The revised Financial Sector Development and Regulation (Resolution) Bill, 2019 (FSDR), is ready to be re-introduced in Parliament as soon as it is cleared by the Cabinet. The new Bill aims to fix the existing regime for resolution of financial firms, which is considered fragmented, incomplete and subject to multiple laws and regulatory authorities.
We have had the opportunity to review a briefing note prepared by economic affairs secretary, Atanu Chakraborty, which provides the contours of the new Bill. It makes some astonishing assertions.
The financial sector resolution framework covers a wide spectrum of financial entities including banks, insurance companies, financial market infrastructure, payment systems and other financial service-providers (excluding individuals and partnership firms) which are now scattered under different legislations. For the first time, it also covers cooperative banks and regional rural banks.
This requires amendment to a bunch of statutes and also covers entities such as stock exchanges, clearing houses, depositories and other insurance and capital market intermediaries which are identified as systemically important financial institutions.
India and a few other countries have yet to put in place ‘an effective resolution regime’. The new Bill expects to provide certain ‘critical powers’ for resolving banks, such as “power to terminate contracts, write down debt, modify liabilities or set up bridge institutions,” as well as a framework for resolving ‘cross-border’ (foreign) banks.
The Bill will also provide clearly defined triggers for prompt corrective action (PCA) framework to bring a problem institution into resolution. It covers parent institutions as well as subsidiaries (a lesson learnt from Infrastructure Leasing & Financial Services—IL&FS—which was allowed to spawn over 347 subsidiaries and associates while the group holding company remained unlisted and out of the public eye).
An earlier version of the Bill, called the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill), was introduced in the Lok Sabha on 10 August 2017 but withdrawn exactly a year later (for further comprehensive examination and reconsideration). It had triggered panic among depositors over the controversial ‘bail-in provision’ which held out the threat of forcibly converting term deposits with banks (above a certain insured threshold) into equity to recapitalise failed banks.
Since the bad loans of banks had touched over Rs10 lakh crore and the late finance minister Arun Jaitley had announced the largest ever bailout (recapitalisation) of public sector banks (PSBs) of Rs2.11 lakh crore in October 2017, the blind panic was completely understandable.
The new FSDR Bill, 2019, claims to cover a ‘systemic vacuum’ with regard to bankruptcy situations and will include the resolution of large non-banking finance institutions. The Bill takes into account situations arising out of giant institutions that failed, such as IL&FS and Dewan Housing Finance Ltd (DHFL).
Resolution Authority (RA): The central part of the Bill is to set up a RA based in Mumbai. Its ambit will be “restricted to only orderly resolution and not to restoration and recovery.” It will have a representation of all financial sector regulators--Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance and Regulatory Development Authority of India (IRDAI), Pension Fund Regulatory and Development Authority (PFRDA), the Central government and will have three whole-time members and two independent members.
Structure: The RA will be self-sustaining and have three types of funds under it. One, the Resolution Authority Insurance Fund (replacing the Deposit Insurance and Credit Guarantee Authority Act, 1961) for deposit insurance. Two, the Resolution Authority Resolution Fund for covering resolution fees; and three, Resolution Authority General Fund for meeting RA’s administrative expenses.
It will also collect fees from ‘specified service-providers’ (who are not defined and could be market intermediaries or institutions). The Central government will provide the final bit of funding, if required, when all other avenues have been exhausted.
Each regulator will be tasked with creating a PCA framework for institutions under their ambit. The Resolution Fund, which will replace DICGC, will collect premiums based on ‘risk-based assessment’. However, if there is a systemic issue, a government bailout (to provide liquidity) is not ruled out.
The Bill aims to handle financial sector failures without transferring the burden to taxpayers by establishing a transparent mechanism to deal with such failures.
The FSDR has removed the controversial ‘bail-in’ provision without eliminating the worries attached to it. It proposes that the RA is empowered to cancel or modify liabilities, subject to safeguards. This power will not apply to deposits covered by insurance. Secondly, while the deposit insurance cover will be increased, it is the RA that will decide the extent of increase and will also have the power to modify the deposit insurance limit.
