Insolvency bill for financial firms credit positive: Moody’s

New Delhi: Moody’s Investors Service on Tuesday said that the draft insolvency bill for financial firms was a credit positive move, which would help bankruptcy reform in the sector.

The government, in September, released the draft bill to address insolvency resolution for financial institutions. This follows the Insolvency and Bankruptcy Code passed earlier this year for similar issues for non-financial firms.

The draft bankruptcy bill—Financial Resolution and Deposit Insurance Bill, 2016—is crucial to have a comprehensive insolvency and bankruptcy framework in the country.

“Currently, the resolution of financial firms in India is based on minor parts of legislation enacted for other purposes,” said Srikanth Vadlamani, vice president and senior credit officer at Moody’s.

He added that the bill will improve the systemic stability for Indian banks. It will thus act as credit positive for financial firms in the country.

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“At the same time, we note that the draft bill will have to go through multiple steps before becoming law, and could therefore be subject to changes and delays,” added Vadlamani.

In its report titled Draft Bill on Resolution Will Enhance Systemic Stability, Moody’s said that bail-ins do not seem to be the preferred form of resolution as suggested in the draft bill, with significant restrictions in place for their usage. A bail-in refers to cancelling or modifying a liability owed by a covered service provider (includes any banking institution, though not a cooperative bank, an insurance company, a financial market infrastructure and a non-banking financial company).

Bail-ins are allowed only if the same is contractually provided. Further, bail-ins are to be used only after means of recovery for a covered service provider have failed.

As a result, Moody’s expects India to continue to remain without an operational resolution regime.

The report says that the impact of bank failure and resolution on depositors and creditors is not clearly specified in the bill. As a result, Moody’s expects to continue to use the basic loss given failure (LGF) framework for rating Indian banks.

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Moody’s also says that the bill ranks depositors above senior unsecured creditors in a liquidation scenario which is contrary to the current laws. This change will be a credit negative for unsecured creditors. The report highlights that law in other countries (with higher credit ratings) preserve such depositor preference. Moody’s rates senior debt ratings on par with deposit ratings, which is a likely outcome for Indian banks.

The draft bill also provides for a significant delineation of regulatory powers between the Reserve Bank of India and the proposed Resolution Corporation, the report says. Such a scenario would represent a change compared to the current structure, where the powers rest almost fully within India’s central bank.

Consequently, there could be some execution risk, as the system transitions to the new arrangement.