The Finance Resolution and Deposit Insurance (FRDI) bill was introduced in Parliament during theBudget Session of 2017 and has been due to be passed since then. The work of establishing a framework for financial resolution and deposit insurance started with the Financial Sector Legislative Reforms Committee (FSLRC) report which came out in 2013, but progress has been so slow that the Insolvency and Bankruptcy Code (IBC)whose idea came much later, has outpaced it and is already anact while FRDI is still in its formulation stage.
The bill is indispensable to build resilience in the financial sector against external shocks or internal disturbances. It ensures that every financial service provider is under the supervision of the Resolution Corporation and any shortcoming is meted out. For this, the bill proposes to institute a Resolution Corporation which will inspect the books of financial entities, classify them into various risk to valuation categories and resolve them if required.
Although the bill has covered for most probable scenarios, it still needs much more work to fill in some of the very apparent gaps left. While no bill can ever be perfect, especially so in today�s changing times, the existing weaknesses of the bill can be addressed.
The very basis on which the strength of the financial entity is to be evaluated i.e. the �risk to valuation categories� is sub-par. The Resolution Corporation, in consultation with the appropriate regulator, has to classify the financial service provider into five categories of risk to valuation on which the plan of action will be determined. However, the classificationis determined on subjective parameters like the capability of management, sensitivity of the firm to adverse market conditions, risk of failure of a holding body or a connected firm, quality of assets etc. This can lead to incorrect classification of the service provider and a different classification of firms which are in a similar financial state. An objective criterion will bring more transparency to this process.
The ability of resolution corporation to correctly gauge the risks associated with each financial service provider is also doubtful. With the complexity of financial engineering involved in this day and age, it is rather difficult to identify weaknesses in the system. Arbitrarily, trusting the Resolution Corporation,which has no history on which to baseexpectations about its performance,can be a mistake. If, however, an error of underestimating risk is made, the FRDI bill doesn�t provide for a swift resolution mechanism.
The bill also allows the appropriate regulator to classify the service providers, which are incorporated in foreign countries and have branches in India, into various risk to valuation categories. The resolution corporation is to resolve any such branch office according to the provisions of the bill.However, unless the government enters into bilateral agreements with governments of other countries, the provisions of the bill stand invalid in those places. Such a situation makes serving justice to consumers and creditors of the international financial service provider a big hassle.
Moreover, different countries might have different approaches to categorise the service providers and what might make a service provider fall into a critical category in India might be of little relevance in other countries. It is also likely that if no such resolution mechanism exists in the foreign nation then it will lead to a total roadblock in proceeding with the resolution mechanism. There might be cases where the government in the other country does not agree to an accord for resolution of financial firms in its own country. All these situations must be ruminated on and the FRDI bill should be amended to incorporate these scenarios.
Lastly, the FRDI bill keeps the actions taken in conformity to the chapters dealing with �Methods and Time Limit of Resolution, Administration and Liquidation� outside the governance of Competition Act 2002. But not involving the Competition Commission of India on matters of mergers, amalgamation and sale of a firm to another firm stands against the idea of both the Competition Act and that of the Competition Commission of India (CCI). It has been argued that the timelines of the bill and that of the working of CCI are different which hampers the working of the bill. This can be corrected by making changes to the process of handling cases referred by the Resolution Corporation to the CCI. The legislature would of course not like to make a law which ends up creating monopolies in the Indian financial system.
A resolution mechanism for the financial sector has been long overdue. The banking crisis has been unfolding and can cripple the financial sector at any point. With many gaps still left in the FRDI bill, it is better to introduce changes in the bill while it is still being debated.