The Working Group examined the existing resolution framework for the entire financial sector in India and identified gaps in the framework vis-à-vis FSB Key Attributes. The Group also reviewed international practices and the ongoing developments in major jurisdictions as well as work in progress by the international standard setting bodies. Taking these into account, the Group unanimously offers the following recommendations on the policy framework for setting up a resolution regime in India and sets a direction towards further steps going forward. The recommendations of Working Group are summarised below.

1. Policy framework to deal with failures

While there are existing regulatory provisions to deal with failing financial institutions, with a view to further strengthening the existing financial safety net framework and bridging the gaps in the resolution framework vis-à-vis the Key Attributes, the Working Group recommends that there should be a policy framework supported by law to deal with the failure of financial institutions¹ and financial market infrastructures² that are nearing non-viability in a manner that avoids disruption to the supply of critical financial services. [Para 4.13]

2. Comprehensive legal framework

Considering the special nature of financial institutions, as well as limitations in applying corporate insolvency laws to these institutions, the Group recommends that there should be a separate comprehensive legal framework for resolving financial institutions and FMIs. [Para 4.28]

3. Objectives of resolution framework

The aim of resolution is not to preserve the failing institution, but to ensure the continuity of the functions that are critical for the financial system as a whole and limit any use of taxpayers’ money. The Group recommends that the resolution framework in India should be guided by the following objectives:

• initiate resolution action in a timely and speedy manner;

• avoid erosion of value and minimise the costs of resolution;

• protect and maintain stability of the financial system as well as public confidence in Indian financial system;

• ensure continuity of essential financial services and critical functions such as payment, clearing and settlement functions;

• protect depositors, insurance policyholders, and client funds/assets, through protection schemes and other arrangements, within reasonable limits;

• avoid use of taxpayers’ money and not create an expectation that public support will be made available, thus ensuring market discipline;

• ensure imposition of losses to shareholders and unsecured creditors in a manner that respects hierarchy of claims; and

• ensure predictability through clear legal framework and procedural clarity. [Para 4.32]

4. Scope of resolution framework

The scope of the financial resolution framework in India should cover all financial institutions – including commercial banks (public sector banks, private sector banks, and foreign banks having branch/subsidiaries in India), co-operative banks, regional rural banks; non-banking financial companies, firms/companies in insurance, pension, securities and commodities markets; and FMIs including payment systems, securities settlement systems, central counterparties, securities depositories, etc. other than those owned and operated by the Reserve Bank of India, viz. real time gross settlement system and securities settlement systems. The proposed legislative framework for resolution should enable the resolution authority in coordination with the respective regulator to designate any other financial institution that will be covered by the framework. [Para 4.39]

The scope of the proposed financial resolution framework should also cover the parent undertaking or the holding company regulated by the financial sector regulator, of the financial groups. [Para 4.42]

5. Structure of the resolution authority

The Group considered the pros and cons of having a single resolution authority. The Group recommends that:

(v) there should be a single Financial Resolution Authority (FRA) mandated under the law for resolving all financial institutions and FMIs, in coordination/cooperation with the respective financial sector regulators, as deemed necessary by the FRA,

(vi) the FRA should be institutionally independent of the regulators/supervisors and the Government,

(vii) the FRA should be the sole authority responsible for operation and implementation of the financial resolution framework, including the decision to choose the appropriate resolution tool, except the power to take an institution into temporary public ownership (TPO) that will be invoked by the Government of India on the recommendation of the FRA, and

(viii) the FRA should be empowered by the law to coordinate/cooperate with financial sector regulators/supervisors and establish appropriate information sharing arrangements with regulators/supervisors before/during the resolution of a financial institution. [Para 4.51]

6. Mandate of resolution authority

the mandate of FRA will be to resolve failed financial institutions and FMIs (other than those owned and operated by RBI) along with providing deposit insurance and protection to insurance policy holders and investors/clients within limits, if required at the resolution stage. [Para 4.52]

7. Setting up resolution authority

Taking all factors into consideration, the Group recommends that the FRA as a separate entity can be set by either transforming the present DICGC into FRA or by setting up a new authority namely FRA that will subsume DICGC. Either option will require amendment or enactment of laws, institutional changes, staffing, and development of tools and options. [Para 4.54]

