Resolution of Financial Institution

Resolution of Financial Institution

Subject – Economy

Context – In recent years, resolution of troubled financial institutions has attracted considerable attention in India especially after the failure of YES Bank, PMC Bank and some prominent NBFCs.

Concept –

• At present, India lacks a special resolution regime or a comprehensive policy/law on bankruptcy, exclusively, for financial institutions.
• Under the existing legal framework, the Deposit Insurance and Credit Guarantee Corporation (DICGC) doesn’t have powers to apply resolution tools to problem banks; it only “assists” the RBI in carrying out resolution.
  • In addition to making payouts to banks under liquidation, DICGC assists in mergers by meeting the shortfalls in depositors’ claims up to the coverage limit (now ₹5 lakh) when the acquiring bank is unable to meet this liability.
• The Banking Regulation Act, 1949, through its various Sections, empowers the RBI to deal with the resolution of problem banks through mergers, moratorium imposition, management suspension and liquidation.
• However, the most ‘common’ method has been an assisted or compulsory merger through which the weak bank is merged with a strong lender.
• In the case of smaller urban co-operative banks, the general approach has been to liquidate them with reimbursement made to the depositors.
• Following the announcement of ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ in 2011 (and updated in 2014) by the Financial Stability Board, the government set up the Financial Sector Legislative Reforms Commission, which in 2013 recommended a single Resolution Corporation (RC) for financial institutions. It also recommended that DICGC be subsumed by the the proposed RC.

Systemically Important Financial Institutions (SIFIs)

• The Financial Stability Board (FSB), in consultation with the Basel Committee on Banking Supervision (BCBS) and national authorities, has identified Global Systemically Important Banks (G-SIBs) since 2011.
• Financial Stability Board (FSB) refers Systemically Important Financial Institutions (SIFIs) as institutions “whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity”.
  • Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system. It was established in 2009. India is a member.
• Systemically Important Financial Institutions (SIFIs) are perceived as institutions that are Too Big to Fail (TBTF).

Domestic Systemically Important Banks

• D-SIB framework is based on the assessment conducted by the national authorities, who are best placed to evaluate the impact of failure on the local financial system and the local economy.
• The RBI had issued the framework for dealing with D-SIB in 2014. The D-SIB framework requires the Reserve Bank to disclose the names of banks designated as D-SIBs starting from 2015 and place these banks in appropriate buckets depending upon their Systemic Importance Scores (SISs).
• The indicators which are used for assessment are: size, interconnectedness, substitutability and complexity.
• Based on their systemic importance scores in ascending order, banks are plotted into four different buckets and are required to have additional Common Equity Tier 1 Capital (CET1) requirements ranging from 0.20% to 0.80% of risk weighted assets (RWA).
• The Reserve Bank of India (RBI) has retained State Bank of India, ICICI Bank and HDFC Bank as Domestic Systemically Important Banks (D-SIBs) or banks that are considered as “too big to fail”.

To know about The Deposit Insurance and Credit Guarantee Corporation (DICGC), please refer September 2021 DPN.

Financial Sector Legislative Reforms Commission

• The Financial Sector Legislative Reforms Commission (FSLRC), constituted by the Ministry of Finance in March 2011, was asked to comprehensively review and redraw the legislations governing India’s financial system.
• This Commission is chaired by a former Judge of the Supreme Court of India, Justice B. N. Srikrishna and has an eclectic mix of expert members drawn from the fields of finance, economics, public administration, law etc