across the world, says a research note. 
     
    In the report, CARE Ratings says, “India features very high up the order and is lower than only Portugal, Italy, Ireland and Greece. Quite clearly, the Insolvency and Bankruptcy Code (IBC) and National Company Law Tribunal (NCLT) have its task cut out to lower these numbers and make the system more robust.”
     
     
    CARE Ratings had looked at the levels of NPAs in various countries to view how India stands in comparison. The study takes information from IMF to maintain comparability in concepts used in calculating the same. The time period for various countries is different depending on the availability of data and hence has been mentioned. The NPA ratios for countries has been categorized under four headings: very low NPAs which are less than 1%, low level 1-2%, medium 2-5% and high levels above 5%. 
     
    Here are highlights from the Report…
     
    • The four major economic drivers in the developed world, UK, US, Japan and Germany had NPA ratios less than 2%. 
    • Within the emerging market economies (EMEs), China, Argentina and Chile had low ratios of between 1-2%. 
    • Within the developed countries, France had a higher NPA ratio of 3.41%. 
    • Brazil and South Africa, which are part of the BRICS Group of nations, had moderately high ratios of 3.69% and 2.83%, respectively. 
    • India’s NPA ratio (which excludes the restructured assets which are around 2% higher than NPA) is one of the highest in the group. 
    • The countries with higher NPA ratios than India are part of the PIIGS group- Portugal, Greece, Italy, Ireland.
    • Spain had a lower number at 5.28%.
     
    The seriousness of the NPA problem can be gauged by the absolute level of impaired assets in the system. “Ever since the Reserve Bank of India (RBI) had spoken of asset quality recognition (AQR) in 2015, there was an increase in the pace of recognizing these assets. It is not clear whether all have been recognised as yet, though judging from the trends witnessed so far, it does appear that the cleaning up operation on this score would be completed by March 2018.
     
    From there on, it would be more a case of incremental NPAs being generated on account of other factors rather than one of recognition by banks,” the report concluded. 
     
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    SuchindranathAiyerS

    2 years ago

    The achievement of Indira Gandhi, her cronies, cohorts and their heirs, successors and assigns: India has the 5th highest proportion of Bad Loans in the World. (This does not include the Bad Loans the Govt dare not admit) Expect Modi-Jaitley Sarkar to implement "Bail In" punish the innocent Indian serfs, and give their beloved Babus another 35% pay hike to match their enhanced extortion empowerment.

    Ramesh I

    2 years ago

    The best way to reduce / prevent NPAs at PSU Banks is by cutting the phone line between South/North Block and Bank chiefs, and make Banks more accountable for loan disbursals. Until political interference is stopped AND Banks aren't forced to be profitable and self-sustaining (instead of being recapitalized with taxpayers' money regularly) nothing will change.

    Can Cooperative Banks be Revived?
    The banking environment in India has become more diversified than before with the small finance banks, payment banks and postal bank emerging on the scene. Mergers and amalgamations in the private and public sector banks and ever increasing non-performing assets (NPAs) in the public sector banks (PSBs) are threatening the stability of the system. Seemingly, strong macro-economic fundamentals notwithstanding, disruptive technologies are also adding fuel to fire. The Financial Resolution and Deposit Insurance (FRDI) Bill poses a threat to the security of depositors and leaders’ promises cannot be insure against what the bill itself holds for the banking clientele. Senior citizens, differently abled citizens, women and customers of small means feel distanced from the services they were expecting at the hands of the banks.
     
    Cooperative banks – both rural and urban – can provide a better alternative to the customers who are seeing a big void between the promise and the performance of the rest of the banking system, if one were to go by the Report of Trends and Progress of Banking in India, released by the Reserve Bank of India (RBI) this month.
     
    The largest constituency of these cooperative banks is the marginalised sections of population: the illiterate and semi-literate people and those heavily influenced by politics. While one segment – the rural credit cooperatives – is now in the throes of change: accounting practices; technology change; regulatory changes; and structural changes – in some places, all others beg for an effective reform process to join the mainstream of the financial inclusion agenda. 
     
    Legal reforms still elude them, with none of the states keen on adopting them. In the wake of a series of failures, the urban cooperative banks (UCBs) that are akin to the community savings and credit banks in the US, have been subject to the rigours of financial discipline. UCBs are undergoing the necessary technological changes have joined the National Payment and Settlement system.
      
    Financial inclusion demands customer centricity and smart technology applications, apart from financial learning, at the institutional and client level. Several developing economies in South Africa, Europe and Asia have adopted such technologies in a big way for the micro finance institutions, as also the developed cooperative institutions in Canada and Europe too have embraced them. Indian cooperatives, both rural and urban, have still to catch up with digital technologies on par with their counterparts in commercial banks. 
     
