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New framework for bank insolvency

The Reserve Bank of India has proposed a new framework for bankruptcy of financial institutions that will align the country with international standards. However, it is feared that the regulation may increase the cost of senior funding for the banks. The proposals are part of a report of a working group of the RBI, which also called for depositors to have preference over senior creditors, a factor that analysts fear would offer depositors an upper hand over other creditors leading to serious implications for bondholders. This may result in higher wholesale funding costs for the banks, they aver. In normal circumstances, no commercial bank in India is allowed to become insolvent, though there have been mergers and acquisitons of at least a dozen banks in the last 10 years. The proposal would involve expansion of the existing deposit insurance agency into a Financial Resolution Authority, along the lines of the Federal Deposit Insurance Corp of the United States. The proposed framework will put the power to trigger writedown clauses of subordinated bonds in the hands of the new Financial Resolution Authority. The authority is expected to get involved once the bank is already near insolvency. This means that by the time loss-absorption clauses are triggered, investors will already be potentially facing total loss on the subordinated debt anyway.

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