What is a financial firm?
- Financial firm is an enterprise such as a bank whose primary business and function is to collect money from the public and invest it in financial assets such as stocks and bonds, loans and mortgages, leases, and insurance policies.
What is insolvency?
- Insolvencyrefers to the inability of a person or corporate to pay up his debt /bills as and when they become due.
- He may be able to pay at a later date some amount or even in full, but at the promised date of payment, he is unable to make the payment.
What is bankruptcy?
- Bankruptcyis the next state of insolvency.
- It occurs where an individual and partnership firm is declared by the relevant authority under a specified law for the purpose, as incapable of paying up his debt / bills at any time in present as well as in the foreseeable future.
- Generally, failure of resolution process leads to bankruptcy.
What is Insolvency and Bankruptcy Code?
- The Insolvency and Bankruptcy Code, 2016 was passed by Parliament on 11.5.2016 and published in the Official Gazette on 28.5.2016.
Provisions of Insolvency and Bankruptcy Code:
- The provisions of Insolvency and Bankruptcy Code are as follows:
Speedy detection and solutions:
- Clear, coherent and speedy process for early identification of financial distress and resolution of companies and limited liability entities if the underlying business is found to be sustainable.
Debt Recovery Tribunal and National Company Law Tribunal:
- Debt Recovery Tribunal and National Company Law Tribunal to act as Adjudicating Authority and deal with the cases related to insolvency, liquidation and bankruptcy process in respect of individuals and unlimited partnership firms and in respect of companies and limited liabilities entities respectively.
Insolvency and Bankruptcy Board of India:
- Establishment of an Insolvency and Bankruptcy Board of India to exercise regulatory oversight over insolvency professionals, insolvency professional agencies and information utilities.
- Insolvency professionals would handle the commercial aspects of insolvency resolution process.
- Insolvency professional agencies will develop professional standards, code of ethics and be first level regulator for insolvency professionals members leading to development of a competitive industry for such professionals.
- Information utilities would collect, collate, authenticate and disseminate financial information to be used in insolvency, liquidation and bankruptcy proceedings.
- Enabling provisions to deal with cross border insolvency.
What are the different challenges for a financial sector in India?
- In its bi-annual Financial Stability Report (FSR), released on June 30, 2017 the Reserve Bank of India (RBI) warned that the sector is under severe stress. The major ones are as follows:
- A bad loan is a loan where repayments are not being made as originally agreed between the borrower and the lender, and which may never be repaid.
- These bad loans are squeezing banks’ profitability and capital positions, threatening the health of some of India’s biggest banks.
- With the growing penetration of computers and smartphones, and increasing access to the internet, Indians are taking to digital channels for their banking needs for which cybercrime is becoming a greater threat.
- The RBI classifies bank fraud as transactions involving any cheating, negligence, misappropriation of funds, or forged documents.
- Another pressing concern for the banking regulator is the increased number of fraudulent transactions at Indian banks.
- What’s adding to the concerns is that banks often seem reluctant to report these cases.
What is Financial Resolution and Deposit Insurance Bill, 2017?
- The Financial Resolution and Deposit Insurance Bill, 2017 is a part of a larger, more comprehensive approach by the Centre towards systematic resolution of all financial firms.
- The Bill comes together with the Insolvency and Bankruptcy Code.
- It aims at finding and finalizing a resolution plan to get a troubled company back on track, or, in the event of failure, ensure a quick winding up.
Importance of Financial Resolution and Deposit Insurance Bill, 2017:
- The need for a specific regulation rose following the 2008 financial crisis.
- The crisis witnessed a large number of high-profile bankruptcies.
- With the Centre also actively encouraging people to engage more with the banking sector — both through schemes like Jan DhanYojana and moves like demonetisation, it becomes important to protect savers and those joining the formal economy in case a bank or insurance firm starts failing.
Provisions of the Financial Resolution and Deposit Insurance Bill, 2017:
- The provisions of the Financial Resolution and Deposit Insurance Bill, 2017:
- The Bill provides for the setting up of a Resolution Corporation.
No major modification:
- The provisions contained in the FRDI Bill do not modify present protections to the depositors adversely at all.
- They provide rather additional protections to the depositors in a more transparent manner.
- The FRDI Bill is far more depositor friendly than many other jurisdictions, which provide for statutory bail-in, where consent of creditors / depositors is not required for bail-in.
Wider range of support:
- The FRDI Bill does not propose in any way to limit the scope of powers for the Government to extend financing and resolution support to banks, including Public Sector Banks.
- The Government’s implicit guarantee for Public Sector Banks remains unaffected.
Strengthening of the system:
- The FRDI Bill will strengthen the system by adding a comprehensive resolution regime that will help ensure that, in the rare event of failure of a financial service provider, there is a system of quick, orderly and efficient resolution in favour of depositors.