    Investment for Computerisation of Cooperatives:
    RBI has allocated Rs4 lakh per cooperative urban bank (UCB) for computerisation and maintenance cost of Rs15,000 per month for a period of three years for the post-implementation period. Union budget for the year FY17-18 made a provision of Rs1,900 crore towards computerisation of Primary Agricultural Credit Societies (PACSs), the bottom most tier of the short-term cooperative credit structure. The initiative offers a correction towards providing a level playing ground to the PACSs in the era of technology driven players like commercial banks, RRBs and the postal banks, a recent entrant.
     
    All customers demand availability of banking services any time during the day. They want to open an account, deposit money, pay money to meet any of their needs anywhere, withdraw money, take a loan, and open a letter of credit. They do not distinguish between a cooperative and a commercial bank when it comes to meeting their own needs. Hence, cooperative institutions need to embrace technologies of a superior order such as artificial intelligence, and predictive analytics and put in place the necessary discretions at different tiers. This requires capital of a huge order.  
     
    Though the organisation may introduce appropriate strategies, it is the culture of the organisation and governance that would require to be looked at in the cooperative banks. They can improve the bottom lines through reduced costs, enhance customer experience and strengthen security and compliance through state-of-the-art encryption practices, audit trails and security certifications. Customers always need their data to be safe and secure. The fact that RBI took almost nine months to present data as of March 2017 is enough proof that computerisation of cooperative banks – both rural and urban – has a long way to go.
     
    District central cooperative banks (DCCBs) used to keep their books open beyond 31st March  – some even up to June for making adjustments and reconciliation between PACS and themselves and between them and the state cooperative banks (StCBs) at the other end. This may be the reason for the lag in presenting the data. 
    Can cooperative institutions provide enough confidence to their customers in the existing environment – legal, regulatory and governance – while complying with the Basel III directed capital regulations?
     
    Do all types of cooperatives hold their accounts with the cooperative banks? Do all the directors of cooperative institutions keep their deposits and the deposits of their kith and kin with the cooperative banks? Is there willing cooperation among the cooperatives for strategic initiatives towards digitisation? Can the cooperative banks get out of the stigma of money laundering through proper KYC audits? The response to all these questions lies in instituting mechanisms for appropriate governance, risk and compliance. 
     
    At the macro level, RBI Report on Trends & Progress of Banking in India, 2016-17 reveals that as of 31 March 2017, 54 of the 1562 scheduled UCBs have been consolidated after the consolidation process of UCBs commenced in 2004. . In the cooperative banking space, 34.3% constitute UCBs and the balance are  rural cooperatives. The states of Maharashtra, Gujarat, Andhra Pradesh and Telangana occupy more than two-thirds of the geographical space. About 156 UCBs having a deposit portfolio of above Rs500 crore, account for 9.9% of the total number of UCBs. Only 90 UCBs have lent advances in that band accounting for just 5.9%. It is interesting to note that 124 UCBs holding a deposit portfolio of less than Rs100 crore though constitute 7.9%. 
     
    As many as 289 of the UCBs lent advances below Rs100 crore, accounting for 41.5% of the total advances. Also, 82% of non-scheduled UCBs held a Capital to Risk (Weighted) Assets Ratio (CRAR) above 9% by March 2016, with four of the scheduled UCBs having a negative capital adequacy ratio. Their non-performing assets (NPA) ratio is below that of the scheduled commercial banks. The Report cautions that the rise in gross NPAs demands higher provisioning and therefore requires higher capital plus reserves from their members. On a broad parameter of financial inclusion, lending to weaker sections by the UCBs constitutes 26% of the Adjusted Net Bank Credit (ANBC) as against the prescribed 10%. However, NPAs in this segment is a cause of concern.
     
    Although the RBI Report seemingly holds a confident view of the sector, it has excluded them from the acceptance and exchange of demonetised currency in the wake of the note ban from November 2016 and mandates a court directive for their inclusion. But do the UCBs and DCCBs see eye to eye? Do these institutions know what regulatory supports are required? If so, will they be able to abide by the requirements of such a support system? The answers rest on the ability of various cooperative banks to see themselves as a formidable economic constituency of the nation.
     
    The sector has the potential to grow beyond narrow horizons if show the courage to insist on the state governments to embrace the Constitution 97th Amendment Act, 2011 and modify all their state laws. Development of cooperatives is no longer an option, but a compelling necessity. 
     
    (Dr B Yerram Raju - is an economist and risk management specialist.)
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    Ramchandra Karve

    2 years ago

    Political leaders at regional levels are responsible for the increasing NPAs. Most of the Directors who are influential political lend funds to their near ones with the sole intention of not recovering them. Cosmos Co Operative Bank went into liquidation 3 years ago as the directors of the said bank had lent huge sums to their near ones without any security. Property of these directors should be attached in order to recover the NPAs rather than utilizing the Hard Earned Money of the depositors to bail in the babks

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