Can RBI catch failing banks into a safety net?

Huzeifa Unwala

Indian banking system was on fire owing to Non-performing assets and the onset of COVID 2019 would perhaps turn it into a fireball impact on the vulnerable financial services sector in India. It may become increasingly difficult for the RBI to regulate and provide emergency administrative action if large number of vulnerable banks in India go down the hill considering corporate governance failures in our country. Incremental global threats such as the fuel price wars and the growing trend of market crashes, that we have witnessed may be enough reasons to compel the RBI to re-invent its regulatory strategy for the Indian Banking System as a whole. There is a growing perception that banks are failing largely on account of poor integrity of promoters and bankers through an unholy nexus design schemes to de-fraud innocent retail depositors and less as a result of genuine business failures of borrowers. Retail depositors have suffered, and confidence of small savers is at the lowest ebb.

In such difficult times the regulators RBI and SEBI together should look at implementing legislations that protect the interests of retail depositors and investors. Regulators may evaluate large banking and non-banking financial institutions to formulate steps to ring fence the interest of retail depositors and investors from unprecedented financial collapses. The regulators could basis net worth, capital adequacy, financial solvency, quantum of Non-performing assets and product mix between retail and corporate portfolios, develop a Ranking Chart of the regulated entity. Post this Ranking Chart, the regulators should develop a 3 to 5-year ring fencing programme that involves segregating the retail and corporate portfolio of the regulated entity. This would be complex and may require a series of re-structuring/ mergers/ de-mergers/ public listing as the health of all banks and non-banking companies may be at different levels of product mixes, risks and vulnerabilities, Further, there could be long term investments schemes and models that Corporate Banking portfolios could design and introduce at higher costs to attract larger depositors.

Identified banks and non-banking companies depending on their rank and priority must ‘ring-fence’ or legally separate their essential or retail banking services from the rest of their banking vertical, that is whole-sale, corporate and investment banking portfolio. The UK Ring fencing regulation that was implemented with effect from 1^st January 2019 may be studied by an Expert Committee set up by the Government, RBI and SEBI.  The essential banking services are the core services that retail banks may offer and include: –

• accepting deposits or other payments into an account
• offering facilities for withdrawing money or making payments from an account
• overdraft facilities to retail depositor and small borrowers

India has already successfully experimented with the Small Finance and Payment Bank model; however, this model is primarily to bring in financial inclusion and the Ring-fencing model can be adopted to protect the core retail depositor interests and household savers.

In the UK as per the Financial Conduct Authority (FCA) the Ring-fencing legislation requires each large UK bank to separate its retail banking activity from the rest of its business. This is to protect customers and the day-to-day banking services they rely on from unrelated risks elsewhere in the banking group and shocks affecting the wider financial system. It reduces the likelihood that essential banking services used by ordinary depositors, like current accounts, savings accounts and payments, are put at risk by a failure in another part of the business, such as investment banking.

Ring-fencing was one of several important reforms brought in by the UK government to strengthen the financial system following the financial crisis that began in 2007.

Ring fencing model may reduce the concentration and contagion risks that are current banking system is exposed to. Segregation of large portfolios into smaller manageable units through a Ring-fencing exercise may be one of the possible solutions to protect the interests of large number of retail depositors and small savers. The solution may come with a huge cost, however, safe banking outweighs the costs involved.