All you need to know about India's NPA crisis and the FRDI Bill

India's NPA crisis and the FRDI Bill:

What are NPAs?

The primary function of the Reserve Bank of India (RBI) is to regulate the supply of money in the economy. For this end, they use tools like the Cash Reserve Ratio (CRR), the Statutory Liquidity Ratio (SLR), the repo rate, and the reverse repo rate. Bad loans arise when banks make poor lending decisions. The CRR is calculated as a percentage of the net demand and time liabilities (NDTL).

CRR is the money that banks are required to deposit with the RBI, for which they will not be paid interest. At present, the RBI has fixed this at 4%. In addition to this, banks have to deposit a portion of their money in relatively safe assets which are easily saleable - such as government bonds, securities or gold - to generate liquid cash in the event of a run on the bank. The current SLR is 19.5%.

For example, out of every Rs.100 deposited in a bank, Rs.4 is parked with the RBI, and Rs.19.5 in assets like bonds or gold. Almost a quarter of the money in the system can be retrieved in case of a contingency while the bank is free to lend the remaining Rs.76.5 to corporate or retail borrowers. The interest gleaned on such loans is used to compensate the bank’s customers as interest payment, and the remainder is the bank’s profit. NPAs arise when banks lend to clients who default on their repayment.

How has the government reacted to the NPA crisis?

The Financial Resolution and Deposit Insurance (FRDI) Bill is the latest attempt at mopping up the bad loans with which banks are saddled with. Previous attempts to this end have been moderately successful. To recover outstanding loans, a slew of legislations including the IBC (Insolvency and Bankruptcy Code), the SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, and the RDDBFI (Recovery of Debts due to Banks and Financial Institutions) were instituted. Debt Recovery Tribunals (DBT) were also set up to fast-track proceedings.

The SARFAESI Act empowers banks to auction assets or properties that were submitted as collateral while sanctioning loans. Under this Act, 64,519 properties were seized in 2015-16. However, the value of recovered assets constitutes only a tip of the NPA iceberg.

What is the Financial Resolution and Deposit Insurance (FRDI) Bill?

The FRDI Bill is aimed at insuring the money of a bank’s depositors in the case of an eventuality where the bank would have to be liquidated. However, some of the provisions of the draft have drawn the ire of depositors and bank employees alike, since it compromises the interests of the depositor and gives the government absolute power in deciding the fate of banks if they go under.

The bill proposes the setting up of a Resolution Corporation, “whose direction and management vests with the Board, subject to the terms and conditions of the Act.” A ‘Corporation Insurance Fund’ is the financial vehicle which will be used to garner insurance inflows.

While debt restructuring and ensuring the robustness of financial institutions was previously the domain of the RBI, the bill gives the government overweening powers by virtue of greater representation in the Resolution Corporation. The Board consists of a Chairperson, one member each from the Finance Ministry, the RBI, Securities and Exchange Board of India (SEBI), the Insurance Regulatory and Development Authority of India (IRDAI), the Pension Fund Regulatory and Development Authority (PFDA), three full-time members and two independent members, both of whom will be appointed by the Central government. This implies that six of the 11 members of the Board will be nominated by the government, giving it the final say in decision making.

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