The Farce of Insured Bank Deposits and Return of Financial Resolution and Deposit Insurance (FRDI) Bill
Finance Minister (FM) Nirmala Sitharaman’s announcement on 15th November -- that the government plans to increase the deposit guarantee limit -- has triggered an important debate over the safety of bank deposits and who will pay the price for deposit insurance.
The announcement may be accompanied by a return of the controversial Financial Resolution and Deposit Insurance (FRDI) Bill.
The Bill, introduced in the Lok Sabha in August 2017, was withdrawn in August 2018, after it triggered panic among depositors and a run on loss-making public sector banks (PSBs), despite the implicit sovereign guarantee because of their ownership.  
The need for a robust financial resolution mechanism is not in doubt, but creating such a mechanism without fixing issues of ownership, safety and regulatory accountability is what alarmed depositors. The attempt to ram the Bill through parliament without dialogue or discussion was primarily responsible for the fright that it caused. 
The government’s propaganda machine, operating through the mainstream media, is busy drumming up support for FRDI 2.0. These media reports attribute the withdrawal of the FRDI Bill in August 2018 to ‘ill-informed social media chatter’, ‘television debates’, ‘misinformation’ and a ‘misplaced campaign that depositors’ money would be used to bail out failed banks’. 
The sweeping falsehood behind these charges is astonishing, given that a series of financial sector debacles began almost immediately after the Bill was withdrawn. 
It started with the default by Infrastructure Leasing & Financial Services (IL&FS) in September 2018. This conglomerate of 347 companies with an outstanding debt of nearly Rs100,000 crore continues to roil the financial sector. 
A blatant example of failed supervision, hundreds of shadowy IL&FS subsidiaries flew below every regulator’s radar right until it collapsed. And IL&FS was classified as a ‘systemically important’ finance company!
Moneylife had reported Dewan Housing Finance Corporation Ltd (DHFL) and its massive mismanagement of funds in December 2018; the Reserve Bank of India (RBI) finally superseded its board of directors only on 20th November. 
Then there is Punjab and Maharashtra Cooperative Bank (PMC Bank), felled by Rs6,500 crore of fraudulent lending to the Housing Development and Infrastructure Ltd (HDIL) group. It was discovered in September 2019, only because of a confession by the managing director after things reached a point of no return. 
It is yet another example of failed supervision. RBI was clueless, even though a former general manager of its urban banks department was among the top three employees in PMC Bank. Documents obtained under Right to Information (RTI)reveal that RBI’s inspections follow arcane processes and had failed to probe the few red flags that went up.
Incidentally, both DHFL and HDIL are part of the Wadhawan family, which separated only 10 years ago. 
The Economic Times (ET) points to another issue in an article cheer-leading the return of FRDI. It says that there is ‘chaos in the financial markets’ because “banks, non-banks and mutual funds are dragging in different directions to recover what is due to them — from promoters such as Subhash Chandra of the Zee Group or the Wadhawans of DHFL.” 
This, it argues, “makes a perfect case to revive” the FDRI Bill “that was kept in abeyance due to rumour mongering.” 
But wasn’t the chaos triggered by the failure of regulatory and supervisory processes?  FRDI 2.0 can, indeed, ‘resolve’ issues; but the fear and turmoil, which is being dismissed as  ‘rumour mongering’, will occur even with a new FRDI Bill, unless regulatory failure is fixed first. 
The Securities and Exchange Board of India (SEBI) was caught napping when leading mutual funds forgot that they were investors and became lenders against shares to Zee, Yes Bank and Anil Ambani group companies.
They also colluded when these companies failed to disclose the lending to stock exchanges, instead of insisting on it. Instead of punishing them, SEBI is busy tinkering with the rules and net-worth requirements for smaller market intermediaries. 
Now let us turn to the wisdom on deposit insurance. Only one private bank (Global Trust Bank) has failed in the past 25 years after economic liberalisation. Deposit insurance was last raised after the securities scam of 1992 (from Rs30,000 to Rs100,000), mainly to cover RBI’s failed supervision, after two small banks collapsed.
The government wants to make FRDI 2.0 politically palatable by hiking deposit insurance to Rs15 lakh. The ET report says that this will cover 90% of individual deposits and that the cost of insurance “could be deducted from the interest offered to depositors.” 
This is a big change from current structure, where the Deposit Insurance and Credit Guarantee Corporation (DICGC) insists that premium must be paid by banks from their own funds and not by depositors. 
Consequently, deposit insurance premium would rise, every time DICGC has to makes a big settlement and depositors will have to sacrifice interest income to cover the cost. 
Interest on savings accounts is already a low 3.5%, while that on term deposits has slipped below 7%. Both are set to fall further. This will hit the vast millions, including senior citizens, who live on interest income and have no government pension or social security to fall back on. 
On 18th November, the All Indian Bank Depositors Association (AIBEA), India’s largest bank unions, jumped into this debate by demanding that PSBs should not be asked to contribute to deposit insurance, since they are covered by a sovereign guarantee.
AIBEA says the aggregate deposits of PSBs are Rs72 lakh crore, of which only Rs22 lakh crore are covered by insurance, but premium is collected on the entire amount. In 2018-19, DICGC collected a premium on Rs120 lakh crore of deposits, although only 28% of them (Rs33.70 lakh crore) were insured. 
While AIBEA is agitated about PSBs paying insurance for ‘deposits that are not covered’, the irony is that every Indian is paying for the massive mismanagement of banks, which caused bad loans to balloon to over Rs10 lakh crore. The exchequer has pumped in over Rs3 lakh crore into PSBs in the past five years alone to recapitalise banks, in addition to multiple ‘recapitalisation’ exercises in the past. 
AIBEA’s letter also supports my contention that the flawed deposit insurance guarantee scheme is only viable because of the hefty premium collected from PSBs and successful private banks. 
DICGC is sitting on premium collected of Rs97,350 crore, when the sum total of its insurance pay-out, since 1962, is just Rs5,120 crore. This was almost entirely for settling dues of cooperative banks. Most cooperative banks are not only under dual regulation (RBI and the Registrar of Cooperatives), but are regularly controlled and exploited by politicians. 
The premium collected from PSBs is, indeed, risk-free and unnecessary. If PSBs are exempted from paying insurance, the whole edifice of deposit insurance cover will crumble, especially if cooperative banks are asked to pay risk-based premium as recommended by several committees set up by RBI. 
A retired PSB chairman tells me, “If an effective insurance risk/actuarial model is used to measure, it will be very clear that DICGC can’t manage the burden of insuring the bank deposits of even up to Rs 1 lakh.” He also agrees that merely increasing deposit insurance (to Rs15 lakh) ‘only adds to moral hazard’, if regulators, lenders and depositors remain just as reckless. 
Compulsory conversion of cooperative banks into commercial banks, and the closure of tiny, unlicensed ones, is imperative before any FRDI Bill can be seriously considered. 
The core of the FRDI Bill will be a powerful Resolution Corporation (RC) to conduct the financial resolution process. RC will be able to “access information, terminate, transfer, sell the institution at its discretion.” It will also decide on invoking the ‘bail in’ provision where a part of the deposits above a certain threshold (which is covered by a deposit insurance) can be compulsorily converted to equity to capitalise the bank and keep it going. This provision had triggered serious panic earlier. 
There are many legitimate questions that need to be answered and some fundamental legislative and policy changes put in place before a re-worked the FRDI Bill can be foisted on us without a repeat of the 2017 reaction.
The status of such disaggregated depositors, especially those with business accounts and large deposits, is one such concern. Will they be treated as unsecured creditors and be the last in the queue (just ahead of equity-holders) when it comes to financial resolution? Or will these be equated with home-owners, who are considered secured creditors, after a Supreme Court verdict?
To dismiss such worries as rumour mongering is arrogant and irresponsible, given that the government has made no attempt to explain the Bill to people. 
As depositors, our primary concern is, indeed, the safety of our savings. That will happen if there is regulatory accountability and strict supervision of all intermediaries that are entrusted with a fiduciary responsibility to protect depositors’ money. Without it, anther FRDI experiment would also fail.

