Economy

KEY POINTS

• Bail-out - where governments step in to protect the interests of creditors or depositors using the taxpayers money.
• Bail-outs of failing banks in Greece, Portugal, U.S., U.K. and Iceland were primarily financed by taxpayers.
• Moral hazard - The fact that huge public funds were used for such support, and bailouts incentivized bank managements to go for risky loans led governments to go for other alternatives. 
• (i.e.) Losses of financial firms had to be borne by shareholders and creditors rather than taxpayers. One of the tools for such resolution is “bail-in”.
• Bail-in - a bail-in forces the borrower's creditors to bear some of the burden by having part of the debt they are owed written off.
• Rescuing the failing bank in Cyprus were primarily financed by bondholders and depositors of that bank.
• It allows resolution agencies to override the rights of the shareholders of the firm.

FRDI Bill

• According to Section 52 of the Financial Resolution and Deposit Insurance (FRDI) Bill, depositors will lose their rightful claim to retrieve their savings in case of liquidation of banks and insurance companies.

Rationale behind this provision

• The principal aim is to minimize the cost of any such failures of financial firms to taxpayers.
• The other objective is that shareholders of banks and creditors must also pay their share of costs, rather than governments or taxpayers absorbing all losses.
• The goal of this clause is to ensure banks no longer remain “too big to fail”, and to make sure that the risks that banks take are properly priced by investors who know they will suffer if things go wrong. 
• India is part of the Group of 20 economies that have endorsed the Financial Stability Board’s proposal called “Key Attributes of Effective Resolution Regimes for Financial Institutions”.
• This proposal has a provision for a “bail-in” to ensure that a country’s economy is not destabilized in the event of a big default by a large bank(s).

Cause of Concern

• India’s financial sector is bank-dominated, and bank deposits make up the dominant share of financial savings.
• If depositors lose confidence in the banking system, it will be a big systemic loss and difficult to regain that trust.
• In India, deposits in banks are insured for a maximum of Rs 1 lakh by the Deposit Insurance and Credit Guarantee Corporation, which is now an arm of the RBI.
• There are concerns that the Bill may not clearly lay down the quantum of protection for deposits, or classify deposits separately.
• It will be politically suicidal for any government to hurt the interests of depositors, unless in extreme cases where the country’s economic ecosystem is on the verge of a collapse.

Please Review.

Please review.