The Sub-Committee of the Financial Stability and Development Council (FSDC) constituted a high level Working Group, to suggest extensive strengthening of the resolution regime taking into consideration the structure of Indian financial institutions and the Financial Stability Board’s Key Attributes of Effective Resolution Regime for Financial Institutions.
This Group has submitted its report to the Governor, RBI and Chairman of the Sub-Committee of FSDC.
In order to bridge the gaps and develop an effective resolution regime for all financial institutions in line with the Key Attributes, the Group has made wide ranging recommendations taking into consideration the international best practices and work in major advanced jurisdictions as also the recommendations given by the Financial Sector Legislative Reforms Commission (FSLRC).
As the contours of the Single Financial Resolution Authority (FRA) are yet to take shape, we Indians too can contribute our ideas.
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The Group emphasizes the need for a separate comprehensive legal framework providing the necessary powers and tools to resolve all financial institutions irrespective of ownership;
and setting up of a single Financial Resolution Authority (FRA) that is institutionally independent of regulators/Government.
The Group also recommends putting in place an early intervention mechanism in the form of a Prompt Corrective Action (PCA) framework with clear trigger levels for regulatory intervention in the early stages and for handing over to the resolution authority for initiating appropriate actions in the last stage.
“The mandate of FRA will be to resolve failed financial institutions and financial markets infrastructures (FMIs) — other than those owned and operated by Reserve Bank of India (RBI) — along with providing deposit insurance and protection to insurance policy holders and investors / clients within limits, if required at the resolution stage,” the group said in its report.
The FRA should be the sole authority responsible for operation and implementation of the financial resolution framework, including the decision to choose the appropriate resolution tool, except the power to take an institution into temporary public ownership (TPO) that will be invoked by the government on the recommendation of the FRA.
FRA can be set up by either transforming the present Deposit Insurance and Credit Guarantee Corporation (DICGC) into FRA or by setting up a new authority, namely, FRA that will subsume DICGC.
“The aim of resolution is not to preserve the failing institution, but to ensure the continuity of the functions that are critical for the financial system as a whole and limit any use of taxpayers’ money,” the group stated in its report.
The group recommended that as the ultimate objective of regulation and supervision in India was to protect the interests of depositors, insurance policyholders, and investors, the proposed statute for financial resolution framework should explicitly provide for preference to be given to depositors, insurance policyholders and investors over other unsecured creditors in resolution of failed financial institutions.
It also said that equal treatment may be provided to uninsured depositors of banks and claims of DICGC on account of payments made to insured depositors.
To ensure that regulators/supervisors can intervene at a sufficiently early stage with clear trigger levels to prevent the institution from reaching situation of non-viability, the group recommended each financial sector regulator/supervisor to formulate a prompt corrective action (PCA) framework for the institutions under their regulatory jurisdiction.
Some of the tools to prevent any too big-to-fail institution wrecking the system include liquidation, purchase and assumption, bridge institution , good-bank and bad-bank , bail-in and temporary public ownership , it said. These are among the at least 38 major, and scores of minor, proposals floated by the group, headed by Finance Secretary Arvind Mayaram, and former deputy governor Anand Sinha, to prevent a meltdown similar to the one in US in September 2008 after the Lehman Brothers Holdings filed for the biggest-ever bankruptcy.
The FRA should be independent of regulators and the shareholders must bear the losses in case of failure, the committee says. “The aim of resolution is not to preserve the failing institution, but to ensure continuity of the functions that are critical for the financial system as a whole and limit any use of taxpayers’ money,” says the report.
India, which escaped the global financial crisis without much of a scar because of its closed market, is evolving systems and institutions to prevent calamities such as in the US where the government bailed out Wall Street banks with tax payers’ money.
The FRA will evolve a plan without moral hazard to ensure financial crisis at systemically important financial institutions does not spread and weaken others. It will be the sole empowered body to resolve a financial crisis, but without the ability to take an institution into temporary public ownership. That will be the prerogative of the government on the recommendations of the FRA, the report said.
“Situations where a financial institution , deemed to be systemically important , comes into financial distress and has the potential to trigger financial instability and cannot be resolved by sale to a third party because of its sheer size, can best be resolved as a last option by the government taking control of the financial institution,” said the report. “This tool, however, needs to be handled with due care. It should be ensured that this tool is operated only as an interim measure and the ultimate objective should be to arrange for a permanent solution such as sale or transfer or merger with a private sector purchaser.”