India’s draft bill on resolution of financial firms credit positive: Moody’s

Moody’s Investors Service says that the draft bill on the resolution of financial firms in India (Baa3 positive) is a credit positive for banks in the country, because it is an important step to having a comprehensive framework in place for the resolution of financial firms.(IIFL)

“Currently, the resolution of financial firms in India is based on minor parts of legislation enacted for other purposes,” saysSrikanth Vadlamani, Moody’s Vice President and Senior Credit Officer. “This bill is therefore a credit positive for Indian banks in terms of enhancing overall systemic stability. At the same time, we note that the draft bill will have to go through multiple steps before becoming law, and could therefore be subject to changes and delays,” adds Vadlamani.

Moody’s report says that based on the draft bill, bail-ins do not seem to be the preferred form of resolution, with significant restrictions in place for their usage. These restrictions include contractual bail-in clauses for instruments that may be bailed in and requirements that bail-ins should be used only after attempts at recovery have been made. Consequently, Moody’s expects that the Indian banking system will continue to function without an operational resolution regime, and banks should continue to be rated under a basic loss given failure framework.

Moody’s also says that 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. At the same time, Moody’s notes that such depositor preference is enshrined into law in other jurisdictions in the region, including Singapore (Aaa stable), Malaysia (A3 stable) and Indonesia (Baa3 stable). 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.

Moody’s also says that 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 Indiaand 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.