FSDR -Rescuing Failed Banks At Whose Cost?

In 2019, media reported that Government was preparing to table a new legislation, the Financial Sector Development & Regulation (Resolution) Bill (FSDR, hereafter).

Reportedly FSDR is meant to rescue banks, among other financial sector institutions, from collapse. It replaces the Financial Regulation and Deposit Insurance Bill, 2017 (FRDI hereafter), which was withdrawn in 2018 following public outcry against a “bail-in” provision, which small depositors did not trust.

The bank-investor relationship is based upon fiduciary prudence. Millions of people, especially senior citizens depend upon this relationship. However sometimes, banks fail them not only financially but equally importantly in terms of trust. Making even a list of bank scams would occupy too much space.

Failure or incipient failure of banks, for which there are many reasons, is not new. Perhaps the most prominent reason is bad loans provided by banks. Banks are unable to, or under influence of powerful lobbies asked not to, recover the interest or principal from defaulting, large-account borrowers. Bad loans are accounted for as non-performing assets (NPAs). The bank approaches collapse when NPAs become a sizeable percentage of the bank’s capital.

Bank collapse has enormous repercussions on public trust in the banking-financial-economic system. So when a bank is on the verge of collapse, the Finance Ministry’s bails out the bank by infusing public funds to re-capitalize it, not unlike blood transfusion for a bleeding patient in ICU. Successive governments have used the bail-out measure to resolve banks’ NPA-caused collapse, so as not to raise public investors’ fears or affect the vital trust-factor.

Around 45% of GDP is generated by small businesses (unincorporated proprietor and partnership firms and MSME) and only around 18% by corporates. But taken value-wise, a few thousand corporates account for 86% of NPAs, while many million small borrowers including farmers owe only 14%. This is evidence of Government’s skewed financial and economic policies.

Indeed Prof.R.Vaidyanathan writes: “The unincorporated or the non-corporate sector in India is the largest contributor to national income, savings and investments and taxes, and accounts for the largest share in manufacturing and service activities and employment. Yet, it is a victim of the myth of superiority [emphasis added] surrounding the corporate sector”. . This remains true even today.

Over decades, faulty economic policies have resulted in 1% of the population owning over 50% of wealth, 77% of total national wealth held by the top 10%, and the richest 1% getting 73% of wealth (2017), even while 67 million Indians comprising the poorest half of the population increasing their wealth by merely 1%. All this reveals a politician-bureaucrat-corporate nexus growing at public cost.

Banks also write-off NPAs from their books, the most recent being SBI “prudentially” writing-off ₹1,23,000-crores while recovering only ₹8,969-crores from borrowers over 8-years FY2013 to FY2020. Such questionable “prudence” amounts to waiving borrowers’ liability and effectively transferring the difference, namely ₹1,14,031-crores of public money, to wilful defaulters.

As of September 2019, 2,426 borrowers with dues of ₹1,47,350-crores were categorised as “wilful defaulters” of PSBs alone. In April 2020, Reserve Bank of India (RBI) revealed that Indian banks have written-off ₹68,607-crores due from 50 top “wilful defaulters”, including absconding diamantaire Mehul Choksi.

Reportedly, 80% of ₹7-lakh-crores of bad loans of the last decade were written-off in the last 5-years – evidence of government’s increasing bias favouring wealthy borrowers at public cost. Such management of public finances in times of severe financial crisis is unjust. It is only fair to point out that such injustice has been unabashedly displayed at least since 1991 by successive governments.

This bias is compounded in successive union budgets up to the present, by foregoing revenues from corporate tax and customs & excise duties amounting to many lakh-crores. This is done to “incentivize industry” but in effect it indirectly strikes at public health infrastructure, farmers, housing, education, welfare, etc., for the majority population.

