MORATORIUM FOR BANK

Subject: Economics

Context: Centre, acting on the recommendation of the Reserve Bank of India (RBI), imposed a moratorium on Lakshmi Vilas Bank (LVB) for a period of 30 days.

Concept :

• As its financial position deteriorated, the regulator placed it under the Prompt Corrective Action (PCA) framework, which restricts certain operations depending on the severity of financial stress.
• After allowing time for the bank to find investors to shore up its capital, the RBI has appointed an administrator for the bank and mooted a merger with the Indian subsidiary of the Singapore-based DBS Bank.

What is a moratorium?

• The RBI, the regulatory body overseeing the country’s financial system, has the power to ask the government to have a moratorium placed on a bank’s operations for a specified period of time. Under such a moratorium, depositors will not be able to withdraw funds at will.
• RBI steps in if it judges that a bank’s net worth is fast eroding and it may reach a state where it may not be able to repay its depositors. When a bank’s assets (mainly the value of loans given to borrowers) decline below the level of liabilities (deposits), it is in danger of failing to meet its obligations to depositors.

Run on Banks

• A moratorium primarily helps prevent what is known as a ‘run’ on a bank, by clamping down on rapid outflow of funds by wary depositors, who seek to take their money out in fear of the bank’s imminent collapse. Temporarily, it does affect depositors .
• A moratorium gives both the regulator and the acquirer time to first take stock of the actual financial situation at the troubled bank. It allows for a realistic estimation of assets and liabilities, and for the regulator to facilitate capital infusion, should it find that necessary.

Can safety of funds be assured by RBI :

• It depends on whether the struggling bank or the regulator is able to find acquirers or investors to save the day. In the case of Yes Bank and Lakshmi Vilas Bank, the RBI was able to bring in investors who infused adequate funds.
• In the case of Punjab and Maharashtra Co-operative Bank,the moratorium — despite being gradually relaxed for depositors — is still in force, over a year after it was imposed, and there is still no sign of a buyer.