Bill on resolution of troubled banks in India is credit positive: Moodý's

Global rating agency Moody’s on Tuesday said that the draft bill to establish a new regime for resolution of troubled banks in India is credit positive as it will help to enhance overall stability of the financial system.

It is an important step to having a comprehensive framework in place for the resolution of financial firms. "Currently, the resolution of financial firms in India is based on minor parts of legislation enacted for other purposes," said Srikanth Vadlamani, a Moody's Vice-President and Senior Credit Officer.

The draft bill which seeks to establish Resolution Corporation will have to go through multiple steps before becoming law.

Moody's just released its a report "Banks — India: Draft Bill on Resolution Will Enhance Systemic Stability,".

The bill ranks depositors above senior unsecured creditors in a liquidation scenario. In contrast, under existing laws, senior unsecured creditors rank pari passu with uninsured depositors. This change is therefore a credit negative for senior unsecured creditors.

Such a depositor preference is enshrined into law in other jurisdictions like Singapore, Malaysia and Indonesia.  In those systems, senior debt ratings are on par with deposit ratings, except where they are impacted by different country ceilings. Moody's expects a similar outcome for Indian banks.

Under the draft bill, public sector banks will be brought under the ambit of the resolution framework. By contrast, according to existing laws, public sector bank resolution can only happen under the direction of the government.

Moody's does not expect this change to have an impact on Moody's assumption of the level of systemic support for public sector banks, because the banks' core public sector character would remain unchanged.

The draft bill also provides for a significant delineation of regulatory powers between the Reserve Bank of India and the proposed Resolution Corporation. This situation will be particularly apparent with respect to some key supervisory powers over banks, including criteria for classifying banks into the various risk categories.

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.