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A takeover best avoided - Outside View by S.S. TARAPORE
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A takeover best avoided
Oct 4, 2013

The Financial Sector Legislative Reforms Commission (FSLRC) made a large number of recommendations which will require fundamental changes in the structure of financial legislation. There has been an intense debate between supporters of the recommendations and those who are against them.

The report ostensibly needs to be carefully examined by parliamentary committees before enactment. Notwithstanding this, the Government, as a first step, has proposed that it would take over the ownership of the Deposit Insurance and Credit Guarantee Corporation (DICGC), now under the central bank's control.

This is in line with the FSLRC's contentious recommendation to subsume the DICGC within the proposed Resolution Corporation. The DICGC would take charge of banks and financial institutions in anticipation of failure.

The takeover is erroneously attributed to the Narasimham Committee II (1998), which recommended that a regulator should not be an owner of banks/financial institutions. The Committee certainly did not recommend the takeover of the Reserve Bank of India's (RBI) holdings by the Government.

This perverted logic enabled the Government to take over successively RBI's holdings in the State Bank of India, the National Bank for Agriculture and Rural Development and the National Housing Bank.

These takeovers were highly profitable to the Government as the RBI's profits were routed back to the Government by way of profit transfer. In effect, the Government picked up these lucrative assets for a song.

The present proposal is for the Government to take over the RBI's holdings in the DICGC. But unlike the earlier takeovers, the DICGC would not provide a bonanza to the Government, as all that it would have to offer are large and increasing liabilities.

Ambit of Deposit Insurance

If the Government uses its muscle power to take over DICGC, there must be an explicit agreement, cast in stone, that the RBI would not, at any stage, be required to provide funds to the DICGC or the proposed Resolution Corporation.

At present, the DICGC covers commercial and co-operative banks and is a mere payout agency without any regulatory or supervisory powers. The Jagdish Capoor Working Group (2000) had recommended that there be a differential premia, according to risk, and that the DICGC be empowered to undertake regulation and supervision relating to bank deposits.

The question which has repeatedly come up is whether deposit insurance should be provided to those placing money with financial companies. The uniform response of various committees and working Groups has been that deposit insurance should not cover financial companies.

The FSLRC recommendation, on the other hand, is that the DICGC be subsumed within the proposed Resolution Corporation, which would cover both banks and financial companies. In such a system, it would become imperative to provide deposit insurance to finance companies.

It is true that deposit insurance has been subsumed under a Resolution Agency in a number of countries, but this does not mean that what worked in Ruritania will work in India.

Prior to 1960, there was a proliferation of commercial banks but after the Palai Bank failure, the legislative framework enabled the RBI to impose a moratorium and merge, amalgamate or liquidate banks.

As a result there was a sudden and drastic reduction in the number of commercial banks. Ever since the nationalisation of banks in 1969, private banks facing difficulties were invariably merged with their public sector banks. Since applications for new banks were not entertained, there was a mushrooming of finance companies undertaking quasi-banking functions.

The reptilian growth of finance companies posed a challenge to the sector, which was litigation-prone. These finance companies still continue to remain a big problem. Hence, bank deposit insurance and resolution mechanisms should be kept distinct and separate.

A number of new private sector players are expected to receive bank licences soon. Moreover, a large number of small, new, private sector banks could also emerge. Securing banks should be a top priority and the DICGC should be immediately empowered from within the RBI itself to undertake regulation and supervision of banks in relation to depositor's interests.

At the present time, the depositor is a distant poor cousin in the financial system. It is time that depositors are given their rightful place. One does not tire of repeating the words of the indomitable consumer activist, the late M. R. Pai, who would say that without the depositor there would be no bank.

Careful with reforms

While the Government has opted to initiate action on deposit insurance, it bears emphasising that financial legislative reform should not be undertaken by stealth. Merging bank deposit insurance with a Resolution Corporation dealing with banks and financial companies is a lethal cocktail which can totally destabilise not only the financial system, but Government finances as well.

If the Government is persuaded by the FSLRC activists, all that one can say is: Forgive them, O Lord, for they know not what they do.

The Deposit Insurance and Credit Guarantee Corporation, now under the RBI, should not be taken over by the government. And, it need not cover finance companies.

Please Note: This article was first published in The Hindu Business Line on October 4, 2013.

This column, Maverick View 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 Freepress Journal, is titled Common Voice.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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