8. Triggers of early intervention

In order to ensure that regulators/supervisors can intervene at a sufficiently early stage with clear trigger levels to prevent the institution from reaching situation of non-viability, the Group recommends that each financial sector regulator/supervisor may formulate a prompt corrective action (PCA) framework for the institutions under their regulatory jurisdiction, which may be graded illustratively with four levels – i.e. (i) Stage 1 : low risk to viability; (ii) Stage 2 : moderate risk to viability; (iii) Stage 3 : high risk to viability; (iv) Stage 4 : extreme risk to viability - in terms of quantitative parameters on a risk-adjusted basis. [Para 4.64]

9. Trigger for resolution

When an institution reaches stage 4 (final stage) and is not able to demonstrate or take corrective action within a given tight timeline, then it should be passed on to the FRA. The FRA should be kept informed of all actions and developments relating to the concerned institution once the PCA framework kicks in. Enhanced coordination with the FRA should begin at stage 3 and it would be open to the regulator/supervisor and FRA to take a distressed institution into resolution even at an earlier stage. [Para 4.66]

10. Review and development of PCA framework

With a view to detecting problems at an early stage and having suitable redressal and revival mechanisms, the RBI may devise an effective methodology for early intervention and structured actions in line with the recommended stages so as to make it compatible with the envisaged resolution framework while taking into account Basel III framework for commercial banks and other regulatory developments for other entities regulated by RBI. Other sector regulators should also devise a PCA framework and take into account international best practices put forth by respective agencies such as International Association of Insurance Supervisors (IAIS), International Organization of Securities Commissions (IOSCO) and Committee on Payment and Settlement Systems (CPSS), etc. [Para 4.67]

11. PCA framework for financial conglomerates

So as to detect problems in the parent company including the group-wide ramifications of the stress developing in parts of the group at an early stage, the Group recommends that the Inter-Regulatory Technical Group of FSDC may set up a Group for formulation of a PCA framework in respect of financial groups/conglomerates. This framework should provide for clear and distinct triggers and early intervention actions in line with the stages recommended by this Group taking into account international standards. [Para 4.71]

12. Resolution tools

The Group recommends that with a view to carrying out orderly resolution of failing financial institutions and FMIs without taxpayers’ support, the FRA should have a variety of resolution tools mandated by the proposed statute, such as, liquidation; purchase and assumption; bridge institution; good-bank and bad-bank; bail-in and temporary public ownership, which can be used flexibly, either singly or in combination with others, to resolve a financial institution and preserve its critical functions. [Para 4.82]

13. Framework for non-bank financial institutions

As FSB, IAIS, CPSS and IOSCO are in the process of preparing guidance for extending Key Attributes to cover a wider range of market participants in the financial sector, including FMIs, insurance companies and other non-bank financial institutions, the Group recommends that while the proposed financial resolution framework would be applicable for all financial institutions, including FMIs, a detailed framework may be formulated at a later stage for non-bank financial institutions based on the policy documents and guidance that are yet to be issued by the FSB and other international standard setting bodies. [Para 4.83]

14. Use of bail-in as resolution tool

As bail-in allows the resolution authorities greater flexibility in their response to the failure of large and systemically important financial institutions (SIFIs) in restoring viability and disincentivize becoming “too-big-to-fail”, the Group recommends taking into account all factors, adopting the bail-in mechanism as a resolution tool in case of global systemically important banks (G-SIBs)/domestic systemically important banks (D-SIBs). [Para 4.91]

The Group, further, recommends that the bail-in framework should cover the capital instruments (additional Tier 1 and Tier 2) as well as other unsecured creditors, while deposit liabilities, inter-bank liabilities, and all short-term debt, which if subjected to bail-in can induce financial instability, would be excluded from bail-in. In order to minimise the uncertainty generated by discretionary use of bail-in power and to avoid uncertainty among unsecured creditors, the bail-in power should be statutorily placed with the FRA. With developments in resolution mechanisms internationally, this tool may be extended to other financial institutions. [Para 4.93]

15. Temporary public ownership

As temporary public ownership (TPO) may be important for ensuring financial stability in exceptional situations, the Group recommends that the Government of India (Ministry of Finance) may, on recommendation by FSDC, be empowered to place a financial institution under TPO and control on financial stability considerations and only if such action is necessary to protect public interest. There should be intensive consultation with the concerned regulator and the FRA before placing the institution under TPO. This tool should be only temporary in nature till a viable alternative such as, sale or transfer or merger is found. [Para 4.98]

16. Features of resolution fund

With respect to funding of resolution, the Group recommends that:

