Distressed financial units: FSDC moots single resolution panel

The Financial Stability and Development Council (FSDC)'s group has proposed a single independent financial resolution authority (FRA) to effectively deal with failed financial institutions and prevent contagion.

FRA should be independent of regulators/government, the group said. It could be formed as a new entity or the existing Deposit Insurance and Credit Guarantee Corporation (DICGC) could be transformed into FRA.

Anand Sinha, then deputy governor at Reserve Bank of India (RBI); and Arvind Mayaram, then economic affairs secretary (now finance secretary) acted as co-chairpersons of the panel. The group made wide-ranging recommendations to bridge the gaps and develop an effective resolution regime for all financial institutions. RBI released the report for public comments on Friday.

A separate comprehensive legal framework with necessary powers and tools is necessary is to resolve crises faced by financial institutions irrespective of ownership, the panel said.

The group recommended putting in place an early intervention mechanism in the form of a prompt corrective action framework. This framework should have clear trigger levels for regulatory intervention in the early stages and for handing over to the resolution authority for initiating appropriate actions in the last stage, the group said.

Now, there are some provisions contained in various Acts governing the respective financial institutions. They empower the respective regulator, supervisor and/or the central government to resolve different types of financial institutions in India once they run into viability problems.

The financial institutions are special due to their inter-connectedness and because they operate on the basis of public trust and confidence. This means that once problems develop in one institution, they can quickly spread to other sound institutions. The loss of private confidence can, in turn, create a domino effect, spreading contagion.

A special resolution framework is needed since the general corporate bankruptcy or insolvency procedures cannot ensure sufficient speed of intervention, thus undermining financial stability.

While India has a history of very few failures of financial institutions, the financial sector is growing in depth and complexity. Effective regulation and supervision can help in substantially reducing the risks but cannot make the system immune from failure of a financial institution, it added.