5 years ago
I completely agree with your statement that the ruling party's social media team would go on a overdrive to spread misinformation.
5 years ago
Well said-Compulsory conversion of cooperative banks into commercial banks, and the closure of tiny, unlicensed ones, is imperative before any FRDI Bill can be seriously considered.
5 years ago
PM Modi Government helped itself to a special dividend from RBI amounting to Rs 1.23L Cr

DICGC is sitting on reserves of 97,350 Cr

This means had Government not helped itself to the special dividend there would have been over 2.0 L Cr of reserves more than adequate to cover a capital erosion of several banks.

We must note here that private sector banks have Tier 1 Capital around 10% of their Balance Sheet. Assuming RBI is doing its job, the risk to a private banks balance sheet would be highlighted well before its NPA hole reaches 10% of its Loan Assets.

Assuming that NPA spirals out of control it may reach 20% of Loans. This means the first 10% would be the Equity holders responsibility and Equity holders would be wiped out. The remaining 10% would have to be taken from Banks depositors with each depositor loosing pro-rata 10% of their deposits.

This means that in a dire situation of 20% Loan Asset loss a depositor would get back 90% of their deposits.

The depositors need to weigh the loss of 10% of their deposits (in excess of the DICGC insured amount) against the option of keeping their cash in a mattress.
5 years ago
Excellent Article !
Nakul Kumar Reddy
5 years ago
With Ur helping hand I will start business in small amounts .
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