(i) the resolution fund would be different from deposit insurance fund and other protection funds;

(ii) it would be pre-funded and built over time through ex ante premiums determined on risk-based assessments;

(iii) in the event a systemic institution is under stress, sufficient backstops, including temporary funding support from the Government, with safeguards, may be provided to ensure adequate liquidity;

(iv) the FRA may raise funds from the market through issue of bonds; government guarantee may have to be extended, if required;

(v) the resolution fund would have arrangements to meet shortfalls in fund through ex post levies on the financial institutions and FMIs;

(vi) the fund would also be built up from recovery of assets from failed institutions; the recoveries may, however, first accrue to deposit insurance or other protection funds if and to the extend they have been used instead of resolution fund;

(vii) the fund could build a core base adopting a suitable methodology for collecting a surcharge (one time capital infusion) from financial institutions and FMIs;

(viii) the fund would maintain separate accounts for different types of financial institutions, viz., banks, insurance firms, securities firms, FMIs, as the premium rates and size of fund requirement for different sectors would vary; and

(ix) inter-fund borrowing to meet shortfalls in one or the other fund would be allowed. [Para 4.107]

17. Deposit insurance and other protection funds

In order to maintain the sanctity of existing deposit insurance and other protection funds, the Group recommends that the deposit insurance fund maintained presently by the DICGC and other funds, if any, maintained by other regulators for protection of insurance policy holders and investors may be kept separate within the FRA. Only those funds will be brought within FRA, which will be used for consumer protection pursuant to resolution action and not during stage of early intervention by the regulator/supervisor. Both resolution and depositor/investor protection funds should be built up simultaneously till a well-defined target level is reached. It is also recommended that the accretion to both funds by way of premium or any other method of contribution should be exempted from tax. [Para 4.110]

18. Need for reforms in deposit insurance framework

Along with setting up of a resolution framework, reforms in deposit insurance may also be taken up to bring the system on the lines expected by international benchmarks, viz., Core Principles for Deposit Insurance Systems. Illustratively, the areas where reforms in deposit insurance in India are important to improve its effectiveness are – reduction in timeframe for reimbursing depositors, collection of depositor information in a ‘single customer view’ format, review of coverage limit, manner of sharing of recoveries, exemption from taxation of premium, review of instruments permissible for investment, back-up funding to support shortfalls in deposit insurance fund and technologically advanced data systems and payment methods. [Para 4.111]

19. Recovery and resolution planning

The Group recommends that:

(i) the RRPs, to start with, will apply only to those financial institutions that could be systemically significant or critical if they fail;

(ii) RRP requirement will also apply to all financial groups/conglomerates, whether they are systemically important or not;

(iii) the RRP regime could be extended to other financial institutions in a phased manner;

(iv) the recovery plan will be prepared on a regular basis by the institutions as per a pre-approved format and will be approved by the respective regulator;

(v) the resolution plan containing resolution strategy to be adopted for resolving the institution will be prepared by the institution and approved by the FRA in consultation with the concerned regulator;

(vi) the regulator/supervisors in consultation with the FRA may prescribe varying levels of collection and sharing of information depending upon the size and complexity of the financial institution; and

(vii) the resolution plan must be reviewed annually, or earlier if considered necessary, by the resolution authority so as to take into consideration the incremental developments in the institution as well as the regulatory/supervisory norms. [Para 4.122]

20. RRPs for FMIs

In order to ensure continuity of critical services provided by the FMIs, the systemically important FMIs may prepare RRPs that would prescribe credible options to recover from extreme and severe stress scenarios. The plans may essentially prescribe methodology to allocate uncovered losses and liquidity shortfalls to direct participants, indirect participants, third-party institutions and/or owners on the basis of and to the extent they are permitted by ex-ante arrangements. [Para 4.125]

21. Determination of SIFIs by regulators

In view of the risks posed by SIFIs to the financial system, the parameters used for assessing systemic importance of D-SIBs could be employed by the respective regulators to determine the systemic importance of other domestic financial institutions in the Indian context. In this context, the Group recommends that other financial sector regulators should, based on the framework being developed by international standard setting bodies, formulate a framework for determining SIFI falling under their respective regulatory jurisdiction. [Para 4.130]

22. Improving resolvability

With a view to reducing the impediments to resolution posed by complex financial institutions, the financial groups and the regulatory authorities should work together in reducing complexity in group structures, and ensure prudent, intra-group transactions and exposures. The financial institutions should identify areas in their existing organizational structure that could pose difficulties in consolidated risk management/monitoring and take suitable measures to reduce those complexities. [Para 4.134]

