What Happens When Your Bank Fails?

what happens when your bank fails

It is difficult to predict if a bank is at risk of failing but it is essential to know the basic safeguards that are at place in order to keep the depositor’s money safe in case there is a systemic bank failure. Here is an introductory guide to financial system failures and the government checks for the same:-

1. What is a systemic bank failure?
A systemic banking failure occurs when a bank is unable to meet its obligations or provide cash when the depositors demand for it. This could be due to a multitude of reasons, either the bank is making losses on its investments, exposed to major risks or is running on faulty business models. The reasons might differ but a prolonged period of incurring losses by the banks should set off an alarm for the common man associated with these institutions.

2. What are the government provisions in place to tackle bank failures?
The Deposit Insurance and Credit Guarantee Corporation (DICGC), which is a wholly owned subsidiary of the Reserve Bank of India insures the bank deposits. In case of a bank failure, people mostly lose their savings but they can recover up to 5 lakh rupees because of this deposit insurance. This money is released only when the bank closes down, not if the bank is going through certain problems.

3. What are too-big-to-fail banks?
These banks have become a significant part of the domestic financial systems. The Banks that have assets valued at more than 2% of the GDP are qualified to be in this category. Such banks enjoy the privileges of certain advantages in terms of funding and different policies for systemic risks and moral hazard issues. Some of the banks that come under the Domestic Systemically Important Banks (D-SIB) are State Bank of India, ICICI and HDFC Bank.

4. What are the latest guidelines issued by the RBI regarding bank deposits and its safety?
The Deposit Insurance and Credit Guarantee Corporation (DICGC) as a part of the Financial Resolution and Deposit Insurance (FRDI) Bill has decided to increase the insurance cover for depositors in insured banks from the previous limit of Rs.1 Lakh to the new limit of Rs. 5 Lakhs per depositor and this will be applicable from 4th February 2020.

5. What are the other important provisions of the Financial Resolution and Deposit Insurance (FRDI) Bill?
The Government will release notifications that would decide if the resolution framework is applicable to public sector banks, a controversial clause of the “Bail-in” option and the hike in depositor’s insurance. The hike has already been announced and the “Bail-in” provision is being debated upon.

6. What is the “Bail-in” provision in the new bill?
This clause if being proposed for the first time in India. According to the ‘bail-in’ clause, it is the customers of a financial institution that is on the verge of failing who would bear a part of the cost of resolution. They will have to bear reduction in their claims.

Due to disagreements by the general public and a spurt of cash withdrawals from banks which led to a cash crunch in ATMs, the bill has been halted. The biggest hurdle for the bill to be approved by the parliament is this particular clause itself.