Bail-In Clause As IYI: We Need Higher Deposit Cover And Bulk Depositors Can Pay For It

In 2008, soon after the Lehman crisis precipitated the global financial crisis, rumour-mongers in India started talking about ICICI Bank’s high exposures to some US financial instruments, leading to a near-run on the bank. As depositors queued up at ATMs to withdraw money from the bank, the Reserve Bank of India and Securities and Exchange Board of India (SEBI) had to step in to reassure the public about the solidity of the bank, thus preventing panic from becoming a self-fulfilling prophecy. The rumours were swelling to a point where even big corporate depositors like Infosys began withdrawing deposits from ICICI Bank and moving them to the State Bank of India.

The point is simple: the last thing we need is the sowing of doubt over whether the public’s deposits in banks are safe or not. But this is precisely what the government has managed to convey by its belated and inadequate response to concerns over whether or not the Financial Resolution and Deposit Insurance Bill, 2017 (FRDI), insures deposits adequately.

The Finance Minister, Arun Jaitley, has now stepped in to assure the public that public deposits will be protected, but in the absence of details, this assurance means little.

The bill, which has a “bail-in” clause that may require depositors to convert their deposits into shares in case a bank looks like going under, is said to be a broad reflection of global thinking on the subject. The idea is that taxpayers must not be expected to bail out failing banks all the time, and that all financial instruments – even basic bank deposits – carry risk. When banks in Cyprus started failing a few years ago, big depositors were forced to convert a large part of their deposits into shares.

In theory this is all right, but in practice – especially in an India where millions of people are just now developing some degree of comfort in formal banking – the bail-in clause is akin to what Nassim Nicholas Taleb calls an “Intellectual, Yet Idiot” (IYI) position. What sounds great in theory to economists and financial sector reformers can be dangerous to public confidence in the financial system. Theoretical propositions are used to trump commonsense.

The bill, which will surely not survive in its present form once it is vetted by the Joint Committee of Parliament, makes a foolish dash for modernity without acquainting the public with its essentials, or even preparing it for the reality of financial risk. In India, no bank has ever been allowed to go under so far, and no depositor in any major scheduled commercial bank has lost his deposits, though in some cases repayments have been delayed. In this scenario, to shove in a bail-in clause is foolhardy. Not only that, even where investors were told of the risks – as in the case of Unit Scheme 1964 – the government has had no option but to bail out investors with taxpayer funds. In fact, leave alone business failures, Indians expect even their inflation risks to be covered by government, as again is evident in the higher than market rates offered on the senior citizens’ savings scheme (upto Rs 15 lakh), or the higher-than-needed returns on the Employees’ Provident Fund.

Currently, bank deposits upto Rs 1 lakh are insured with the Deposit Insurance and Credit Guarantee Corporation (DICGC), but the new FRDI, which will take over the DICGC’s functions, does not specify if the guarantee limit will be raised. The Rs 1 lakh limit was fixed by the Narasimha Rao government nearly a quarter century ago. Since then inflation has made this meaningless, and the minimum that needs insurance today is probably Rs 5 lakh, if not more.

There is, of course, a point to saying that taxpayers must not guarantee the rich who want to eat their cake and have it too: they want iron-clad security guarantees and high returns when they keep their surpluses with banks.

A cash-rich Infosys or a billionaire who maintains a lot of bank deposits need no protection, but even here there is no gainsaying the fact that if bank failures do happen and the bail-in clause can kick in, even billionaires’ losses will shake the confidence of depositors in general.

Clearly, we need a via media. The answer may be a simple one: over the next five or 10 years, when depositors are educated about risks in any financial instrument, we need an insurance bridge for all deposits.

One point is to raise the minimum insurance cover to, say, deposits upto Rs 5 lakh. Above this limit, depositors themselves can be asked to pay a risk insurance premium (which can be collected through lower interest of 0.5 per cent on deposits) on bulk deposits. Right now we have the perverse situation where large depositors often get higher rates than retail investors. If an Infosys – or any high net worth investor – wants to keep money in bank deposits, it can do so by paying this insurance premium directly to the FRDI or through its bank.

This is a simple, yet effective way, to make the public aware of risks without causing a panic. Risks exist, but they can also be mitigated by pencilling in a small insurance cost that the bulk depositor can pay.