Financial Resolution and Deposit Insurance Bill, 2017: Key highlights

Financial Resolution and Deposit Insurance Bill, 2017: Key highlights

The outbreak of global financial crises in 2007 08 caused panic amongst depositors regarding the lack of a regulated framework or entity to avoid failure of financial institutions. Countries around the world started developing legislative frameworks to protect deposit holders and develop resolution regimes to reduce systemic impact in case of failures. In India, the absence of a comprehensive legal framework for the resolution of distressed financial firms has paved the way for the Financial Resolution and Deposit Insurance Bill (FRDI), 2017. The rationale behind the introduction of is to develop a resolution regime for financial institutions in distress while protecting the interests of taxpayers. The FRDI Bill aims to create an integrated framework which involves the early detection of risks by continuously monitoring financial firms. The Insolvency and Bankruptcy Code (IBC), 2016, is a strong framework for minimising the cost and time incurred during the liquidation process. With IBC established, FRDI is a step towards having an efficient and integrated resolution structure to improve the resilience of the Indian financial system. 2 PwC

3 PwC Establishment of a Resolution Corporation: The Central Government will establish a Resolution Corporation with the power to enter into contracts, power to sue or get sued, and power to acquire/hold/dispose properties. The members will include representatives from various financial regulators as well as the Ministry of Finance. Some key functions the corporation are: Provide deposit insurance to banking institutions; Specify the criteria for classification of a specified service provider into one of the categories of risk to viability; Act as an administrator for service providers that have been classified in the category of critical risk to viability; Exercise powers in relation to certain termination rights in respect of specified service providers; Resolve a specified service provider which has been classified in the category of critical risk to viability; Act as a liquidator for a specified service provider against which an order of liquidation has been made; Any other powers and functions as may be prescribed. Deposit insurance: The Deposit Insurance and Credit Guarantee Corporation (DICGC) is a subsidiary of the Reserve Bank of India. It was established in 1978 under the Deposit Insurance and Credit Guarantee Corporation Act, 1961, for the purpose of providing insurance of deposits and guaranteeing of credit facilities. Currently, DICGC provides deposit insurance of up to 1 lakh INR and the rest of the amount is forfeited in the event of a bank failure. Under the proposed FRDI bill, the Resolution Corporation has the rights to fix the threshold for deposit insurance which is not yet decided. In order to achieve the main objective of the FRDI Bill in terms of the safety of the depositors, the government may have to increase the deposit insurance threshold tenfold to protect 80 90% of deposits. Factors such as inflation and cost of living have to be kept in mind to fix the deposit insurance amount in the proposed bill as it has not been increased according to the economic situations in the past 25 years. However, with this anticipated increase in the deposit insurance threshold, whether the premium would be borne by customers or is yet to be cleared. The Corporate Insurance Fund will be used by the board of the corporation to pay a specified amount to a depositor of a financial institution with respect to their deposit in case of liquidation of the service provider. Risk-based classification: Another key function of the corporation along with appropriate regulators is to assess and classify the insured service providers based on the risk to viability. Five categories based on the probability of failure of an insured service provider will help in the determination of risk to viability: Category Low Moderate Material Imminent Critical Probability of failure Substantially below acceptable levels of probability of failure Marginally below or equal to acceptable levels of probability of failure Marginally above acceptable levels of probability of failure Substantially above acceptable levels of probability of failure Substantially above acceptable levels of probability of failure and on the verge of failing to meet its obligations to its depositors

