Highlights of the Bill
Key Issues and Analysis
PART A: HIGHLIGHTS OF THE BILL[1]
Context
Figure 1: Distribution of financial assets in India
Sources: Report of the Working Group on Resolution Regime for Financial Institutions; PRS. |
Financial firms include banks, non-banking financial companies, insurance companies, pensions funds, stock exchanges, and depositories. These firms accept deposits from consumers, invest these funds, and provide loans. Often these firms borrow from each other. Failure of a firm may result in adverse consequences for other financial firms, and could trigger off system-wide financial instability. Such failure may be resolved by merging the failing firm with another firm, transferring its assets and liabilities, or reducing its debt. If resolution is found unviable, the firm may be liquidated, and its assets sold to repay creditors.
In 2008, the failure of a large financial firm impacted countries across the world, and led to a global financial crisis.[2] After the crisis, several countries such as the US and those across Europe developed specialised resolution capabilities for addressing such failure.2,[3],[4]
Currently in India, there is no specialised law for the resolution of financial firms. Monitoring and resolution of firms are managed by the respective regulators. Over the last few years, expert committees have noted certain limitations in the current framework which include: (i) involvement of multiple regulators preventing specialised resolution capabilities for the entire financial sector being developed, (ii) regulators exercising forbearance and delaying resolution in the hope of reviving a firm, and (iii) availability of limited methods to resolve firms.2,5 Committees have also noted that currently there are no provisions to resolve certain financial firms such as companies managing mutual funds or securities firms. The powers of regulators to resolve similar entities also varies (e.g., RBI has powers to wind-up or merge scheduled commercial banks, but not co-operative banks).2,[5]
In this context, the Financial Resolution and Deposit Insurance Bill, 2017 was introduced in Lok Sabha on August 10, 2017.1 The Bill seeks to establish a Resolution Corporation to monitor financial firms (along with regulators), and resolve them in case of failure. Note that the Insolvency and Bankruptcy Code, enacted in 2016, addresses the failure of non-financial firms such as companies and partnership firms.[6]
Key Features
The Bill seeks to establish a Resolution Corporation to monitor financial firms and resolve them in case of failure. It repeals the Deposit Insurance and Credit Guarantee Corporation Act, 1962 and amends 22 other laws.1
Resolution Corporation
Further, firms in the ‘material’ and ‘imminent’ categories will formulate resolution and restoration plans. The Corporation may supersede the board of a firm, if it is classified under the ‘imminent’ or ‘critical’ categories, for a maximum period two years.
Figure 2: Monitoring and resolution of financial firms
Sources: The Financial Resolution and Deposit Insurance Bill, 2017; PRS. |
Resolution Process
Figure 3: Order of priority for distributing assets
Sources: The Financial Resolution and Deposit Insurance Bill, 2017; PRS. |
If the Resolution Corporation fails to resolve the firm within two years, the firm will be liquidated to repay its debt. Proceeds from liquidation will be distributed in an order of priority specified in Figure 3.
Other Provisions
PART B: KEY ISSUES AND ANALYSIS
Certain powers of the Corporation may not have a review mechanism
The Bill establishes the Resolution Corporation to monitor financial firms (such as banks, insurance companies, stock exchanges, and depositories), pre-empt their failure, and resolve or liquidate them in case of failure. Failure of these financial firms may impact financial stability as they hold consumer deposits, extend credit, facilitate investment in the economy, and also borrow from each other. Therefore, the Resolution Corporation may have to exercise its powers with urgency, and address such a failure to avoid any risk to the financial system. The Bill does not specify a review or appeal mechanism for some of these decisions.
One argument to not allow an appeal may be that certain decisions of the Resolution Corporation may require urgent action to prevent the failure of a financial firm. However, this may leave aggrieved persons without a recourse to challenge the decision of the Resolution Corporation if they are unsatisfied. Given that clause 133 of the Bill prevents courts from entertaining any matters related to decisions of the Resolution Corporation, the only remedy available to a person aggrieved by an order of the Corporation is to file a writ before the High Courts under Article 226 of the Constitution.[7] The RBI Working Group on Resolution Regime for Financial Institutions (2014) had recommended that an appeal and grievance redressal mechanism should be available for stakeholders to challenge an improper decision of the Corporation.2 We discuss two instances where an appeal mechanism is unavailable, below:
Classification of financial firms based on their risk of failure
The Resolution Corporation may classify a financial firm under the ‘material’, ‘imminent’ or ‘critical’ categories. Before such classification, the financial firm will be given an opportunity to be heard. However, the final order passed by the Resolution Corporation will be binding on the financial firm, and has to be complied with.
Depending on its classification, the firm may be subject to corrective action or resolution, including steps which: (i) prevent it from accepting deposits, (ii) prohibit it from acquiring other businesses, or (iii) require the firm to raise additional capital by issuing securities or selling assets. The Resolution Corporation will take over the management of a firm under the ‘critical’ category, and resolve it. The Bill does not specify a mechanism for an aggrieved financial firm to appeal the classification order of the Resolution Corporation.
Ordering members of financial firms to return performance based incentive
Under the Bill, the Resolution Corporation may designate a proportion of remuneration given to the chairperson, chief executive officer (CEO) or director of a financial firm, under ‘material’ or ‘imminent’ category, to be linked to their performance. Subsequently, if the financial firm is classified as ‘critical’, the Resolution Corporation may order the chairperson, CEO or director to return their performance based incentive after giving them an opportunity of being heard. Such direction may be issued to these officers if their actions or omissions resulted in the financial firm being classified under ‘critical’ risk.
