When it comes to their savings, a majority of Indians like to play it safe. They like to park their money in banks. As of September 2019, the total deposits of scheduled commercial banks in India stood at ₹130.4 trillion. Of this ₹81.6 lakh crore, or 62.5% of the total deposits, were with public sector banks. In smaller cities and rural areas, the proportion of deposits with public sector banks (PSBs) is higher.
But this confidence in bank deposits has taken a knock over the past few years, especially after demonetization, which increased insecurity around money. This feeling has been fuelled by recent troubles at the Punjab and Maharashtra Cooperative (PMC) Bank and Sri Guru Raghavendra Sahakara Bank in Karnataka.
Late last year, hours after the Reserve Bank of India (RBI) limited withdrawals from PMC, the news was all over social media. A fake message—claiming that after PMC Bank, the RBI and the government planned to shut down nine PSBs—went viral on WhatsApp. The RBI even had to put out a press release stating no such plan was on the anvil.
Soon, videos showing panicky PMC depositors started doing the rounds. One viral video featured a schoolteacher who had put her life savings in PMC Bank, but lost access to her money, and hence, couldn’t get her daughter married. Another news item that went viral was about a depositor who died of cardiac arrest even though he had a good amount of money in the bank. Such videos have created a sense of panic among depositors across the country.
There’s another factor that has been fuelling doubts about bank deposits. Over the last few years, the entire banking system in general and the state-owned in particular, have faced a lot of trouble.
A lot of loans given by these banks have gone bad. A bad loan is essentially a loan which hasn’t been repaid for a period of 90 days or more. The bad loans of the public sector banks peaked at ₹8.95 trillion as of March 2018. Since then they have fallen to around ₹7.79 trillion as of September 2019.
The bail-in concept
In August 2017, the government introduced the Financial Resolution and Deposit Insurance (FRDI) Bill, 2017. This Bill was referred to a Joint Committee formed by members of the Lok Sabha and the Rajya Sabha. One year after it was introduced, the Bill was quietly dropped in August 2018. That’s because there was widespread ere apprehension about the controversial ‘bail-in’ clause in the Bill.
What exactly is a ‘bail-in’? The FRDI Bill essentially envisaged the setting up of a resolution corporation (RC). The RC was supposed to monitor the health of financial firms like banks, insurance companies, mutual funds, non-banking finance companies, etc. In case of failure of any of these firms, the RC had the mandate to resolve the failure.
The term bail-in first appeared in clause 52 of the FRDI Bill. This clause basically empowered the RC “in consultation with the appropriate regulator, if it is satisfied that it is necessary to bail-in a specified service provider to absorb the losses incurred, or reasonably expected to be incurred, by the specified service provider.”
Simply put, in case of the failure of any financial firm, be it a bank or any other firm, it can be rescued through a bail-in.
Over the last few years, the word bailout has been extensively used in the context of banks. Between April 2017 and March 2020, the government will have ended up investing ₹2.66 trillion in PSBs. With the massive losses that these banks incurred thanks to their bad loans, the capital of these banks was eroded and the government had to invest more money in these banks to keep them going. In short, it had to bail them out.
A bail-in is basically the opposite of a bailout. In a bail-in, a financial firm is rescued by restructuring its liabilities. What does that mean? Any bank deposit is a liability for a bank, given that it has to be repaid and a regular interest has to be paid on it. The Clause 52 of the FRDI Bill allowed the RC to cancel a liability or even modify its form.
So, it allowed the RC to cancel the repayment of any kind of deposit that individuals or firms had invested in. It also allowed the RC to impose a haircut. A haircut is a situation in which the bank would have negotiated with the deposit holders and repaid only a portion of the deposit and not the entire amount. The Clause 52 also allowed the RC to convert the deposits into long-term bonds or into equity as well.
Not surprisingly, the concept of bail-in created a lot of upheaval on WhatsApp. But curiously there was one devil in the detail that was not red-flagged enough: deposit insurance.
The bail-in was supposed to only impact the amount of deposit over and above what was insured through deposit insurance. The Deposit Insurance and Credit Guarantee Corporation (DICGC) essentially insures deposit amounts up to ₹1 lakh.
What this means is that if you have deposits of, say, ₹2.5 lakh with a bank that is failing, the RC has three options. It can cancel the repayment of ₹1.5 lakh ( ₹2.5 lakh minus ₹1 lakh of insured amount); or negotiate a haircut and not repay the entire amount above ₹1 lakh; or simply convert ₹1.5 lakh into long-term bonds or stocks of the failing bank (irrespective of whether you want it or not).