4 PwC Systematically Important Financial Institutions (SIFIs): The Central Government in consultation with the appropriate regulator would prescribe criteria. A financial service provider that fails to meet these criteria will be designated as a SIFI. The features of a financial service provider, such as (a) size, (b) complexity, (c) nature and volume of transactions with other financial service providers, and (d) interconnectedness with other financial service providers and such other related criteria, may be prescribed. These would be taken into consideration while specifying an entity as a SIFI. With the theory of too big to fail and their economic impact, the bill encompasses some additional powers in respect of these SIFIs when it comes to their resolution or bankruptcy. All SIFIs are expected to provide the required information in such frequency and manner as may be prescribed by the Resolution Corporation, mainly to monitor their safety, soundness and solvency. The Resolution Corporation can inspect SIFIs in addition to sectoral regulators. It is specified in the bill that the Central Government may by an order to be published in the official gazette appoint a body it constitutes to discharge its powers and functions in respect of SIFIs. Resolution plan Service providers falling under the imminent or critical risk category are obliged to provide resolution and restoration plans to the corporation, which will include all the information regarding assets and liabilities and resolution plans to improve the risk categorisation. Resolution methods proposed under the bill are mergers and acquisitions, bridge service providers, transfer of all assets and liabilities or bail-in. When a financial service provider falls under the critical risk to viability stage, the resolution by corporation must be incorporated within one year which could be extended to two years at the maximum. Furthermore, if any of the above resolution strategies is not undertaken within two years, the firm may be liquidated. For the purpose of liquidation and distribution of assets, the corporation will require the approval of the National Company Law Tribunal to liquidate the assets of the financial service provider in distress. If liquidation and distribution of assets take place, the proceeds are given in priority to the corporation insurance fund used for the deposit insurance, resolution costs, secured creditors, wages for employees, uninsured depositors, unsecured creditors, government dues, other debt and dues, and shareholders. - - Penalties are imposed for fraudulent activities such as concealment, destruction or falsification of evidence. Imprisonment with fines are also imposed as penalties for the highest nature of offences.

The National Company Law Appellate Tribunal or Tribunal is a quasi-judicial authority created under the Companies Act, 2013 to handle corporate civil disputes arising under the act. It is an entity that has powers and procedures like those vested in a court of law or judge. The following are the powers and key functions of : Where the corporation determines that liquidation is the most appropriate method for the resolution of a specified service provider, the corporation shall make an application to the Tribunal for an order of liquidation in respect of such specified service provider. The Tribunal shall pass an order of liquidation appointing the corporation as the liquidator for a specified service provider. It provides the order of liquidation and may prohibit the commencement or continuation of all legal actions and proceedings against the service provider being liquidated till the continuance of the period of liquidation. It provides that on the appointment of the liquidator, all powers of the board of directors, key managerial personnel and the partners of the service provider shall cease to have effect and shall vest in the liquidator. It deems the order of liquidation to be a notice of discharge to the officers, employees and workmen of the specified service provider. The bill provides that if the liquidator is of the opinion that any person who has taken part in the conduct of business of the service provider or has been a director or an auditor of the service provider should be publicly examined, it may file an application before to hold a public sitting on a date to be appointed for that purpose and may direct that such person, director or auditor shall attend and be publicly examined as to the conduct of the business of the specified service provider, or as to his conduct and dealings. The Tribunal also has the powers to provide for public examination of directors and auditors of a specified service provider being liquidated by the corporation. It provides that if the liquidator is of the opinion that any promoter or any person has taken part in the conduct of business of the specified service provider or has been a director or an auditor of the specified service provider, they can be publicly examined. 5 PwC

The FRDI Bill provides for detecting emerging insolvencies in financial firms by introducing a five-stage health classification of financial firms and stepping in to appropriately recover a financial firm at the stage when its health becomes weak and it is classified in the category of material risk to viability, much before it is classified in the category of critical risk to viability when the need for resolution or liquidation arises. In the material risk to viability stage, the corporation identifies the financial health of a service provider as weak when it is marginally above the level of acceptable probability of failure. In the imminent risk to viability stage, the probability of failure is substantially above the probability of failure. During these stages, the firms under risk need to develop restoration plans to be submitted to the regulator and the corporation. The restoration plan involves developing strategies and including steps to be undertaken to be classified under at least moderate risk if not low risk to viability. In the critical risk to viability stage, the resolution plan includes the formulation of an exit strategy which makes the firm move to the stage. During this stage, the financial service provider fails to meet the obligations towards its depositors and is on the verge of failing. In the critical stage, the corporation will take over the management of the financial service provider in distress from the date the firm has been identified as critical. The exit strategy has to be submitted to the corporation, which would involve various resolution tools or a liquidation process in a rare event. 6 PwC

