PMC Bank Rescue Plan Offers Bank Depositors A Reality Check

The draft scheme of amalgamation of Punjab and Maharashtra Cooperative Bank with newly instituted Unity Small Finance Bank will likely be debated in banking circles for some time to come.

The scheme proposes to pay out depositors over a 10-year period. It also proposes to convert institutional deposits into perpetual non-cumulative preference shares and equity warrants of the small finance bank.

In doing so, it delivers a reality check to bank depositors and potentially sets new templates for bank resolution.

For decades now, when a scheduled commercial bank has been on the brink of failure, the Reserve Bank of India has stitched together a merger with a stronger lender. Some have criticised the approach as ad hoc, but for depositors of this set of banks, it meant limiting the pain involved.

Most recently, in the case of Yes Bank, which was rescued by a consortium of lenders, deposit restrictions were in place for just about a fortnight. Likewise, in the case of Lakshmi Vilas Bank, which was merged with DBS Bank India, the moratorium on deposit withdrawals was lifted in about 10 days.

This has not been the case with cooperative banks, which have been the most frequent to fail. Many of these lenders go into liquidation and deposits are paid out partially or in full only thereafter.

In the PMC Bank case, a hybrid solution has emerged. Not only was a consortium of Centrum Financial Services and BharatPe given a licence specially for the resolution, the draft scheme of amalgamation proposes staggered deposit payments and differential treatment for retail and institutional depositors.

Reality Check 1: Not All Your Deposits Are Insured

Fixed-deposit holders of non-bank lenders have had to take haircuts in recent cases like Dewan Housing Finance Corp. Bank deposits are safer but not completely safe. The PMC Bank case emphasises this.

In any bank failure, a depositor is only assured up to Rs 5 lakh of his or her deposits. The insurance cover is estimated to cover 98.3% of all deposit accounts by number, and 50.9% of deposits by value, according to a comment by Finance Minister Nirmala Sitharaman in July. But it still doesn't cover all deposits and depositors.

Until recently, there was no timeline for this insurance to be paid out but a recent amendment to the Deposit Insurance and Credit Guarantee Corporation Act has meant that most deposits will be paid out in 90 days.

In PMC Bank's case, an additional 90 days have been sought by the DICGC under a special provision of the amended act, which means deposits up to Rs 5 lakh will likely be paid out by March. Unity Small Finance Bank will repay DICGC over 20 years.

In this case, while there is no haircut proposed for retail deposits, technically, there is nothing stopping such a proposal in future instances.

Reality Check 2: Accessing Uninsured Deposits Can Take Time

The decision to stagger the payout over 10 years will likely raise some eyebrows.

The scheme proposes that deposits of up to Rs 5.5 lakh, over and above the insured amount, will be paid out within five years. Any remaining deposits will be paid out after 10 years on demand.

Why such a long time to pay out PMC Bank depositors? Because the entity acquiring it is not a running bank. It neither has a deposit base of its own, nor does it have the necessary collateral to access liquidity from the RBI if the regulator were to contemplate a special liquidity window like it did in the case of Yes Bank.

If all deposits flow out immediately, Unity Small Finance Bank will start with a blank balance sheet.

Also, remember that in the case of cooperative banks which have been liquidated in the past, the time over which depositors have been paid back has been over an estimated eight to 10 years. So, the PMC Bank payout period is not the only case where depositors will have to wait a long time to get access to all their funds.

While a decision to pay out deposits is troublesome for depositors, it is also perhaps the only realistic option. To be sure, this is a draft scheme and room for amendment remains in the final scheme.

Reality Check 3: Institutional Deposits Can Be Treated Differently

The PMC Bank case is also rare in that it treats different categories of depositors differently.

It asks that 80% of the uninsured deposits held by these institutional depositors be converted to perpetual non-cumulative preference shares with a dividend of 1% per annum. The remaining 20% of the deposits shall be converted to equity warrants, at a price of Re 1 apiece. These warrants can be converted to equity shares of Unity Small Finance Bank at the time of its initial public offering.

In doing so, the scheme attempts to give this segment of depositors upside from the resolution of the bank in return for converting their deposits into other instruments.

This is akin to a provision in a proposed Financial Resolution and Deposit Insurance (FRDI) Bill, which was put in cold storage.

Among other things, the bill had proposed to allow a service provider (i.e. a financial institution) to convert a liability from one form or class to another. It had also proposed that one class of instruments could be replaced with another when a "bail-in" provision in a weak financial institution is invoked. The bill had also proposed to specify the classes of deposits that could be subject to such bail-in provisions.

The bill never saw the light of day on concerns that it would reduce depositor confidence in the banking system.

Reality Check 4: We Still Need A Framework For Resolution Of Bank Stress

In the absence of a framework for resolving stressed banking institutions, there is no option for the regulator and institutions acquiring weak lenders to come up with bespoke solutions.

While there is nothing wrong with this and, more often that not, solutions have eventually been found, it does leave greater room for questioning the fairness and justness of each individual solution.

Ira Dugal is Executive Editor at BloombergQuint.