The FRDI Bill was withdrawn due to wide-ranging concerns about the implications of the law, but it laid down several notable provisions which were essential in any law on bank resolution. In the absence of the FRDI Bill, the current framework for bank resolution in India comprises several laws, including the Banking Regulation Act, 1949. However, this article focuses on the regulatory framework proposed by the FRDI Bill.

In this context, this article highlights an important aspect of the ongoing WG deliberations – the role of resolution tools. Within this, we look at two specific tools, bridge banks/bridge service providers (BBs/BSPs) and bail-in, to highlight aspects of India’s regulatory framework on bank resolution and offer some suggestions, which may assist the WG’s deliberations.

Overview of Resolution Tools

The range of tools available in bank liquidation proceedings varies across jurisdictions. On one hand, some jurisdictions have a narrower toolkit enabling only piecemeal liquidation. On the other hand, in some other jurisdictions, the bank liquidation regime provides for a broader toolkit.

The Guide covers within the ambit of its ongoing discussions, aspects of a toolkit used in bank liquidation proceedings, namely, tools such as BSPs/BBs and bail-in. The Guide follows other international instruments, including the Financial Stability Board’s ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ (Key Attributes). The Key Attributes have informed the adoption of bank resolution regimes in jurisdictions around the world, and are considered an international standard for financial sector resolution regimes.

In India, the Committee suggested a broad resolution toolkit including tools such as acquisition/merger/amalgamation, bridge institutions, bail-in, and liquidation. Practical experience, even within the existing regulatory framework in India, has also been to use a combination of acquisition/amalgamation, bail-in and bailouts.

Bridge Service Providers/ Bridge Banks

Understanding BSP/BB & the Indian Framework:

Generally, a BSP/BB is an entity intending to take over the ownership/control of and continue operating certain critical functions of a failing institution (which could have a material impact on third parties, give rise to contagion, or undermine the general confidence of market participants), for a specified period of time. This is done to prevent a knee jerk reaction in the market, which may lead to further deterioration of the failing institution.

Jurisdictions with a broader resolution toolkit may allow transfer of a part of the failing bank’s business /assets/ liabilities to another bank, or to a BSP/BB.

In India, the FRDI Bill, contemplates BSPs as a resolution tool. The intention is to create a BSP to transfer the assets and liabilities of a Specified Service Provider (SSP) under resolution, to such BSP, with the aim of eventual resolution of the BSP [cl. 50(1)]. A BSP is used where an immediate sale cannot be conducted but is likely in the future. In such cases, the Resolution Corporation (RC), which is the primary resolution authority established under the FRDI Bill [cl. 3] to monitor financial firms, anticipate risk of failure, take corrective action, and resolve them in case of such failure, may transfer the business of a failing bank to a new BSP, owned, and operated by the RC [cl.50]. The FRDI Bill provides three ways in which a BSP is resolved – first, by transferring the business of the BSP to any other entity capable of acting as an SSP; second, by sale of shares of the BSP to a private sector purchaser; or third, by liquidation [cl.50(12)].

UNIDROIT WG Discussions

The Guide is still a work-in-progress, and the nature of the resolution toolkit thereunder is still unknown. While its draft structure specifically includes BBs, there is no conclusive determination on this. The WG reports reveal discussion on other tools including asset management vehicles, and how best to position them within the Guide.

Suggestions for the WG

Going forward, the Indian position may influence the WG discussions in the following ways.

• First, the Guide, being a global benchmark on the subject, may contemplate a broader resolution toolkit.
• Second, the Guide could give a clearer understanding of the concept of a BSP/BB, by specifying the ambit of its role.
• Third, the Guide may provide time-limits and methods for resolving a BSP itself, after its purpose is met. This would make bank resolution time-bound and efficacious.

Bail-in

Understanding bail-in

Bail-in is a resolution tool that enables continuity of essential functions of a failing bank, by internal recapitalisation. Conceptually, bail-in promotes market discipline, by reducing claims of shareholders and creditors, who are responsible for monitoring banks and preventing excess risk-taking, in the first place. This contrasts with a bailout, where recapitalisation is external, often based on public funds. Bailouts were a key part of the aftermath of the Global Financial Crisis in 2008, particularly in relation to government support for “too big to fail” banks.

The significance of bail-in for loss absorption and recapitalisation is highlighted in the Key Attributes, and is bolstered by the FSB Principles for Effective Execution of Bail-in (2018), detailing how financial regulators may develop bail-in strategies for global systemically important banks (G-SIBs), in whose resolution, bail-in is a core strategy.

The Indian position

The Committee was emphatic on orderly resolution of failing financial firms, to avoid reliance on taxpayer-funded bailouts. Importantly, the Committee noted the Key Attributes and the role of bail-in as part of a broader resolution toolkit; this reflected in its recommendation that the proposed FRDIC should be empowered to use bail-in, especially where continuation of services was important, but selling the distressed firm was infeasible.

The FRDI Bill builds on this understanding in viewing bail-in as one of multiple resolution tools, to be used with adequate safeguards. Bail-in may be used by the RC for resolving an SSP [cl 48] and may involve multiple measures including cancellation and modification of liabilities [cl 52(3)(c)]. Under the scheme of the FRDI Bill, bail-in must be used judiciously and where the RC, in consultation with the appropriate regulator, is satisfied that it is appropriate to use bail-in.

Importantly, the FRDI Bill proposes safeguards to using bail-in as a resolution tool. Some of the salient safeguards include the exclusion of certain liabilities from bail-in (such as, deposits as covered by deposit insurance; secured liabilities) [cl 52(7)]. Additional safeguards include application only for liabilities containing contractual provisions that such liability is eligible for bail-in, and equal treatment to all liabilities and rights of the same class [cl 55(2)].

Suggestions for the WG

As indicated, the WG has noted that the toolkit for bank resolution varies across jurisdictions, while considering whether best practices for resolution tools may be provided for in the Guide.

In this, there is significant insight to be drawn from the FRDI Bill’s understanding of bail-in. Specifically, the WG deliberations and the final Guide, which is focused on medium and small banks, may benefit from providing a clear list of exclusions for the use of the bail-in tool, as well as providing clear safeguards for its use.

Conclusion

The Guide will help several jurisdictions shape their laws on resolution of small & medium banks, including India. The Guide will also serve as a global guidance, like other UNIDROIT Guides (such as, the UNIDROIT Legislative Guide on Intermediated Securities). Hence, it is an important intergovernmental legislative exercise.

We have looked at, specifically, the theme of resolution tools and focused on bridge banks and bail-in. Our discussion highlights aspects of the Indian position on these which would serve as useful aids to the ongoing UNIDROIT deliberations. Accordingly, Indian policymakers may bring these to the attention of the WG.

This article was originally published in NUL Delhi on 30 June 2023 Co-written by: Ulka Bhattacharyya, Research Fellow; Riddhi Vyas, Research Fellow. Click here for original article

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