The Financial Resolution and Deposit Insurance Bill, 2017: Key Highlights

By Nidhi Bothra, (nidhi@vinodkothari.com)

In March, 2016 a committee was constituted under the Chairmanship of Mr. Ajay Tyagi to draft and submit a bill on resolution of financial firms. In September, 2016, the Committee submitted its report and bill which was titled as “The Financial Resolution and Deposit Insurance Bill, 2016”[1] (Bill 2016). The objective of the Bill, 2016 was to provide for a framework for safeguarding the stability and viability of financial services providers and to protect the interest of the depositors, as the name of the bill also suggests[2].

The Financial Resolution and Deposit Insurance Bill, 2017[3] (Bill, 2017) is formulated to provide resolution to certain categories of financial service providers in distress; the deposit insurance to consumers of certain categories of financial services; designation of systemically important financial institutions; and establishment of a Resolution Corporation for protection of consumers of specified service providers and of public funds for ensuring the stability and resilience of the financial system and for matters connected therewith or incidental thereto.

The proposed legislation together with the Insolvency and Bankruptcy Code, 2016 is expected to provide a comprehensive resolution mechanism for the economy.

The existing draft of the Bill, 2017 has been referred to a Joint Parliamentary Committee of both the Houses, under the Chairpersonship of Shri Bhupender Yadav, for examination and presenting a Report to the Parliament.

The Bill is divided into several chapters, which deal with establishment of a Resolution Corporation, its powers, management and functioning which is broadly to function along with the appropriate regulator[4] of financial services provider, classification of persons as systematically important financial institutions, deposit insurance, restoration and resolution plan, method of resolution, liquidation etc.

Highlights of the Bill, 2017

The brief highlights of the Bill[5], 2017 are as follows:

1. Establishing the Resolution Corporation – A resolution corporation would be formulated broadly with the objective of
   1. monitoring certain financial services provider^[6];
   2. providing deposit insurance to banking institutions;
   3. classifying certain persons as specified service provider [7] into one of the categories of risks to viability;
   4. acting as an administrator or liquidator for such service provider or resolve a specified service provider which has been classified into critical risk category;
   5. set up funds including Corporation Insurance Fund, set up for deposit insurance provided by the Corporation to the insured service providers[8] and other funds such as Corporation Resolution Fund for meeting the expenses of carrying out resolution of specified service providers and Corporation General Fund for all other functions of the Corporation.
2. Deposit Insurance – Chapter IV of the Bill, 2017 discusses about deposit insurance and largely deals with
   1. Determination of amount payable by the Corporation, to a depositor on account of deposit insured;
   2. Amount payable to an insured service provider[9] on account of resolution but not bail-out or eligible co-operative bank on account of merger or amalgamation;
   3. If the Resolution Corporation is dealing with the resolution of an insured service provider, then the Corporation may decide to invite offers from other insured service providers to take over the liabilities, deposits or realisable assets of the insured service provider.
3. Categorisation as SIFIs[10] – Certain persons can be classified as SIFIs by the Central Government in consultation with the appropriate regulator, as per Section 25 of the Bill, 2017, if it meets the criteria prescribed by the Central Government in this regard. Once categorised as an SIFI, then are deemed to be specified service provider and the provisions of being a specified service provider under the Bill, 2017 become applicable to them. It is important to mention that any financial service provider or domestic systematically important banks can be classified as SIFIs. Once classified as SIFIs, the Central Government may designate, its holding, subsidiary, associate company or any other body corporate related to it as financial service provider and falling into the ambit of being SIFI.
4. Registration of specified service provider – Chapter V of the Bill, 2017 talks about registration of specified service providers and states that if a person classified as a specified service provider or deemed to be a service provider, it shall be deemed to be registered under the Act, from the date of classification. If the appropriate regulator has issued a license in favour of a specified service provider, such license shall be deemed to be registration for the purpose of this Act as well.
5. Risk to viability categories – The Bill, 2017 specifies 5 categories[11] of risk to viability under Section 36 (5) and are as follows —
   1. low, where the probability of failure of a specified service provider is substantially below the acceptable probability of failure;
   2. moderate, where the probability of failure of a specified service provider is marginally below or equal to acceptable probability of failure;
   3. material, where the probability of failure of a specified service provider is marginally above acceptable probability of failure;
   4. imminent, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure;
   5. critical, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure, and the specified service provider is on the verge of failing to meet its obligations to its consumers