One of the resolution tools that the corporation may undertake is bail-in in case of the failure of a financial institution. This has created a stir amongst depositors and bank unions because it poses a threat to their deposits with various public sector. This bail-in clause gives statutory rights to the government to convert depositors money into equity and convert existing depositors into shareholders in order to recapitalise the financial institution in distress. This is the opposite of a bail-out wherein the government or an external agency helps the in distress. The only amount that cannot be used for a bail-in is the amount under deposit insurance. In order to avoid bank runs on public sector, the government has cleared the air regarding the clause. The bail-in clause will not be used for public sector. The government has also emphasised its implicit guarantee of a public sector bank s solvency, stating that since they fall under the jurisdiction of the government, the bail-out procedure would take place if needed, eliminating the need for a bail-in. However, this implicit guarantee increases the moral hazard and leads to risky behaviour by and poor monitoring of deposits. Another important clarification was that the cancellation of the liability of a depositor beyond the insured amount cannot take place without his or her prior consent. The bail-in clause as a restoration plan can only be used in private, and is also considered as a last resort by the Resolution Corporation. The government needs to acknowledge the fact that private hold 25% of the deposits in the country and the need for protection of these private bank depositors also exists. 7 PwC

The FRDI Bill has proved to be a bill for various reasons. Some of the key impacts of the bill on are discussed below: The FRDI Bill has been introduced for the sole purpose of providing a comprehensive resolution regime for distressed companies in the financial sector, such as, insurance companies and financial institutions. The bill aims to protect large numbers of retail depositors and customers of financial service providers. By providing a comprehensive resolution mechanism, the FRDI Bill, along with the IBC, will facilitate the reduction of NPAs and also maintaining stability in the economy. It promotes ease of doing business in the country, improves financial inclusion and increases access to credit, which may also reduce the cost for obtaining credit. Once enacted, the Resolution Corporation aims to strengthen the stability and resilience of the entities in the financial sector. 8 PwC

Vivek Iyer Partner vivek.iyer@pwc.com Mobile: +91 9167745318 Dnyanesh Pandit Director dnyanesh.pandit@pwc.com Mobile: +91 9819446928 Vernon Dcosta Director vernon.dcosta@pwc.com Mobile: +91 9920651117 Rajeev Khare Manager rajeev.khare@pwc.com Mobile: +91 9702942146 Vidhi Trivedi Consultant vidhi.trivedi@pwc.com Mobile: +91 98203 41011 9 PwC

About PwC At PwC, our purpose is to build trust in society and solve important problems. We re a network of firms in 158 countries with more than 2,36,000 people who are committed to delivering quality in assurance, advisory and tax services. Find out more and tell us what matters to you by visiting us at www.pwc.com In India, PwC has offices in these cities: Ahmedabad, Bengaluru, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai and Pune. For more information about PwC India s service offerings, visit www.pwc.com/in PwC refers to the PwC International network and/or one or more of its member firms, each of which is a separate, independent and distinct legal entity. Please see www.pwc.com/structure for further details. 2018 PwC. All rights reserved pwc.in Data Classification: DC0 This document does not constitute professional advice. The information in this document has been obtained or derived from sources believed by PricewaterhouseCoopers Private Limited (PwCPL) to be reliable but PwCPL does not represent that this information is accurate or complete. Any opinions or estimates contained in this document represent the judgment of PwCPL at this time and are subject to change without notice. Readers of this publication are advised to seek their own professional advice before taking any course of action or decision, for which they are entirely responsible, based on the contents of this publication. PwCPL neither accepts or assumes any responsibility or liability to any reader of this publication in respect of the information contained within it or for any decisions readers may take or decide not to or fail to take. 2018 PricewaterhouseCoopers Private Limited. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers Private Limited (a limited liability company in India having Corporate Identity Number or CIN : U74140WB1983PTC036093), which is a member firm of PricewaterhouseCoopers International Limited (PwCIL), each member firm of which is a separate legal entity. VB/March2018-12279