Though the Indian financial sector regulators have been conservative in letting evolution of complex structures, the Group expects innovative developments and complexities that could evolve in the light of increased globalization and financial integration. In view of this, the Group recommends enabling the regulatory/supervisory authorities to have powers for taking measures, such as restructuring the financial institution’s business practices and structure, for improving the resolvability of systemically important financial institutions. Such actions could form part of the early intervention mechanism. [Para 4.135]

23. Financial holding company structure

To improve resolvability of financial conglomerates, the Group recommends that the Financial holding company structure³ may be introduced for Indian financial system. The appropriate method for resolving such institutions could be decided at a later stage as policy evolves and taking into account international developments. [Para 4.138]

24. Information sharing between FRA and regulators

With a view to enabling the FRA to make appropriate decisions and implement an effective resolution action plan, the Group suggests an indicative template that would facilitate financial institutions furnishing information relating to their structure to the concerned regulators/supervisors, who in turn can cooperate and coordinate with the FRA in finalization of resolution plan by FRA. [Para 4.143]

25. Development and management of database

The Group recommends setting up of an integrated financial database management centre, which would function as a centralized database wherein all financial institutions and FMIs will submit regular financial information electronically. The database will also capture the information/ database currently being collected/managed by the respective regulators. In order to ensure availability of high-quality and timely data (as high frequency as possible), the supervisory agencies and FRA should have access to the integrated financial database in respect of the data that they are authorized to collect from the regulated financial institutions. [Para 4.145]

26. Service level agreements

In order to ensure continuity of essential functions in a resolution, for example, for the parts of a financial institution transferred to a bridge institution or surviving parts of a resolved institution, the Group recommends that key service level agreements should be legally enforceable in crisis situations and also in resolution. This is, however, feasible only through ensuring continuity of payment on the terms already agreed upon. In such cases, FRA would have to be duly empowered to ensure that the payments to the service providers continue to be un-affected during resolution or there are powers in place to ensure that the payments to service providers rank higher in the hierarchy of creditors/ payments to be made by the FRA. [Para 4.147]

27. Framework for set-off, netting and collateral arrangements

In order to have systems in place that reduce systemic risk and costs for the institutions, increase liquidity in the financial market as a whole, and facilitate resolution of individual financial institutions, the proposed financial resolution framework or the existing statutes governing the financial institutions and FMIs should explicitly provide for rules, laws and practices governing enforceability of contractual set-off, close-out netting and collateral arrangements, and segregation of client assets. The legal framework should be clear, transparent and enforceable to facilitate the effective implementation of resolution measures. [Para 4.160]

28. Temporary stay on contractual obligations

In order to allow time to FRA to decide a resolution action, the FRA should have clearly defined legal powers to impose a brief stay on the exercise of early termination and netting rights only in situation of entry of a firm into resolution. In order to contain the adverse impact on market of such a stay, the stay should generally be limited to two days (48 hours), which however could be extendable by a maximum of another three days after specifying the reasons in writing by the FRA. The FRA should not have any options to cherry-pick individual contracts with the same counterparty for effecting transfer. Further, following the transfer of financial contracts, the early termination rights of the counterparty should be preserved against the acquiring entity (transferee) in respect of subsequent independent default by the transferee. It should also be ensured that the substantive obligations under the financial contracts, including payment and delivery obligations, and provision of collateral, continue to be performed. [Para 4.164]

29. Claims of secured creditors

The FRA should not be allowed to transfer those assets that have a claim of secured creditors. It implies that, for example, in case of a bank or its counterparty having a security interest over an asset that secures a liability owed to it by the other party, the charged asset may not be split up from this liability under a partial transfer. This would mean that the secured creditors’ claims cannot be separated from the assets securing the liabilities in a partial property transfer. [Para 4.165]

30. Hierarchy of claims in distribution of assets/allocation of losses

With a view to fair distribution of assets from assets recovered from a failed institution, the Group recommends that:

(i) the allocation of losses in the times of bankruptcy or application of resolution tools or use of any resolution powers should clearly be defined in the statute for financial resolution framework;

(ii) the highest ranking creditors should be repaid first and the lower priority ones should be repaid only after all the senior creditors have been paid, thus respecting the hierarchy of claims (this implies that the equity should absorb the losses first, and then the subordinated debt holders, including all regulatory capital instruments in terms of seniority, and finally to the senior debt holders);

