The Financial Resolution and Deposit Insurance Bill 2017 has been brought by the government and presently is under examination by JPC. The greatest threat to the existence of a Bank arises when large default in loan repayments occur and the security against which loans were given does not yield the expected value. Continuous incurring of loss erodes the capital base. Inadequacy of capital is a serious threat to the very existence of Banks.
In India, in such a scenario, the government steps in and either infuses fresh capital or RBI in exercise of its statutory power amalgamates/merges the ‘sinking’ Bank to a healthier one. This in banking parlance is ‘Bail Out’. The public doesn’t raise a hue and cry although it is the taxpayers’ money that goes out. Further, many governments give doles, gifts, freebies etc. also to garner votes with taxpayers money of which public remains mute spectators.
In developed countries such sort of ‘Bail Out’ is not resorted to either by the government or Federal Bank for simple reason that the conscious public will raise outcry against using their hard earned money to save a sinking ship. In 2000-02 the Prime Bank crisis that engulfed USA Banking system arose because of home loan defaults ( securitised and wrongly rated AA or A). Many banks became bankrupt and Lehman Bros had to fold up. Citi Amex etc. suffered huge loss but could take the hit. Banking is a business where risk is taken after evaluation and is managed properly. In this game some banks will prosper and some will be extinct. Nobody should shed any tear for that.
Here comes concept of ‘Bail In’ as opposed to Bail Out :
In Bail, no tax payer’s money will be deployed to save a sinking bank and the Bank will have to adjust its own resource to stave off liquidation. When all securities of defaulting borrowers at its disposal are sold but the proceeds are not adequate the capital will shrink. This may result in downsizing further business.
In the extreme circumstances the depositor’s money may get reduced/ adjusted. Some people are spreading panic about the objective of this bill but at the end of the day the system of ‘Bail Out’ has to be done away with. And there lies the crux of the problem in the name of Bail Out.
(The views expressed by the author in the article are his/her own.)