4th May 2014
MUMBAI: Concerned that the present framework for resolving failed banks and financial institutions may not work in a major collapse, the government and the Reserve Bank of India (RBI) are looking at a proposal to create a Financial Resolution Authority (FRA) backed by law, which will permit temporary nationalization of failed institutions.
The FRA has been proposed by a panel comprising RBI and finance ministry officials, which said that the present system of resolution of bank failures through shotgun marriages may not work in future if larger institutions fail.
To avoid a situation where the government may have to use public money to bail out distressed institutions that are 'too big to fail', the panel has recommend a 'bail-in'. Under this mechanism, investors in capital instruments lose money but small depositors are protected. This method has been recommended for use during failure of domestic and global systemically important banks.
Until now, failure of financial institutions has been addressed through government bailouts or through forced mergers with government banks. The report comes at a time when public sector banks are facing a capital crunch even as the government is holding back from making big investments to contain its fiscal deficit.
The working group — on 'Resolution regime for financial institutions' — was constituted last year with RBI deputy governor Anand Sinha as chairman and Arvind Mayaram as co-chair. It has recommended resolution mechanisms for financial institutions as well as financial market infrastructure. The group has said that financial institutions covered would include all kinds of banks — public, private, foreign, rural, and cooperatives. It would also include insurance companies, securities firms, commodities markets and pension schemes. Financial market infrastructure includes payment systems and central counterparties, which would include clearing houses, securities settlement systems, depositories and trade repositories.
According to the RBI, the objective of creating a financial resolution regime was to ensure continuity of financial services, protection of depositor and policy holder funds and to establish financial stability. The report has recommended a single financial resolution authority for all financial institutions and financial market infrastructure, which will work in coordination with regulators. The authority will also take over the task of providing depositor insurance protection to insurance policyholders within limits. To facilitate this, the panel recommends that either the Deposit Insurance and Credit Guarantee Corporation be upgraded to an FRA or the DICGC itself be subsumed under a new FRA.
One of the roles of the regulator (RBI, Sebi or Insurance Regulatory and Development Authority) would be to classify distressed institution within four levels depending on how viable the institution is. Upon reaching the stage where the institution is headed for failure, the regulator has to work in coordination with the FRA so that the distressed institution can be resolved at an earlier stage. To resolve failures without using taxpayer funds, the group recommended that the FRA uses a variety of measures, including liquidation; purchase and assumption; bridge institution; good-bank and bad-bank; bail-in and temporary public ownership.
The working group — on 'Resolution regime for financial institutions' — was constituted last year with RBI deputy governor Anand Sinha as chairman and Arvind Mayaram as co-chair. It has recommended resolution mechanisms for financial institutions as well as financial market infrastructure. The group has said that financial institutions covered would include all kinds of banks — public, private, foreign, rural, and cooperatives. It would also include insurance companies, securities firms, commodities markets and pension schemes. Financial market infrastructure includes payment systems and central counterparties, which would include clearing houses, securities settlement systems, depositories and trade repositories.
According to the RBI, the objective of creating a financial resolution regime was to ensure continuity of financial services, protection of depositor and policy holder funds and to establish financial stability. The report has recommended a single financial resolution authority for all financial institutions and financial market infrastructure, which will work in coordination with regulators. The authority will also take over the task of providing depositor insurance protection to insurance policyholders within limits. To facilitate this, the panel recommends that either the Deposit Insurance and Credit Guarantee Corporation be upgraded to an FRA or the DICGC itself be subsumed under a new FRA.
One of the roles of the regulator (RBI, Sebi or Insurance Regulatory and Development Authority) would be to classify distressed institution within four levels depending on how viable the institution is. Upon reaching the stage where the institution is headed for failure, the regulator has to work in coordination with the FRA so that the distressed institution can be resolved at an earlier stage. To resolve failures without using taxpayer funds, the group recommended that the FRA uses a variety of measures, including liquidation; purchase and assumption; bridge institution; good-bank and bad-bank; bail-in and temporary public ownership.
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