The Hindu Business Line : An organised bailout

BANKS should not be allowed to fail — since the interests of many depositors are at stake. In their role as custodians of public wealth, they have to retain public confidence. Bank collapses therefore are anathema to regulators the world over. When such disasters happen, despite supervisory control by central banks, the only option is an "organised bailout".

Indian banking laws provide for such eventualities. According to Section 45 of the Banking Regulation Act, the Reserve Bank of India as regulator and supervisor of the banking system in the country, can intervene in "public interest" or in the interest of depositors and initiate mergers and draw up a scheme of amalgamation of the failing bank with another stronger bank.

This is what the RBI has done with the proposed amalgamation of Ganesh Bank of Kurundwad with Federal Bank. It had occasion to carry out a similar exercise in July 2004 when the Global Trust Bank (GTB) was on the verge of collapse.

The Union Government passed an order of moratorium with respect to GTB. A moratorium order is an order normally passed by sovereign authority sanctioning a delay in payment of debts in the backdrop of a financial crisis. The order is normally sanctioned for a period of 3 months, during which the RBI would look at various options for the troubled bank. During this period, there is a limit on the amount that depositors can draw from their accounts. In the case of GTB depositors, this was fixed at Rs 10,000.

Although the moratorium order is worded in a way as to give the correct chronological sequence, the RBI has in most cases decided who the suitor would be and sounded out the bank concerned before the order for the troubled bank is issued.

For instance, in the case of GTB, the Government passed the order on July 24, 2004, a Saturday. Within 48 hours, the RBI had come out with a draft scheme of amalgamation for GTB with Oriental Bank of Commerce.

More Stories on : RBI & Other Central Banks | Mergers & Acquisitions

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An organised bailout

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