The Bill does not specify a mechanism for an aggrieved person to challenge the order of the Resolution Corporation. This order directing a person to return the performance based incentive will be final, and a failure to comply with it will result in recovery being initiated in the manner specified in the Income Tax Act, 1961.
Lack of clarity in certain parts of the classification and resolution process
Under the Bill, the Resolution Corporation or the regulators may classify financial firms in any of the five categories based on its risk of failure: (i) low, (ii) moderate, (iii) material, (iv) imminent, or (v) critical. In this context, we examine certain processes in the Bill which may be unclear.
End of the resolution process unclear in certain cases
The Bill specifies that the Resolution Corporation will take over the administration of the financial firm once it is classified as ‘critical’. The Resolution Corporation may then resolve the financial firm using any of the following methods: (i) transfer of assets and liabilities to another entity, (ii) merger or acquisition, (iii) transferring assets and liabilities of the financial firm to a temporary firm known as a bridge financial firm, (iv) bail-in (involving internal restructuring of liabilities including conversion of debt into equity), or (v) liquidation. However, the Bill does not indicate the point at which the resolution process will be deemed to be complete.
For some of these methods, such as transfer or merger, the completion of the resolution process may be inferred from the point when the new management takes over the administration of the firm. In case of liquidation, the Bill specifies that the National Company Law Tribunal will approve the dissolution of the financial firm after all its assets have been sold. However, for some other methods such as bail-in, the point at which the resolution process is complete may be unclear.
Note that under the Insolvency and Bankruptcy Code, 2016, the resolution process for a defaulting company ends when a resolution plan is approved by the National Company Law Tribunal. Further, the Tribunal passes an order lifting the moratorium on any lawsuits against the company.6
Resolution Corporation takes over the financial firm but may choose to resolve it
The Bill establishes the Resolution Corporation to monitor financial firms, prevent risk to their financial health, and resolve them in case of failure. Clause 58 of the Bill specifies that upon being classified as ‘critical’, the Resolution Corporation will take over the administration of a financial firm to continue its operations. However, Clause 48 of the Bill states that the Resolution Corporation may choose to resolve the financial firm. Since the purpose behind taking over the administration of the financial firm is to resolve it, it is unclear why the Resolution Corporation is being given a choice to undertake resolution.
Corporation superseding the board of a ‘critical’ firm’ may be redundant
Under Clause 58 of the Bill, the Resolution Corporation takes over as the administrator of a financial firm as soon as the financial firm is classified as ‘critical’. As the administrator, the Resolution Corporation will: (i) manage the operations of the financial firm, and (ii) exercise the powers of the board of directors, among others. However, Clause 62 (1) of the Bill allows the Resolution Corporation to supersede the board of directors of the financial firm if it is classified as ‘critical’.
Given that the powers of the board of directors of the financial firm are vested in the Resolution Corporation as soon as it is classified as ‘critical’, a separate provision allowing the Corporation to supersede a firm’s board when it is classified as ‘critical’ may be redundant.
Fees payable by financial firms under section 33 not specified
Clause 22 (1) of the Bill requires financial firms to pay the Resolution Corporation: (i) fees for resolution, and (ii) fees for administrative expenses including fees charged under Clause 33. However, Clause 33 does not mention fees which the financial firms will be required to pay to the Resolution Corporation.
Table 1 below compares the provisions of the Financial Resolution and Deposit Insurance Bill, 2017 with the laws of other countries.
Table 1: International comparison of resolution laws
Action |
United States |
United Kingdom |
Australia |
India (Proposed Bill) |
Authorities |
|
|
|
|
Coverage |
|
|
|
|
Monitoring |
|
|
|
|
Initiation of proceedings |
|
|
|
|
Time limit |
|
|
|
|
Resolution methods |
|
Stabilisation tools: 1. Transfer of assets and liabilities. 2. Bridge Service Provider. 3. Bail-In (internal reduction of debt).
|
|
|
Deposit Insurance |
|
|
|
|
Note: Bank Insolvency Procedure is used when the failing firm is put into liquidation and depositors are paid off; Bank Administration Procedure is used to put a part of a failed firm (that has not been transferred to a bridge service provider or private sector purchaser) into administration.
Sources: United Kingdom Banking Act, 2009, United Kingdom Insolvency Act, 1986, United States Code Title 11-Bankruptcy, United States Federal Deposit Insurance Act, 1950, Report of the Working Group on Resolution of Regime for Financial Institutions, RBI, January 2014, The Bank of England’s Approach to Resolution, 2014; The Australia Financial Sector Legislation Amendment (Prudential Refinements and Other Measures) Act 2010; The Australia Banking Act 1959; Report on Strengthening APRA’s Crisis Management Powers, 2012; The Deposit Insurance and Credit Guarantee Resolution Corporation Act, 1961; The Financial Resolution and Deposit Insurance Bill, 2017; PRS.
[1]. The Financial Resolution and Deposit Insurance Bill, 2017.
[2]. Report of the Working Group on Resolution Regime for Financial Institutions, Reserve Bank of India, January 2014.
[3]. Banking Resolution and Recovery Directive, European Union, Directive 2014/59/EU of the European Parliament and of the Council, May 15, 2014.
[4]. Key Attributes of Effective Resolution Regimes for Financial Institutions, FSB, 2014.
[5]. Report of the Committee to Draft Code on Resolution of Financial Firms, September 2016.
[6]. The Insolvency and Bankruptcy Code, 2016.
[7]. Writ is an extraordinary remedy available to all persons for enforcing their constitutional and legal rights, or to compel public authorities to discharge their relevant duties.
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