The classification of a specified service provider into any of the categories of risk to viability except the category of critical risk to viability under section 45, shall be kept confidential by the appropriate regulator, the Corporation and by all relevant parties.

6.   Categorisation of specified service providers under risk to viability categories —

1. The Resolution Corporation in consultation with the appropriate regulator categorise specified service providers under risk to viability categories.
2. The Resolution Corporation shall have no power to classify a specified service provider into the category of low or moderate risk to viability.
3. While classifying under risk categories, they can assess, evaluate and classify the holding or non-regulated operational entity within the group of the specified service provider as deemed to be a specified service provider.

7.   Restoration and Resolution Plan — Any specified service provider, classified in the category of material or imminent risk to viability shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of such classification. Every restoration plan will prescribe for the details of restoring category to low moderate and resolution plan on who resolution will be achieved.

Where a systemically important financial institution is classified in the category of low or moderate risk to viability, it shall submit the information required under this subsection assuming that it is classified in the category of material or imminent risk to viability.

Where the Resolution Corporation determines that liquidation is the most appropriate method for the resolution of a specified service provider, notwithstanding anything in any other law for the time being in force relating to liquidation and winding up, the Corporation shall make an application to the Tribunal for an order of liquidation in respect of such specified service provider.

The detailed actions as prescribed under the Bill for various categories of risks is tabulated in Annexure I to this note.

Changes from the Bill, 2016

The Bill, 2016 aimed at including all NBFCs its foray. Bill, 2017 only intends to cover such NBFCs and other entities in the group, if such NBFC is classified on high risks to viability categories. This was an important and a necessary change from the Bill, 2016.

All the NBFCs, big and small will be continued to be monitored by the appropriate regulators, however, matters will get escalated only if they are on the risks to viability meter. Similar would be the case with other financial services providers as well.

Some key issues

Some key issues that the Bill, 2017 does not address or overlook are as follows:

1. Definition of financial services provider – The Bill does not provide for a definition of financial services providers. The specified services provider will be deduced from the financial services providers, by and large. However the Bill, 2017 does not expressly provide for the universe of which the monitoring will be carried out. The Bill, 2017 indicates, NBFCs, insurance companies and banking institutions will fall in the ambit of discussion.
2. NBFC-Ds – While the concept continues to be theoretical for all practical purposes, but the Bill, 2017 does not make a mention at all of this category of entities.
3. Resolution and restoration plan — Chapter VII provides for resolution plan and restoration plan to be submitted to appropriate regulator and resolution corporation for material and imminent risk category specified service providers. The plans are to be submitted with 90 days. The brief contents of the plans to be provided to the authorities is prescribed in the Bill, 2017. However, are both plans to be provided within 90 days from the date of categorisation and for both categories?

For both categories of risks to viability, there can be strong intervention of the authorities in running of the business itself. One may find it difficult to find the distinction between the two categories of the risks to viability as the action taken by the authorities and from the specified service providers seems to be almost similar.

In case an entity is categorised as critical risk to viability, the turnaround of the resolution plan is to be carried out within one year, else the Resolution Corporation may require the liquidation of the entity. The entities, in determination here have an element of systemic risks and therefore liquidation of such entities can have daunting consequences on the economy. The provision for triggering liquidation should be well defined or determined in consultation with the Central Government.

4.   Rule-making – The devil, as they say, lies in the details. A lot of actions to be taken in each of the risks categorisation will come by way of rule-making. This will determine the effectiveness of the resolution plans and restoration plans prescribed in the Bill, 2017.

