In August 2017, a rather innocuous-sounding Financial Resolution and Deposit Insurance (FRDI) Bill was introduced in the Lok Sabha. After the Bill was introduced it was referred to a Joint Committee of members belonging to the Lok Sabha as well as the Rajya Sabha.

The major objective of the Bill was to provide a framework which went beyond just the failure of banks and look for a resolution for the bad loans plaguing financial institutions. This included NBFCs, insurance companies, regional or cooperative banks, mutual or pension funds, a payment system operator and a securities firm.298

The basic idea behind the Bill was to establish an all-encompassing Resolution Corporation. In case a financial service provider was staring at failure, the Resolution Corporation had the power to liquidate the firm or acquire and transfer its assets to another healthy firm, and thus carry out a merger.

The different segments of India’s financial sector were overseen by different regulators. Each of these regulators was set up by a different Act. The intention of the FRDI Bill was to amend around twenty such laws and bring the resolution function – when a financial service provider was staring at failure – under one umbrella of the Resolution Corporation.

Within months of the Bill being presented in parliament, WhatsApp forwards highlighting what the Bill could do to deposits in banks started to do the rounds.

I came to realise the gravity of the situation only when I started getting questions from my family and friends, who normally never asked me anything, either on money in particular or economics in general. And they were asking me whether the WhatsApp forwards going around happened to be true.

There was one clause in the Bill which really spooked people in general. Clause 52 of the FRDI Bill used the term “bail-in”. This clause essentially empowered the Resolution Corporation “in consultation with the appropriate regulator, if it’s satisfied that it was necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider.”

What does bail-in actually mean? It means that financial firms or a bank on the verge of failure can be rescued through a bail-in. Typically, the word bailout is used, and refers to a situation where money is brought in from the outside to rescue a bank or financial firm. In the Indian context, the government constantly recapitalising PSBs over the last decade is a very good example of a bailout. But what is a bail-in? At a very simple level, in the case of a bail-in, the rescue is carried out internally by restructuring the liabilities of the bank.

Given that banks pay an interest on their deposits, a deposit is a liability for any bank. Clause 52 of FRDI essentially allowed the Resolution Corporation to cancel a liability owed by a specified service provider or to modify or change the form of a liability owed by a specified service provider.

Hence, Clause 52 allowed the Resolution Corporation to cancel the repayment of various kinds of deposits. It also allowed it to convert deposits into long-term bonds or equity for that matter. Haircuts could also be imposed on firms to which the bank owed money. A haircut refers to a situation where the borrower negotiates a fresh deal and does not repay the entire amount it owes to the lender.

Nevertheless, there were conditions to this. The bail-in would not impact any liability owed by a specified service provider to the depositors to the extent such deposits are covered by deposit insurance. This meant that the bail-in would impact only the amount of deposits above the insured amount. At that point of time, deposits of up to Rs 1 lakh were insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). This amount hadn’t been revised since 1993.

Typically, anyone who has deposits in a bank tends to assume that they are 100 per cent guaranteed to get their money back. But that is clearly not the case. Over the years, the government has prevented depositors from taking any hit by merging banks which are in trouble with another bigger bank.

So, to that extent, the situation, if the FRDI Bill had been passed, wouldn’t have been very different from the one that already prevailed. The trouble, as always, nuance and learnings from the WhatsApp University rarely go together. This time was no different.

Not surprisingly, one year after it was introduced, the Bill was quietly dropped in August 2018. It seems that the then finance minister, Piyush Goyal, told the parliamentary committee constituted to look into the Bill that the government had decided to drop it due to apprehensions that had developed among people around the “bail-in” clause. The clause was perceived to be against the interest of depositors, Goyal informed the committee.

In early 2020, it was reported that the FRDI Bill was making a quiet comeback under the new name of Financial Sector Development and Regulation (Resolution) (FSDR) Bill, 2019.

Bad Money

Excerpted with permission from Bad Money: Inside the NPA Mess and How It Threatens the Indian Banking System, Vivek Kaul, HarperCollins India.