A lot has been said of how the Reserve Bank of India (RBI) saved two banks within months of each other. If we were to go beyond thinking about the rescue acts of Yes Bank and Lakshmi Vilas Bank (LVB), there is something off the beaten track. The well-known part is that in PSBs (public sector banks), whenever there are NPA (non-performing asset) write-offs and consequent losses, the Government infuses the requisite capital to shore them up. LIC was made to take over the IDBI Bank. It was argued then that LIC’s funds belong to policy-holders. The capital infusion is a load on the Central Exchequer, which ultimately runs on tax-payers’ money.
Some stakeholders made to take the hit
In Yes Bank’s and LVB’s cases, a set of stakeholders was made to bear the losses. For Yes Bank, the holders of the Rs 8,415 crore Additional Tier I Perpetual Bonds had to take the hit. The case is in the court of law on the grounds the bonds were mis-sold with the promise that they were ‘safe.’ In LVB’s case, the entire equity has been written off and shareholders are mulling legal action.
The justification or otherwise of the hit on shareholders/quasi-equity bond holders may be debatable, given that there could be ways to get around the issue. In Yes Bank’s case, the AT1 bonds could have been converted to equity. While rescuing LVB, instead of full write-off, its shares could have been written down to say Re 1. However, that is a separate debate, which is case specific. The line of thought of the regulator and the government is reminiscent of a Bill introduced in 2017, which is in the backburner now, due to loud protests by a section of people, probably driven by a particular interpretation of the provisions. We are talking of the Financial Resolution and Deposit Insurance (FRDI) Bill 2017.
The objection to the Bill was that Clause 52 provided for the concept of “bail-in” instead of “bail-out” that is usually followed. Bail-out means external funding for a distressed institution: for e.g., Government infusion of capital in PSU Banks, using tax payers’ money. Bail-in involves owners or stakeholders taking the hit and rescuing the entity. The Clause 52 mentioned above stated that “The bail-in instrument or scheme under this section shall not affect any liability owed by a specified service provider to the depositors, to the extent that such deposits are covered by deposit insurance.”
Ghosts of a past proposal on deposits
This was construed as meaning that deposits beyond the coverage in Banks, which currently is Rs 5 lakh under the Deposit Insurance Credit Guarantee Corporation (DICGC) insurance (it was Rs 1 lakh at that time), can be forfeited in case of trouble.
Some went on to the extent of saying that the Government is bringing a law that could make you forfeit your deposits in banks. While the logic of the objection was valid, it was carrying things too far. The intention was to limit the losses to internal stakeholders before an external bail out. Stakeholders – equity shareholders or AT1 perpetual bondholders – would logically be the contributors of risk capital. No government would antagonise a large section of the public by using common depositors’ money for bank bail-ins. The Government stated that the FRDI Bill “seeks to protect and enhance depositors’ existing rights and brings in a comprehensive and efficient resolution regime for financial firms.”
Why bring up the ghost of FRDI Bill 2017 now in 2020? We may debate. But we cannot have good money (taxpayers’ funds) chasing bad money (bank NPAs and low net-worth cases).
A Finance Ministry press release in Jan 2018 read: “The resolution instruments presently available under the respective legislations are limited, and so is guidance on the process leading up to the resolution . . . RBI can effect change in bank management, or impose moratorium and recommend mandatory mergers. In the case of a bank, typically either of the two methods of resolution has been used, that is, amalgamation or merger of a weak bank with another bank; or winding up of the bank. Other resolution instruments are not available . . . The FRDI Bill will replace the existing resolution regime by providing 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.”
The Yes Bank and LVB cases show that the decisions taken are in the spirit of a bail-in rather than a bail-out. After IL&FS, DHFL, Yes Bank, PMC and now LVB, there is a case for adding a few new tools to the arsenal of the RBI.(The writer is a corporate trainer (debt markets) and author)