5.  Existing resolution mechanisms – The appropriate regulators have introduced several policy initiatives and resolution guidance and schemes for restructuring of stressed assets, special restructuring norms, strategic restructuring norms, corporate debt restructuring wherein the entities were required to submit resolution/ restructuring/ restoration plans within certain timeframes. The experience with these guidelines have indicated the failure of these guidelines and schemes to provide for a resolution plan within the dedicated time frame and also restoring the position of the entities.Therefore, appropriate learnings from those guidelines should also be reflected in the Bill,2017.

Annexure I

[1] http://dea.gov.in/sites/default/files/FRDI%20Bill-27092016_1.pdf

[2] See our article titled – Financial Resolution and Deposit Insurance Bill: Implications for NBFCs, by Vinod Kothari and Niddhi Parmar, here http://vinodkothari.com/blog/financial-resolution-and-deposit-insurance-bill-implications-for-nbfcs-by-niddhi-parmar/

[3] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf

[4] Appropriate Regulator is defined in First Schedule to the Bill, 2017 to include a) RBI, b) IRDA, c) SEBI, d) Pension Fund Regulatory Development Authority or any other regulator as notified by the Central Government.

[5] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf

[6] Financial services provider categorised as specified service providers and SIFIs fall within the purview of the Resolution Corporation. The detailed mechanism of monitoring is discussed further in the highlights.

[7] A specified service provider is a person as defined in Second Schedule to Bill, 2017 and includes

1. A banking institution, , other than eligible co-operative bank including an insured service provider;
2. Any insurance company
3. Any Financial Market Infrastructure
4. Any payment system, as defined under the Payment and Settlement Systems Act, 2007 (51 of 2007), not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
5. Any non-banking financial company, not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
6. Any systemically important financial institution
7. Any other financial service provider (excluding individuals and partnership firms), not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
8. A holding company of any specified service provider enumerated under items 1 to 7, registered in India which is not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), subject to the determination by the Corporation under the proviso to sub-section (1) of section 33
9. Non-regulated operational entities within a financial group or conglomerate of a specified service provider enumerated under items 1 to 7 subject to the determination by the Corporation under the proviso to sub-section (1) of section 33.
10. Branch offices of body corporates incorporated outside India, carrying on the business of providing financial service in India.
11. Any other entity or fund which may be notified by the Central Government

[8] As defined in Section 2 (19) of the Bill, 2017 — means any banking institution, that has obtained deposit insurance under sub-section (3) of section 33. Section 33 (3) states that every banking institution that has been granted a banking license by the appropriate regulator shall be deemed to be categorised as insured service provider for obtaining deposit insurance under the Act.

[9] Insured service provider is a banking institution that has obtained deposit insurance

[10] To qualify as an SIFI, the Central Government will consider the size, complexity of the financial service provider, the nature and volume of transactions undertaken, interconnectedness with other financial service providers and nature of services offered and possibility of substitution such business.

[11] The categorisation are based on assessment of the following parameters:

(a) adequacy of capital, assets and liability; (b) asset quality; (c) capability of management; (d) earnings sufficiency; (e) leverage ratio; (f) liquidity of the specified service provider; (g) sensitivity of the specified service provider to adverse market conditions; (h) compliance with applicable laws; (i) risk of failure of a holding company of a specified service provider or a connected body corporate in India or abroad; and (j) any other attributes as the Corporation deems necessary

[12] A restoration plan as per the provisions of Section 39, will contain details of assets and liabilities of the entity, including contingent liabilities, steps to be taken by the entity to move to moderate classification at least, time frame within which such restoration plan will be executed and other information relevant for the appropriate regulator to assess the plan.

[13] A resolution plan, as per the provisions of Section 40, will contain details of assets and liabilities of the entity, identification of critical functions of the specified service provider, access to financial market infrastructure services, either directly or indirectly, strategy plans on exiting the resolution process and any other relevant information.

[14] The resolution plan must be completed within one year from the date of classification into critical risk to viability. Where the plan is completed within one year and the Corporation deems necessary, it shall require liquidation of the entity.