It is unclear how this will work in practice and whether the RA will announce the floor on a case-by-case basis after the need for resolution is triggered, especially since the insurance premium is based on risk-assessment.
Systemically Important Financial Institutions (SIFIs): Institutions whose failure may pose a risk to consumers and the overall financial stability of the country will be designated SIFIs by the Central government. Newly-designated SIFIs will be given a six-month transition period and can appeal against such a designation (which comes with greater regulatory oversight and disclosures) to the National Company Law Tribunal (NCLT).
The RA, along with sector regulators, will classify all service-providers into five categories, namely, low, moderate, material, imminent and critical. The classification will take into account several features of the specified service-providers, including adequacy of capital, asset quality, leverage ratio, liquidity and capability of management.
The power of the RA to initiate action against the entity will depend on the classification. The powers of the RA come into play at the ‘material’ (when it can restrict certain activities), the ‘imminent’ and, finally, the ‘critical’ stage. At the ‘critical’ stage, a receiver will be appointed and payments as well as legal actions/contractual proceedings against the entity stayed as part of the resolution process. There are some checks and balances envisaged by circumscribing the powers of the RA.
Tools of Resolution: These include the use of one or more of the following: 1) transferring the whole or part of the assets and liabilities to another entity; 2) creating a bridge service-provider; 3) cancellation /modification of liabilities; 4) Merger or amalgamation; 5) Acquisition; 6) Liquidation; 7) Run-off, in case of an insurance company, if deemed appropriate.
Timeframe for Resolution: Resolution has to be completed in one year, with the provision for an extension of one additional year, except in the case of liquidation.
Administratorship: When the resolution process kicks in, the RA will suspend the board and take over as the administrator. It is empowered to make executive decisions on behalf of the entity including appointment or removal of managers and act as a receiver. A decision on liquidation, however, has to be cleared by the NCLT, which will appoint the RA as liquidator.
Interestingly, a service-provider wanting to close business will also have to make a written application to the RA who will decide on liquidation or resolution in consultation with the sector regulator. The RA can also recognise and enforce foreign resolution actions and has the option of refusing recognition and enforcement “in the interest of the financial stability of India, among other factors” including the right to protect local creditors. This would come into play for protection of Indian depositors in branches of foreign banks operating in India.
Amendments to Other Statutes: For the FSDR to become operational, it envisages amendments to several statutes. These include: amendments to the Insolvency & Bankruptcy Act, The Companies Act 2013, Pension Fund Regulatory and Development Authority, Payment and Settlement Systems Act, the Multi-State Cooperative Societies Act, Reserve Bank of India Act, Insurance Act, National Housing Bank Act, Export-Import Bank of India Act, Banking Companies (Acquisition and Transfer of Undertaking) Act, the Central Goods and Services Tax Act, Regional Rural Banks Act, General Insurance Business (Nationalisation) Act, Income Tax Act, Customs Act, Securities Contracts Regulation Act, Life Insurance Corporation Act and State Bank of India Act, among others.
While this is the structure and operational details of the Bill, the government’s note justifying its provisions makes several incongruous assertions going back to 1961 to justify some claims.
For instance, it argues that the Indian experience of the past 50 years has been one of ‘forced mergers’ of PSBs which has imposed a huge cost on shareholders and the government in terms of recapitalisation support to transferee banks and poor recoveries.
Clearly, a correct assessment ought to be post-1991, after India’s economic liberalisation led to the entry of new private banks, private insurance companies, the setting up of massive non-banking finance companies as well as private sector-professionally managed stock exchanges and depositories.
Since then, there have been only two or three force-mergers, while the successful private sector banks, such as HDFC Bank, Kotak Bank and ICICI Bank, have acquired smaller banks, or they have been transformed after a change in management (RBL Bank).