Bail blues

A heated discussion is on in India on the ramifications of Financial Resolution and Deposit Insurance Bill (FRDI) and its impact on depositors. In developed economies, a clearly spelt out mechanism has been put in place to deal with banks going under and it has evolved gradually through trial and error method, mainly after the 2008 crisis. The two methods that are generally employed are bail-out and bail-in. Bail-outs are by support from outside the balance sheet and Bail-In is by absorbing the loss within balance sheet.

Deposit insurance is an established global practice and has been in place in India since long with the Deposit Insurance and Credit Guarantee Corporation (DICGC) of RBI providing insurance coverage to depositors up to ₹1 lakh per person. The DICGC would now be dissolved and the role be subsumed into Resolution Commission. In US, Federal Insurance Development Corporation (FDIC) provides insurance coverage to depositors up to $250,000 and is one of the three prominent regulators with wide ranging responsibilities including examination of banks.

FDIC, with other regulators exercises strict control over banks including scrutinising loan book to ensure safety of deposits. In comparison, the DICGC plays a minimal role and strengthening the mechanism by dissolving it and entrusting Resolution Commission with more responsibilities is welcome.

In US, it was thought appropriate to bail out banks with tax payers’ money than to enforce cuts onto bond holders as they encourage run on banks. Interesting to note is that all the banks that were bailed out were private reflecting capitalistic structure of the US. A combination of methods have been employed by regulators which include creating a dollar corpus under the Troubled Asset Relief Program (TARP) to bail out banks, allowing weaker banks to merge with strong banks, etc. Banks that had availed money under TARP have repaid to government and gave decent returns on tax payers’ money.

Unlike the US, Europe has inclined towards bail-in enforcing cuts on to unsecured bond holders. The outcome has been of limited results as it encouraged run on the banks. Recently, Italy has to reverse their approach back to bail-out as it exemplifies the strong backing of the government behind banks.

Both approaches have their own advantages and disadvantages. Bail-out is employed when the Government’s own debt is manageable and it is of the view that banks would turn around. But it brings up the ‘Moral Hazard sentiment’ suggesting failing banks have been bailed out with taxpayers’ money.

Bail-in is adopted when markets are mature; the Government enforces strict financial discipline and does not want to take the burden of rescuing them from own balance sheet. It indirectly implies that bond holders and depositors should also be aware of the strengths and weaknesses of the banks they deal with.

The FRDI Bill can draw from both US and Europe experiences and adopt strategies that best suit the Indian context. As most banks are in the public sector and the Government is keen to maintain the status quo, it has to keep infusing to maintain their present shareholding to enable banks’ growing needs. If US can bail out even private banks, the Government is also expected to come to the rescue of banks and in turn that of depositors.

The writer is V-P (Syndications), SBI, US Operations, New York. The views are personal

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