Understanding FRDI Bill

The FRDI (Financial Resolution and Deposit Insurance) Bill was introduced in the Parliament last week and is likely to be proposed in the upcoming Union Budget. Let us get some insight of what the FRDI Bill is all about and why is there a controversy around it.

Overview

The bill is a proposal to create a framework to overcome bankruptcy of Financial Institutions like banks (including payment banks) and non-banking institutions like insurance companies. At present, India does not have a specialized law to insure insolvencies of these financial institutions, and the FRDI bill is an attempt to regulate them.

If the bill is cleared, a 'Resolution Corporation' (RC) will be formed to regulate the risk of insolvency of all the financial institutions operating in India.

Financial firms will be classified into five categories of low, moderate, material, imminent and critical risk to viability based on their risk of failure. The RC has set rules to curb the crisis at each level of risk.

At the critical risk stage, it will take over the administration of the institution and resolve the crisis. The solutions include transferring all of the assets and liabilities of the firm to another, putting up the failing firm for acquisition, create a bridging financial firm to take over assets, liabilities, and management, using the 'bail-in' clause to convert the debt of the firm or lastly, liquidating the firm. Note that there is also a 'bail-out' clause where the public taxpayer's funds can be induced into the firm's capital to save it.

Concerns

If such a hypothetical event were to occur, the 'bail-in' clause would cause a loss of deposits of the failed institution's depositors in the process of absorption of losses. The clause allows the RC to cancel, modify, or change the form of liability of the institution or cancel the liability altogether. This means that depositors will also have to incur the losses faced by the firm.

Should we be worried?

Now that the bail-in clause is clear, it is important to understand that the deposits insured will not be affected. The proceeds from the sale of assets of the bankrupted institution will go to the insured depositors.

As of today, the deposits of less than 1 lakh are covered by insurance by the DICGC (Deposit Insurance and Credit Guarantee Corporation). With the formation of a 'Resolution Corporation' (RC), this limit might also be revised as per Inflation Index with RBI's consultation. Whether or not this limit will be extended remains a concern. Those with deposits over 1 lakh could be at threat of not getting their investments in return.

With the increasing number of deposits made after 2016's demonetization and the Indian government's initiative to promote banking transactions, whether or not our deposits will be safe if the FRDI Bill were to be implemented is the concern. Some experts say that the risk of losing deposit amounts will remain the same as before when our deposits were insured DICGC. Also, bail-in is just one of the steps that could be taken if a bank were to become insolvent.