Wednesday, December 20, 2017

FRDI: Grossly at Odds with the Indian Financial System

The government’s penchant for painting all legitimate questions about its faulty policy-making as scaremongering or anti-national is getting rather irksome. Prime minister Narendra Modi (at the FICCI annual general meeting) and finance minister Arun Jaitley have both responded to fears over the implications of the Financial Resolution and Deposit Insurance Bill (FRDI Bill) , 2017, by lashing out at critics and reassuring people that the government will protect bank deposits. 

Yes, we are quite certain that the government will not confiscate bank deposits and convert them into equity to bail out bleeding public sector banks (PSBs) in the year and a half before the 2019 general elections when this government’s term ends. It is true that people have been rattled by social media messages into believing that such a move is imminent. But whose fault is that? 

The government certainly wants to enact legislation that will enable such action and public assurances by ministers will have no sanctity, especially if there is a different government or even different ministers in relevant positions. What is worse, the legislation itself is completely at odds with the structure and operation of Indian banking. 

Moneylife Foundation has sent a representation to the Joint Parliamentary Committee (JPC) which is examining this Bill. In my last column, I had also written about the ‘bail-in’ provision that would allow a bank, on the verge of bankruptcy, to convert un-insured deposits above a threshold into equity in order to recapitalise banks. But I realise that it makes no sense to present the bail-in as a last resort action, when the FRDI Bill itself is so drastically flawed that it is bound to cause a wanton destruction of PSBs. 

The main reason why the FRDI Bill must be withdrawn is this: The only part of Indian financial sector where it can be potentially applied to is wobbly PSBs which account for over 63% of Indian banking; but then it is illogical to apply it on them. If a bank goes bankrupt the owner is responsible; and, in case of PSBs, the government is the owner. You cannot have a bail-in clause where the owner pays no price but depositors are made to take the risk.

If the FRDI Bill has to be made applicable to PSBs, they must be privatised and the government holding brought below 26% in order to insulate them from political interference and behest lending. Clearly, this is impossible without resolving the massive bad loan issue; because, without a sovereign guarantee that ensures the safety of depositors’ money, deposits will instantly flee to profitable private banks with a low incidence of bad loans. This would end up destroying the Indian banking system instead of curing it of a hypothetical problem that does not apply to Indian banks in the first place. 

Dr KC Chakrabarty, former deputy governor of the Reserve Bank of India (RBI), highlights another issue. He says, “Globally, all deposit taking institutions are regulated and supervised under a single regulatory framework and same standard of regulation.” This means that cooperative banks have to be removed from the clutches of politicians and the Central and state registrars of cooperatives. 

In the past 20 years, every single payment made by the Deposit Insurance Guarantee Corporation was on account of politically-controlled cooperative banks which fail with astonishing regularity. In most cases, RBI as well as the registrar of cooperatives have ignored whistleblowers and refused to initiate strict action. Bombay Mercantile Cooperative Bank is a good example. The Bank has gone steadily downhill over the past 15 years, despite innumerable attempts by a set of whistleblowers to rein in dubious management. They were ignored and victimised. 

In a last ditch attempt, they filed a public interest litigation (PIL) alleging breach of trust by the chairman and directors; the PIL named RBI and the Central Registrar of Cooperative Societies (CRCS) as respondents. On 21st September, a bench headed by then chief justice Dr Manjula Chellur and Justice NM Jamdar, Bombay High Court directed the CRCS to consider representations made by the whistleblowers and dispose them within a month. The CRCS has not even bothered to respond to this court order. In fact, getting CRCS to bestir itself is a herculean task. The FRDI Bill excludes cooperative banks, but does not provide a separate deposit insurance scheme for them, so they may be quietly included later on. The loss-making Bank of Maharashtra’s whistleblower was similarly victimised for drawing attention to the most egregiously dubious lending decisions. 

As Dr Chakrabarty says, all deposit-taking entities, including deposit-taking non-banking finance companies and cooperative banks, must be brought under the same stringent supervision in order to ensure that money does not flow from one set of institutions to another and weaken the financial system. But regulation of deposit-taking finance companies under the RBI’s supervision has also been poor. 

A third issue, which is also a global problem, is the lack of accountability of regulators. Three former RBI governors have published self-congratulatory memoirs in 2017 that have one thing in common—silence about their failure to deal with cronyism, behest lending and burgeoning bad loans which are set to touch Rs10 lakh crore. Even in the US, which is pushing for creditors to bailout bankrupt institutions in the future, regulatory failure of 2008 went unpunished, despite a huge public outcry.

It is pertinent to note that D Subba Rao and Raghuram Rajan had ignored the All India Bank Employees Association (AIBEA) campaign since 2013 to ‘Stop the loot of PSU Banks and start recovery of funds’. The Association had gone ahead and published the list of top defaulters even while RBI has been acting coy about revealing names even in 2017. Isn’t AIBEA fully justified in demanding withdrawal of the FRDI Bill that could potentially destroy PSBs and lead to massive job losses?

A fourth issue is the ‘corporate insurance fund’ which, we are given to understand, will cover a larger chunk of deposits (as opposed to Rs1 lakh per depositor today). There is no discussion on the cost of this insurance and who will bear it. The annual insurance paid by banks to cover Rs30,509 billion deposits was Rs101 billion in 2017. If the insurance cover per depositor is raised to Rs10 lakh or Rs20 lakh per depositor, there will logically be a 10-fold increase in premium paid. The FRDI Bill intends to cover insurance as well. Neither the government nor the FRDI Bill explains where this money will come from. Won’t we, as depositors, end up paying a significant cost for deposit protection? After all, banks already extract all charges from consumers, despite enjoying a fat spread on our deposits. We need an explanation. 

A fifth issue that remains unclear is the role and authority of RBI itself. In the past few decades, RBI has ensured that no big bank has failed, by engineering mergers with strong banks. These decisions have been dictated as much by the need to cover its own lapse of supervision, as to safeguard the financial system. 

Under the FRDI Bill, this will be decided by a Financial Resolution Authority (FRA) which is only obliged to consult RBI. More importantly, without a sovereign guarantee, neither the FRA nor RBI can possibly force a merger like that of Global Trust Bank with Oriental Bank of Commerce. It is not clear whether those who wrote the FRDI Bill saw this possibility. 

Far from protecting the taxpayer and exchequer from the cost of large bankruptcies, the FRDI Bill threatens to weaken the Indian banking system when it urgently needs fixing. In a country that provides no social security to people, a legislation that can appropriate hard-earned, tax-paid, savings is bound to cause anxiety and fear. But when the Bill itself is incompatible with the structure of our banking system, it needs to be withdrawn until PSBs that have been looted for decades by dubious industrialists and politicians are restored to health. 

The above is from Sucheta Dalal's Petition

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