December 24, 2017
FRDI stands for Financial Resolution and Deposits Insurance. FRDI Bill, introduced by the government in June 2017 has sparked controversy, forcing the government to defer it till the Budget Session. While some fears are blown out of proportion, certain issues warrant a greater discussion regarding this bill. The main aim of the bill is to set up a resolution corporation to monitor the financial institutions and prevent them from going sick(bankrupt).
Check out the career options in financial institutes
Financial Institutions such as banks, insurance companies, pension funds, non-banking finance companies play a crucial role in an economy of the country. These institutes give interests to deposits for their deposits and use these deposits as capital to generate revenue. But these firms are not free of risk. Often, banks invest in assets that turn out to be non-performing. When banks accumulate assets which are non-performing, depositors fear for the safety of their money and seek to withdraw their stake. When many depositors claim their dues at the same time, the bank is forced to default on the payment of dues. This leads to collapsing of an otherwise functioning bank. Therefore, a growing ratio of NPAs is an alarming fact that may result in the insolvency of financial firms. Read more about insolvency here
Currently, the resolution of financial firms in India depends on their constitution. While RBI has the power to resolve such crises in scheduled banks, co-operative banks are governed by Registrar of Co-operative Societies. There are different regulators for insurance companies (IRDA), stock exchanges (SEBI) and pension funds (PFRDA). While these regulators are experts in their own industry, the resolution of such firms in case of a failure is a different matter altogether. Hence, as far as liquidation of these firms is concerned, the need for a single competent authority was felt. FRDI Bill proposes that a Resolution Corporation will be constituted for this purpose.
Secondly, in the existing system, the options available to resolve a financial firm are limited. For example, scheduled banks (governed by RBI) can be forced to merge with each other in times of financial failure, but co-operative banks have a different mechanism for winding up. Insurance sector also mostly relies on forced merger/acquisition. For instance, recently IRDA asked ICICI Prudential Life Insurance to take over the business of Sahara Insurance to save the latter from liquidation. The new FRDI Bill allows for more options at the disposal of the Resolution Corporation.
Further, under the current system, different financial firms are exposed to differential treatment. For example, SBI has a competitive advantage because people have this implicit understanding that in case of a failure, the Central Government will ‘bail-out’ the firm. This results into an additional risk for other firms. Hence, by according a differential treatment to few selected firms, the risk of other financial firms is exacerbated.
Lastly, banks are currently covered by Deposit Insurance and Credit Guarantee Corporation (DICGC) where every single deposit is insured to a maximum of ₹ 1 lakh. For this purpose, banks need to pay premium to DICGC and in times of such financial crises, the DICGC will insure an amount of up to ₹ 1 lakh for every deposit. The new framework of FRDI Bill aims to transfer the insurance cover from DICGC to the Resolution Corporation.
The Resolution Corporation will have various options at its disposal to resolve the failure of a financial firm:
Know more about FRDI bill