What is FRDI Bill all about? Understand in the easiest language

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Everyone is talking about FRDI Bill, if you still don’t know how it will affect you life and why there is a huge public outcry over it then keep reading this article to understand it all:

Background

The need for a specific regulation arose following the 2008 financial crisis, which witnessed a large number of high-profile bankruptcies. Centre has been also actively encouraging people to engage more with the banking sector through schemes like Jan Dhan Yojana and moves like demonetisation. It has become critical to protect savers and those joining the formal economy in case a bank or insurance firm starts failing.

What is the full form of FRDI Bill?

FRDI stands for Financial Resolution and Deposit Insurance Bill 2017.

What are the objectives of FRDI?

  • Minimize the failure of financial institutions/ banks.
  • Finding and finalizing a resolution plan to get troubled financial institutions/ banks back on track
  • In the event of failure of any financial institution/ banks, ensure quick winding up.

Present scenario: Bail-out approach

  • From past couple of years, banks in India have been facing lots of difficulties due to increasing amount of loan defaulters that are also called NPAs (Non Performing Assets).
  • Whenever there is a loan default, bank has to create a provision against it which reduces its capital. In lay man’s language, creating a provision means recording loss in books of accounts.
  • Continuous provisioning for NPA may endanger the solvency of a banks. In order to keep banks afloat, the Central Government steps in with a Bail-out. A bail-out refers to financial support given by the government to any company or organization (in this case the banking company).
  • In December 2017, the Central Government has announced that it will infuse Rs. 80,000 Crore of fresh capital in public sector banks to deal with the ongoing NPA menace. Central Government has to take a big hit at its fiscal deficit targets in order to fund such huge amount of fresh capital infusion into banks.

Scenario if FRDI Bill, 2017 becomes a law: Bail-in approach

  • All saving bank deposits, fixed deposits and other deposits made by any person in his bank account is actually a liability for the bank, which has to be returned to depositor whenever the depositor asks for his money.
  • The  FRDI Bill proposes to give autonomy to banks to convert its liability towards depositors into share capital of the bank if it is required to save the bank from insolvency or in times of distress. In return the depositor will be allotted preference shares for their deposit amount which may be returned in future when the financial status of the bank improves. This process of converting banks’ liability towards depositors into banks’ share capital is called Bail-In.

Why is there a public outcry?

There are several misconception in the minds of people regarding FRDI. These are generally based on a few myths, let’s clear the air around some of them:

Myth: No more insurance of deposits upto Rs. 1 lakh

  • Right now the Central Government provides an insurance of deposit of upto Rs. 1 lakh per person if a bank fails. This means in case of insolvency of any bank, each individual would only be able to recover:
    • Either the amount of deposit in that bank
      OR
    • Rs. 1 lakh, whichever is lower
  • There is a misconception that such guarantee will be withdrawn if FRDI becomes a law, however, the fact is that Central Government has already clarified that similar insurance by Central Government will be there in FRDI Act also. It is also expected that the limit of Rs. 1 lakh may be increased as this limit was set way back in 1993.

Myth: I will lose right over my money immediately when FRDI becomes a law

  • People fear that if banks get such autonomy then their deposits will be immediately converted into shares immediately and they will not be able to withdraw their money when they need it. However, the fact is that such power will be only used when a banks in times of distress if no other option of revival exists. Till the time there is no problem with bank’s financial status, your money will stay safe.
  • In present scenario, if a bank fails no amount above Rs. 1 lakh is recoverable as it is forfeited. But after FRDI becomes a law, in the event of failure of a bank the amount of deposit above the amount insured by central government, will be converted into preference shares, which may be redeemed once the financial status of the bank improves.

Conclusion:

All the outcry is based on half baked knowledge which has been wrongly presented by the media. The fact is that the risk is no more or no less than it ever was if FRDI Bill becomes a law.
Author:
Sahil Goel | LinkedIn