Government ordered merger of ten PSBs effective April 1, 2020, to relieve the precarious situation of NPA-wounded PSBs before the Covid-19 Pandemic. Merging PSBs prevents bank collapse by merging the liabilities of a collapsing bank with a bank declaring less liabilities. However, insofar as cancerous NPAs are concerned, it is merely a band-aid dressing. Merger has no curative value.

The NPA crisis is expected to worsen, with a “pile of bad loans” adding up to ₹20-lakh-crore by year-end due to post-Pandemic borrower-defaults. Banks will need re-capitalization to prevent collapse.

India’s financial crisis is due to a combination of global and domestic financial crises including demonetization and unprepared GST rollout, coming on top of regularly writing off NPAs and foregoing revenues to favour big business. Today, Government has no money to re-capitalize banks using the bail-out resolution process, since bank-mergers are only cosmetic.

It is more than probable that Government may resort to rescuing failed/failing banks using the earnings and savings of small investors. Thus, bail-in is a near certainty.

In 2017, when FRDI draft became available for comments, it was noticed that NPA-affected banks could re-capitalize by utilizing the moneys of its depositor-creditors by a process called “bail-in”. Depositors’ savings were safe only to the extent of the insured amount according to government’s discretion. Since 58% of bank deposits belong to many million small investors, the bail-in clause triggered serious public apprehensions, even though government gave assurance that fears were “misplaced”.

Knowing government bias favouring big borrowers responsible for around 80% of NPAs, small investors feared loss of their life-savings. The FRDI bail-in clause had punctured the trust of large numbers of small investors.

Briefly, FRDI “... 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”. Thus, following public outcry, the Government announced in 2018 that it had withdrawn the FRDI Bill.

What is known about FSDR is from articles and YouTube interviews , since the Draft is not available to the public. The reason for secrecy is difficult to understand especially since the law when operationalized, can impact millions of individuals, institutions and public funds.

According to FSDR, when financial sector entities like stock exchanges, clearing authorities and depositories or other capital market and insurance market intermediaries fail or are about to fail, the means for resuscitation are inadequate. FSDR establishes a comprehensive and effective resolution regime for the financial sector, of which banks are at the core.

FSDR is a legislation to save financial institutions from bankruptcy caused by financial imprudence, mismanagement, defalcation, fraud, etc.

FSDR creates a Financial Resolution Authority (FRA) with absolute authority to undertake resolution measures. FRA will # Assess vulnerability of a financial service provider (a bank) to failure due to NPAs, etc., # Grade its risk as low, moderate or imminent/critical, and # Resolve banks at imminent/critical risk.

Resolution options are # Bail-out, # Merger with another financial entity, or # Transfer bank’s NPA liabilities to other financial entities. But further, FRA is also empowered to “terminate contract”, write down debt, and modify liability of the bank under resolution. That is, terminate the contract between the depositor and the bank, write down the bank’s debt to its creditors (depositors), and modify the bank’s liability to protect the deposits of its investors. Although “bail-in” is not explicitly mentioned, these resolution measures are effectively jargon for bail-in.

FSDR assumes that consumers’ deposits are vulnerable to risk of bail-in. So FRA provides insurance at its discretion. At best – for the depositor – it can keep individual deposits on hold and, with a no-appeal finality, disburse deposit insurance at its discretion.

Scams of mismanagement, financial imprudence, defalcation, fraud, etc., among financial service providers, and growth of NPAs taking PSBs to the brink of collapse, are cause for public disquiet because personal savings are at stake.

Government has no finances to bail-out failed/failing PSBs, even as it writes-off big borrowers’ NPAs (86%), and foregoes revenues favouring corporates which contribute only 18% to GDP. It is worrying that FSDR helps truant corporates by re-introducing disguised bail-in which threatens small depositors’ savings. Is this not questionable financial and economic policy?

Whether FSDR actually does or does not include disguised bail-in will only be known if the Finance Ministry provides the draft for public information and comments, giving adequate time. Only this can show that the Government cares for the People and values their trust.

Major General S.G.Vombatkere is retired from the Indian Army.