Bail in, Bail out & FRDI Bill

Bail Out: It refers to a situation when government enters to safeguard the interest of deposits

However, this has certain negative impacts

  1. It increases burden on tax payers as bail out is by government through taxation
  2. It encourages bankers to take ‘risky calls’ that is termed as ‘moral hazard’ by economists. That is they take “risk without responsibility”

Bail inIt refers to the rescuing a financial institution on the brink of failure by making its creditors & depositors take loss of their holding.

Bail in is resorted to when

  1. The failure of Financial institution does not pose any systemic risk i.e. will have no great impact on economy
  2. The government does not possess the financial resources for a bail out because it is itself heavily indebted.

Aim of bail-in:

  1. To minimize the cost of any such failure of financial firms to tax payers
  2. Shareholders & creditors must pay for their share of cost as it is they who make profit with the benefits of the banks.
  3. To ensure that the banks no longer remain “too big to fail”
  4. To make sure that the risks that banks take are properly priced by investors who know they will suffer if things go wrong.

Provision under FRDI: It was proposed by Financial Sector Legislative Reform commission, headed by Justice B. N. Sri Krishna.

Aim of FRDI BILL

  1. To establish Financial Resolution Corporation, which will
    1. Monitor financial company
    2. Categorize them as per their risk profiles
    3. Step in to prevent them from going bankrupt by writing down their liability
  2. To anticipate the risk of failure in financial entities & resolve them
  3. To protect consumer’s of specified service providers & public fund

PROVISIONS IN THE BILL : FRC will subsume (Deposit Insurance & credit Guarantee Corporation) DICGC & will work across the financial system, including banks, insurance, Mutual Fund, Pension fund, etc.

  1. It empowers FRC to bail in specified service provider to absorb the losses incurred
  2. Under this, FRC can
  • Cancel liability
  • Modify or change the form of liability
  • Convert instrument from one class to another
  • Replace an instrument with another
  • Create a new security
  • Enforce  haircuts
  • In the extreme cases, FRC can
    • Cancel repayment of deposits
    • Convert deposits in to long term bonds or equity
    • Enforce haircuts to whoever the banks owes monies
    • It, however, exempts insured deposits i.e. up to 1 lakh

Negative impacts of the Bill: It will have negative impacts on

  1. Savings for retirement; marriages, education, house etc which could exceed insured deposit limit.
  2. Salary accounts & working capital of industries may get blocked.

Why depositors should be punished?

  1. Depositors, who provide low cost capital to the banks as Banks pay low interest on their saving and other deposits, be punished for the banker’s failure.
  2. Why depositors who have no saying in the management be forced to pay for the failure of the management.
  3. Why cost of systematic failure be shifted from Government and tax payer to the depositors

Government’s explanation

  1. Government still guarantees PSU banks depositors
  2. Deposit insurance up to 1 lakh still continue
  3. Insurance Premium is paid by the banks and not charged from depositors.

Why FRC?

  1. Financial firms do not fall in the ambit of Insolvency and Bankruptcy Code (IBC) & so bankruptcy of financial firms have to be coordinated outside IBC process. So, FRC is equivalent to IBC. This will enhance ease of doing business.
  2. RBI is opposed to it as it will clip some of its power like resolving dispute among financial companies. But the idea is that RBI should focus only on monetary and prudential measures.
  3. FRC will have representatives of RBI & other regulators, as well government’s representatives & so will provide better coordination to resolve financial frauds.
  4. It will be in line with other developed countries.

Deposit Insurance & credit Guarantee Corporation: is a subsidiary of RBI, established in 1978 under Deposit Insurance & Credit Guarantee Corporation Act 1961.

  1. It insures all bank deposits such as SA, FD, RD, CA up to a limit of 1 lakh of each deposit in a bank
  2. The maximum insurance include both principal & interest amount
  3. If a customer has accounts in different banks, all of those accounts are insured to a maximum of 1 lakh, however, if there are more accounts in the same bank, all those are treated as single account.
Please follow and like us:
100

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

error: Content is protected !!