What is Resolution Corporation?
- The Bill establishes a Resolution Corporation to monitor financial firms, anticipate risk of failure, take corrective action, and resolve them in case of such failure.
- The Resolution Corporation seeks to replace the existing Deposit Insurance and Credit Guarantee Corporation.
Functions of Resolution Corporation:
- The Resolution Corporation will be tasked with monitoring financial firms, anticipating their risk of failure, taking corrective action and resolving them in case of failure.
- The corporation is also tasked with providing deposit insurance up to a certain limit yet to be specified, in the event of a bank failure.
- Furthermore, it classifies financial firms on their risk of failure
- These categories in the order of increasing risk are: (i) low, (ii) moderate, (iii) material, (iv) imminent, and (v) critical.
- The Resolution Corporation will take over the management of a financial firm once it is classified as ‘critical’.
- It will resolve the firm within one year (may be extended by another year).
- If resolution is not completed within a maximum period of two years, the firm will be liquidated.
What isDeposit Insurance and Credit Guarantee Corporation?
- Deposit Insurance and Credit Guarantee Corporation (DICGC) is a subsidiary of Reserve Bank of India.
- It was established on 15 July 1978 under Deposit Insurance and Credit Guarantee Corporation Act, 1961.
Functions of Deposit Insurance and Credit Guarantee Corporation (DICGC):
- It provides insurance of deposits and guaranteeing of credit facilities.
- It insures all bank deposits, such as saving, fixed, current, recurring deposit for up to the limit of Rs. 100,000 of each deposit in a bank.
- It insures all deposits such as savings, fixed, current, recurring, etc., except the following types of deposits:
- Deposits of foreign governments,
- Deposits of central/state governments,
- Inter-bank deposits,
- Deposits of the state land development banks with the state co-operative bank,
- Any amount due on account of any deposit received outside India, and
- Any amount that has been specifically exempted by the corporation with the previous approval of Reserve Bank of India.
- The insurance premium is paid by the insured banks itself.
- This means that the benefit of deposit insurance protection is made available to the depositors or customers of banks free of cost.
- The Corporation has the power to cancel the registration of an insured bank if it fails to pay the premium for three consecutive half-year periods.
- The Corporation may restore the registration of the bank, which has been de-registered for non-payment of premium.
What are the different financial resolution techniques adopted by Resolution Corporation?
- Resolution may be undertaken using methods including:
Merger or acquisition:
- In a merger, the boards of directors for two companies approve the combination and seek shareholders approval. After the merger, the acquired company ceases to exist and becomes part of the acquiring company.
- In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or legal structure.
Transferring the assets, liabilities and management to a temporary firm:
- The assets, liabilities and management of the ‘critical’ financial firm will be handed over to another firm.
- Liquidationis the process by which a company (or part of a company) is brought to an end, and the assets and property of the company are redistributed.
- A bail-in clause is one where the creditors of the bank would be forced to bear a part of the loss in case the institution sinks.
- All depositors are considered creditors in banking terms. In fact, they are unsecured creditors, in the sense that no depositor seeks security from banks while making their deposits.
- The bank uses these deposits to extend loans and earn interest.
Current status of the Bill:
December – 2017:
- The Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill), is presently under the consideration of the Joint Committee of the Parliament.
- The Joint Committee is consulting all the stakeholders on the provisions of the FRDI Bill.
- Certain confusions have been expressed in the media regarding “bail-in” provisions of the FRDI Bill.
January – 2018:
- The government issued a clarification on the Financial Resolution and Deposit Insurance Bill’s “bail-in” provision.
- According to the government the bail-in clause will not be used for public sector banks (PSBs).
- The “bail-in” clause can only be used in private banks, and that too only if the customers allow it.
- Furthermore, the use of the “bail-in” clause by the Resolution Corporation will be subject to government scrutiny and parliamentary oversight.
- In the event of a “bail-in”, the Resolution Corporation will have to ensure that depositors get back at least as much money as they would have if the bank had been liquidated.
- The claims of uninsured depositors (that is, beyond 1 lakh) would be given precedence over the claims of unsecured creditors and government dues.
Joint Committee of the Parliament:
- Joint Parliamentary Committee (JPC)is one type of ad hoc Parliamentary committee constituted by the Indian parliament.
- A financial assetis a non-physical asset whose value is derived from a contractual claim, such as bank deposits, bonds, and stocks.
- Financial assets are usually more liquid than other tangible assets, such as commodities or real estate, and may be traded on financial
Financial Stability Report (FSR):
- Financial Stability Report (FSR) is a biannual publication.
- The FSR reflects the overall assessment on the stability of India’s financial system and its resilience to risks emanating from global and domestic factors.
- Besides, the Report also discusses issues relating to development and regulation of the financial sector.