(iii) the FRA may be provided flexibility to depart from the general principle of equal treatment of creditors of the same class, for example in case of bridge institution with limited assets or in use of bail-in authority, only in exceptional circumstances and by giving sufficient reasons. [Para 4.170]

31. Preference to depositors, insurance policy holders and investors

The Group recommends that as the ultimate objective of regulation and supervision in India is to protect the interests of depositors, insurance policyholders, and investors, the proposed statute for financial resolution framework should explicitly provide for preference to be given to depositors, insurance policyholders and investors over other unsecured creditors in resolution of failed financial institutions. [Para 4.177]

32. Claims of uninsured depositors vis-à-vis DICGC

Equal treatment may be provided to uninsured depositors of banks and claims of DICGC on account of payments made to insured depositors. This would require that the claims of DICGC rank pari-passu with other uninsured depositors in sharing the distribution of proceeds of liquidated assets of a failed bank. [Para 4.178]

33. Right to judicial review of resolution actions

The Group recommends that the rights to judicial review of resolution actions and available remedies should be framed in a way that does not undermine effective resolution (meaning resolution action cannot be reversed) and the necessary legal certainty of resolution actions. However, legal remedies should be available for improper decision or action by the FRA, in the form of monetary compensation for the loss suffered by the stakeholders. The resolution framework may also provide a suitable mechanism for appeals and grievance redressal for affected stakeholders. [Para 4.182]

34. Statutory mandates to foster cross-border cooperation

Keeping in view plausible opening up of the Indian financial system in future and Indian financial institutions becoming G-SIFIs with large scale cross-border operations, the Group recommends that the proposed legislation for resolution regime for financial institutions should enable the FRA to achieve cooperative solution with foreign resolution authorities. [Para 5.24]

35. Access to information and information sharing

While work in the area of cross-border information sharing is underway, which is being enhanced by the FSB through Resolution Steering Group, the Group recommends that the resolution framework in India should enable the FRA to share non-public information of Indian financial institutions with foreign home/host resolution authorities on reciprocal basis and subject to confidentiality requirements and protection for sensitivity. [Para 5.38]

36. Supervisory Colleges

Considering the development of supervisory colleges as a forum for sharing information on the overall risk assessment of individual financial entities as well as the financial group and also the fact that the RBI and IRDA have signed MoUs/MMOUs with various jurisdictions/IAIS for sharing of supervisory information, the Group recommends that the supervisory colleges could be used as an information sharing platform for crisis resolution also. However, this needs to be taken up with the relevant authorities and the parties to the supervisory colleges. [Para 5.42]

37. Constitution of Crisis Management Groups (CMGs) and Institution-specific Cross-border Cooperation Agreements (COAGs)

The Group recommends that in the situation of an Indian financial institution becoming a G-SIFI in future, the FRA may be empowered to form CMGs and COAGs. [Para 5.49]

38. Way Forward

The Working Group has taken into account the essential features of a sound and effective resolution regime as prescribed by international standard setting bodies. It, however, needs to be recognized that the guidance on resolution regime is generally more developed and advanced for banks and progressively less for insurers, securities or investment firms and FMIs. In addition, the cross-border issues are still evolving and being addressed. Therefore, FSDC may consider a review of the recommendations made by this Group at an appropriate stage to take into account the documents and guidance as and when issued by FSB and other international standard setting bodies with respect to evolving areas, especially those relating to non-bank financial institutions including FMIs and cross-border issues. [Para 6.1]

The Group also recognises that different types of financial institutions have distinct features and thus all essential features of a resolution framework as prescribed by international standard setting bodies may not be relevant for all types of financial institutions. The legal framework that will evolve therefore needs to take into account the specificities and peculiarities of different segments of the financial sectors. [Para 6.2]

¹The term “financial institutions” refers to banks (including public sector banks, private sector banks, foreign banks having branches in India, regional rural banks, state co-operative banks, district central co-operative banks, and primary urban co-operative banks), non-banking financial companies, insurance companies, securities firms, commodities markets and pension schemes.

²The term “financial market infrastructures” refers to payment systems, central counterparties (CCPs) including clearing houses, securities settlement systems (SSSs), central securities depositories (CSDs), and trade repositories (TRs), etc.

³This structure has already been proposed as one of the important criteria for licensing of new private sector banks.