FSLRC Revamp of Deposit Insurance and Consumer Protection

The existing financial legislation/administration framework is not satisfactory and many fundamental changes are required to ensure effective consumer protection; in this context it is important to examine the recommendations of the Financial Sector Legislative Reforms Commission (FSLRC).

Setting Up of a Resolution Corporation

The FSLRC claims that, under the present framework, action is initiated far too late when banks/financial companies get into trouble, and hence it lays great store on setting up a 'Resolution Corporation', backed by legislative powers, to undertake timely intervention. As in every other sphere, in the area of deposit insurance and consumer protection, the FSLRC game plan is to first demolish the existing framework before setting up a new framework.

Scope of the Resolution Corporation

The Resolution Corporation would be a hybrid organisation covering both deposit insurance as well as safeguarding the interests of stakeholders. At the present time, insurance cover is provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the Reserve Bank of India (RBI), only for bank deposits and that to for deposits up to Rs one lakh per depositor. The Deposit Insurance Agency is a mere passive pay-out agency and it has no role in early rectification of the problems of the banks/institutions.

In contrast, under the FSLRC recommendation, the Resolution Corporation is to have sweeping powers to intervene well before financial firms fail The proposal is based essentially on the US Resolution Trust but it is also envisaged that the kind of activities undertaken by the US Federal Deposit Insurance Corporation (FDIC) would be subsumed under the proposed Resolution Corporation.

Present Structure of Deposit Insurance in India

While the FSLRC gives extensive acknowledgement to many previous Reports, by Committees/Working Groups, it uses selective institutional memory. The FSLRC fails to take cognisance of the Jagdish Capoor RBI Working Group on Deposit Insurance (2000) which made many path-breaking recommendations. This Report advocated differential deposit premia for banks according to their risk profile and more importantly advocated the granting of regulatory and supervisory powers for the Deposit Insurance Agency akin to the US FDIC. The US FDIC has sweeping powers of regulation and supervision over banks in the area of deposits. The reference to Prompt Corrective Action, correctly emphasised by the FSLRC, is not new to India but in this area, as in other areas, there is considerable pussy-footing when it comes to effective action- this is essentially because the polity does not support strong, timely and effective corrective action. The FSLRC would have gained credibility if it were to acknowledge the lineage of its ideas to the Jagdish Capoor Working Group.

The onus of lack of progress in this area lies partly with the RBI, partly with the government and partly with the overall attitude of the Indian polity. The whole issue of providing teeth to the Deposit Insurance Agency is bogged down in inter-departmental dominance within the RBI. The reluctance to go in for differential premia is attributable to the unfounded fear of government that banks which have a high premia could face a run on their deposits. If this were to happen it would not necessarily be a bad thing as it would trigger faster Prompt Corrective Action. The core of the problem is the Indian philosophical leaning of the Indian psyche which encourages banks/institutions to lend, to lose and to live and death of banks/institutions is just not acceptable in our ethos.

Hazards of Subsuming Deposit Insurance Within the Resolution Corporation

One of the major hazards of subsuming deposit insurance (presently provided only for banks) under the Resolution Corporation, as proposed by the FSLRC, would be that there would be pressures, which cannot be resisted, to bring non-bank finance companies (NBFCs) within the ambit of the insurance agency. More than one Committee/Working Group has examined this issue and they have unanimously concluded that it would be hazardous to bring NBFCs within the ambit of the insurance agency. If such insurance was provided, there would be an exodus of funds from banks to non-banks. This is the primary reason why the Deposit Insurance Agency should not be subsumed within the Resolution Corporation. The obvious solution would be to leave Deposit Insurance where it is at present, but give the Deposit Insurance Agency effective powers of regulating and supervising banks' deposit activities. But this does not fit into the philosophy of the FSLRC: 'Give me a problem and I will give you a new institution'.

Need for Caution on Setting Up a Resolution Trust

The success of the US Resolution Trust is unlikely to be replicated in the Indian context. In the US, the Resolution Trust was set up in the context of the housing collapse and the Resolution Trust took over real assets which were subsequently sold off once the housing market improved. In India, it is likely that by the time the Resolution Corporation swings into action, the NBFCs would be empty shells and all that the Resolution Corporation would become is an agency to pick up losses. Hence, there should be great care in setting up a Resolution Corporation. Recognising that increasingly banking activity could be in the private sector the Resolution Corporation could, at best, be restricted to banks. The NBFC segment has historically been the most difficult segment to regulate and supervise and has also been litigation prone. Setting up a Resolution Corporation which would also cover NBFCs would ensure that profits will be private and losses will be public.

Consumer Protection and Redress Agency

The FSLRC does well to stress the need for better consumer protection as there is a proliferation of unequal contracts which calls for an effective Redress Agency. While the FSLRC needs to be commended for placing consumer protection at the heart of financial regulation its iconoclastic obsession leads it to first destroy existing institutions and then build them once again with an article of faith that the new architecture would be the ideal structure. During the past two decades considerable advances have been made in the area of consumer protection and the development of the Redress mechanism and it is not optimal to knock down the present system to satisfy the FSLRC's grand design.

While the consumer protection and Redress system needs to be strengthened, it does not make sense to clean swipe the present structure and build everything afresh; any strengthening should be via improving the existing infrastructure. If the Commission's recommendations are implemented in toto, it would merely result in a highly centralised control system which would go against the very thought of financial liberalisation. The Commission's Report pays scant attention to the ground realities. Our Parliamentary system requires minute scrutiny of legislative changes. While the Commission's recommendations may be pulsating, they are unlikely to see the light of day in the life time of the Commissioners.

Please Note: This article was first published in The Free Press Journal on May 06, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

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