The proposed law is credit positive for banks and it will deter senior unsecured creditors
The draft bill on the resolution of bankruptcy of financial firms would put public sector financial companies on par with their private counterparts, according to Moody’s Investors Service.
“Under existing laws, resolution of public sector banks can only happen by order of the government and in the manner it directs,” according to a note prepared by Moody’s. “This differential treatment would be removed if the bill becomes law, and they would be brought on an equal footing with other financial firms in terms of resolution.”
While the proposed law is a credit positive for banks, Moody’s said it would be a deterrent for senior unsecured creditors due to their altered rankings.
“Under the proposed law, uninsured depositors would rank above senior unsecured creditors in a liquidation scenario, compared to the existing scenario where they rank pari passu (on an equal footing),” the note said.
“Currently, resolution of financial firms in India is based on provisions spread across various laws,” according to the note. “More important, the current provisions are minor parts of laws made for other purposes. Thus, in practice, the resolution process has been ad-hoc to an extent. This bill addresses the lacunae of a having a legally codified framework for resolution, and hence is a credit positive in terms of enhancing overall systemic stability.”
Significant delineation
The note also highlighted the fact that once enacted, the Bill would create a significant delineation of regulatory powers between the Reserve Bank of India and the Resolution Corporation (RC), the organisation to be formed under the Bill.
“The RBI would have the predominant regulatory role for banks in the first three categories in terms of risk to viability, while the RC would be the key authority for banks in the last two categories.”
A key role of the Corporation will be to assign risk ratings to financial sector companies based on their viability, according to the draft Financial Resolution and Deposit Insurance Bill, 2016. The ratings will range between ‘low’, “where the probability of failure of a covered service provider is substantially below the acceptable probability of failure”, to ‘critical’, “where the probability of failure of a covered service provider is substantially above the acceptable probability of failure.”