That’s scary, right? It’s not surprising the government had to do away with the FRDI Bill.
Recent media reports suggest that FRDI Bill now seems to be making a comeback, albeit in a new avatar. Financial journalist Sucheta Dalal reports in Moneylife that there’s a new form of the FRDI Bill doing the rounds. It’s called the Financial Sector Development and Regulation (Resolution) (FSDR) Bill, 2019.
According to Dalal, this new Bill does away with using the term bail-in. Having said that, it does allow the RC to cancel or modify the liabilities of a failing financial firm. This basically means that deposits can still be cancelled or modified into equity, with the deposit holder ending up with stocks of the bank.
It seems the Bill also talks about increasing the deposit insurance limit from the current ₹1 lakh, which has been in place since 1993. So, in that sense there isn’t much of a difference between the FRDI Bill and the new FSDR Bill. Both Bills envisage a situation where if the RC wants it may not return the deposit amount above the insured amount.
All you need is confidence
Theoretically, if a bank is failing, in the current system, the deposit holders can end up getting only ₹1 lakh irrespective of the amount they have deposited in the bank. Remember, this insurance has been around for a while.
The problem is many deposit holders don’t understand this. They have a lot of confidence in PSBs (although this has started to change in the recent past, with private banks getting a bigger share of fresh deposits). Where does this confidence come from? This has been built over the years because of the nationalization of private banks; 14 banks in 1969 and then six banks in 1980.
The third volume of the history of the Reserve Bank of India (RBI), quotes IG Patel, who was the Economic Affairs secretary in the central government when the first round of bank nationalization happened, and was the RBI governor when the second round of nationalization happened, as saying: “By all accounts, the nationalization of major banks was a great success initially… It greatly increased popular confidence in the banking system.”
Another reason for the public confidence comes from the way the RBI has acted in the past in dealing with a bank that is failing. Section 45 of the Banking Regulation Act 1949 empowers the RBI to “make a scheme of amalgamation of a bank with another bank if it’s in the depositors’ interest or in the interest of overall banking system.” Hence, if a bank is in a bad shape and there is a risk of the depositors losing their money, the RBI has the power to merge this bank with another bank in the interest of the overall banking system.
The merger of Global Trust Bank (GTB) with Oriental Bank of Commerce (OBC) in July 2004 is a good example of this. GTB was a private bank which got into trouble and was merged with OBC in the interest of the depositors.
When it comes to PSBs, there was a forced merger of New Bank of India with Punjab National Bank (PNB) in 1993. The RBI had forced this merger under Section 45, because the New Bank of India had reached a precarious state of liquidity. Simply put, the bank did not have enough money to pay out its depositors.
Due to these mergers, the confidence that people had in the PSBs has remained intact. The FRDI Bill and the proposed FSDR Bill have hurt this confidence of the bank depositor, despite not suggesting anything which was very different from the current system, at least in theory.
So, where does this leave the depositor? Chances are that like in the past, the RBI will move quickly to save a bank that is failing—be it a PSB or a private bank. Having said this, it still makes sense for depositors to take a few basic precautions.
First, it makes sense to have deposits spread across three to four bank accounts. Access to deposits is as important as their safety. While, any dud bank is likely to be saved, there is always a chance of a limit being placed on deposit withdrawals. This is something that happened with many depositors in PMC Bank—they had all their deposits in that one bank. Hence, if deposits have been placed across banks, even if a withdrawal limit is placed at one bank, the deposits at other banks will remain available for withdrawal.
Another point to remember is that it’s best to stay away from having deposits in cooperative banks. This is not to say that every cooperative bank is unsafe, but for a deposit holder it is very difficult to figure out which one is and which one isn’t.
Also, there are too many cooperative banks out there, making it difficult for even the RBI to follow the performance of each one of them very closely. Also, the RBI’s treatment of failing cooperative banks and failing scheduled commercial banks has been different. The PMC Bank hasn’t been merged with any bank. This is a point worth remembering.
Finally, PSBs are also of different kinds. A bank like State Bank of India with a bad loans rate of 7.2% as of September 2019 is very different from an Indian Overseas Bank which had a bad loans rate of 20% or an IDBI Bank which had a bad loans rate of 29.4%. (IDBI Bank is technically no longer categorized as a PSB given that it is now majorly owned by the Life Insurance Corporation of India. But for all practical purposes, it is one).
So, even if you are comfortable banking only with PSBs, it makes sense to bank with good PSBs and to avoid the bad ones.
The days when bank depositors worked on the principle of “Fill it, Shut it, Forget it,” seem to be on the way out. They need to take some care.