Resolving Financial Firms in India - The Way Forward

The Covid-19 pandemic has put to test the resilience of the entire Indian financial system. But even before the pandemic struck, Indian policymakers had been struggling with resolution of stressed financial institutions. 

In March, the Government placed Yes Bank Ltd. under moratorium and capped withdrawal by depositors, while the Reserve Bank of India (‘RBI’) superseded its board. Ultimately, state-owned and private banks jointly contributed to rescuing Yes Bank through a scheme of reconstruction prepared by the RBI and sanctioned by the Government. Overall, the out-of-court resolution of Yes Bank was swift and decisive. 

The same cannot be said for the resolution of co-operative banks, non-banking financial companies (‘NBFCs’) and housing finance companies (‘HFCs’). For instance, the Punjab and Maharashtra Co-operative Bank suffered a crisis last year, but its resolution is still ongoing. Similarly, the resolution of Infrastructure Leasing & Financial Services Ltd., an NBFC, and Dewan Housing Finance Corporation Ltd. (‘DHFL’), a HFC, continue to linger on, without any definite closure in sight. 
 
Against this backdrop, the RBI Governor, Shaktikanta Das, recently emphasized the need for a statutory resolution corporation in India. Governor Das is correct. The Insolvency and Bankruptcy Code, 2016 (‘IBC’) was meant to resolve corporate and personal insolvency, not that of financial institutions. To fill this significant legislative void, the Indian Government temporarily extended the IBC framework for resolution of bigger NBFCs and HFCs through the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (‘the Rules’). 

In our recent paper titled ‘Resolving Financial Firms in India- the Way Forward’, we argue that the Rules are inadequate and that India needs a dedicated statutory resolution corporation in the long run. 

First, we summarise the global evolution of resolution regimes and highlight the fragmented nature of the existing Indian framework for the resolution of financial service providers (‘FSPs’). In 2013, the Financial Sector Legislative Reforms Commission had acknowledged this lacuna. Subsequently, a dedicated financial resolution framework, the Financial Resolution and Deposit Insurance (‘FRDI’) Bill, was introduced in the Parliament. Although this Bill was subsequently withdrawn, we conclude that policy thinking in India on this subject has evolved and matured over time. 

Second, we explain the rationale for a special resolution law, analyse the potential concerns with the Rules under the IBC, and suggest the broad contours of an ideal resolution regime. We begin by classifying FSPs into three generic categories based on the risk exposure to their balance sheets and then explain the differences between these FSPs and other real sector firms. Accordingly, we argue that the corporate insolvency framework under the IBC is ill-suited for the resolution of these FSPs. We also identify potential concerns with the IBC Rules which create a temporary framework for resolution of certain bigger NBFCs and HFCs. Finally, we offer policy suggestions on the broad design aspects of the resolution corporation, including its objectives, its interactions with the prudential regulator and deposit insurance, and the resolution tools that it should have at its disposal. 

Third, we identify two broad issues that Indian policymakers should focus on while designing the new resolution regime. On cross-border resolutions, we highlight the limitations in the Banking Regulation Act, 1949 that were sought to be addressed by the FRDI Bill. The new resolution law must build on this framework suggested under the FRDI Bill. With respect to systemically important financial institutions and financial market infrastructure institutions, we highlight the need for a credible resolution mechanism to avoid moral hazard concerns. This remains an important area for future research to identify a graded approach for the resolution of different categories of such institutions, depending on the particular risks each of them faces. 

Fourth, we highlight two specific concerns with the draft FRDI Bill. On the controversial bail-in clause, we argue that statutory bail-in may not be of much practical significance in the Indian context. Even if this clause is retained, we argue that retail deposits below a certain threshold could be excluded from this bail-in provision. Separately, we highlight some unique issues regarding application of the FRDI Bill to public sector banks and cooperative banks. Refinancing of public sector banks does not involve the kind of moral hazard that arises due to government bail-out of private banks using taxpayers’ money. Therefore, we pose questions on the merit of extending the FRDI Bill to public sector banks. With respect to cooperative banks, we explain the unique constitutional concerns which may arise from application of the FRDI Bill to such banks. We suggest Indian policymakers reconsider these specific aspects of the FRDI Bill.  

Overall, our paper provides a conceptual analysis of the recent developments on the resolution of FSPs and highlights the relevant issues that may have a bearing on the future of FSP resolution in India.

Pratik Datta is a Senior Research Fellow at Shardul Amarchand Mangaldas & Co.

Varun Marwah is a Research Fellow at Shardul Amarchand Mangaldas & Co.

Ulka Bhattacharya is a Research Fellow at Shardul Amarchand Mangaldas & Co.