BANK COLLAPSE AND RIGHTS OF DEPOSITORS

Adv.K.Shahzad, Partner- Alishahz Legal LLP

Almost all the people will have at least one bank account, be it a savings account or a current account. People who are averse to risk, usually, park their savings or income in the bank accounts; through which they believe that their money is super safe with the bank and that,not only the bank keeps their money safely, the bank even will pay interest to them. Is, the money deposited in the bank or which is in your credit in the bank account, absolutely free of risk?Just like any business, banking is also a business. If so, what if the bank business flops? Ever thought of a situation where, on you visiting the bank finds the shutters of the bank closed indefinitely without any satisfactory reply. What will be the fate of your money in such cases? What if the bank didn’t open thereafter? Whom do you approach? Don’t you have the right to get back your money? Or Are you only to forget the money deposited in the bank, if the bank fails?

History shows many instances of the collapse or failure of banks. What is a collapse or a failure of bank?What are the rights of the depositors in case of the collapse of bank?

A collapse of a bank is the failure of the bank to honour its promise of returning the money to the customer due to the non-availability of funds. A failure of the bank happens when the net asset of the bank comes below that of its liabilities. The bank will fail to meet its obligations towards the depositors or creditors if its liabilities outweigh the receivables. So, the question would be how the bank would repay your money when it does not have enough assets to pay you. Circumstances of such nature happen sometime, and we have seen the instances of government coming forward to rescue the banks in order to protect the investor money. There are many private banks operating in the country. It would be highly imaginary to expect the government saving the private banks from collapse. Governments, through the Reserve Bank of India or negotiation with some major banks may take a facilitating role, but is under no obligation to involve in each and every case.

So, what happens to the money of the depositors in case of a bank collapse?

The depositors of bank are the creditors to the bank, and being unsecured creditors, their position with the bank would be below that of the secured creditors. In the event of the failure of the bank, the depositors would receive back the money from the assets of the bank, only after the liabilities to the secured creditors are paid off. So the question would be what the depositors get in case the bank does not have any assets to meet the liabilities. It is in such a scenario the Deposit Insurance and Credit Guarantee Corporation Act, 1961 has been enacted and through which the Deposit Insurance and Credit Guarantee Corporation (DICGC) is constituted, which provides registration and insurance to all banks and eligible co-operative banks[i]. However, mere closure of a branch or stoppage of the business does not make DICGC liable to pay money to the depositors.

Are the depositors entitled to receive the full money which was in credit at their account?

Since DICGC being an insurer of the bank it is bound by its terms. The maximum insured amount at the time of the enactment of the DICGC Act, in the year 1961was Rs.1,500/-,which eventually increased, and by virtue of the DICGC Amendment Act, 2020, the maximum limit now stands at Rs.5,00,000/- per depositor[ii], which means his/her money in his credit in the bank (be it a single account or multiple accounts) would be safe to a maximum of Rs.5,00,000/-, beyond which he/she would be in the shoe of an unsecured creditor. DICGC shall pay the sum up to the level of Rs.5,00,000/- to the depositor before the expiry of two months from the date of the receipt of the list of depositors and their deposit[iii]. Even though the total time period for the payment of the above said time including the three months period for the preparation of the list by the liquidator is five months, in reality, it takes years to pay off the insured amount to the depositors.

It is in the light of such circumstances, the Government has introduced amendment to the DICGIC Act in this year, and that a new section 18A has introduced, which provides for the payment of such insured amount to the depositors within a period not exceeding 90 days from the date of any direction, prohibition, order or schemes restricting the depositors from accessing the their deposits is issued by the Reserve Bank of India (RB). RBI, being the Central Bank of India, controlling all banks, has the authority to issue suitable directions under the Banking Regulation Act. In the event of any stressful situations at any banks in their business, RBI, use to issue moratorium or other restrictions from accessing the banks, in an attempt to rescue the bank and to safeguard the public interest. Punjab and Maharashtra Co-operative Bank is the latest in the array, which when become stressed, RBI issued moratorium. Now, with the 2021 amendment, the depositors shall be paid the insured amount within 90 days from the date of such restriction. The Government of India, with its notification dated 27.08.2021, notified that the new amendment shall takes into effect from 1^st September 2021.

Financial Resolution and Deposit Insurance Bill

The Government of India in the year 2017 has proposed the repealing of DICGC Act, 1961 through the introduction of Financial Resolution and Deposit Insurance Bill (FRDI Bill). FRDI Bill proposed the establishment of Resolution Corporation replacing the DICGC, which would have the authority to monitor financial firms, anticipating their risk of failure, taking corrective action and formulating resolution schemes. The ‘Bail-in Clause’ introduced in the said bill, proposed to grant the Resolution Corporation the authorityto convert the liabilities of the bank towards its depositors into shares or other scripts. Though the above said ‘Bail-in Clause’ was intended to save the bank from quick collapse, since the same augmented the risk of the depositors, by pushing them further in the queue for the realisation in the event of a winding up of the bank, the concerns arose from various corners, which resulted in a withdrawal of the bill.

The amendment of the DICGC Act, 1961 mandating the DICGC to pay the insured money to the depositors not exceeding 90 days period of time, in the case of any moratorium or other restrictions, which always follow in case of any liquidity issues in a bank, is definitely a welcome measure and would help in gaining the depositors confidence in the banking system.

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[i]Section 10 and 13A of the Deposit Insurance and Credit Guarantee Corporation Act, 1961.

[ii]Section 16 of the DICGC Act, 1961.

[iii]Section 17(2) of the DICGC Act, 1961.