People repose immense faith in India’s banking system and the safety net it offers to their financial savings. This faith stems primarily from the fact that public sector banks owned by the government account for the lion’s share of the banking activities in the country. That invariably makes people believe that the Centre will bail them out if any bank lands in trouble. As a consequence, bank deposits are growing with every passing year.

A recent study by Karvy Private Wealth revealed that fixed deposits in banking sector reached Rs 38.87 lakh crore in 2016-17, registering a growth of 11 per cent from Rs 35.12 lakh crore in the previous fiscal. These deposits continue to account for the highest chunk of the total individual financial wealth owned by Indians.  This is so despite the fact that the interest rates on fixed deposits have come down and most banks are not offering more than 7 per cent.

In addition, money lying in the saving bank accounts went up by nearly 28 per cent to Rs 27.60 lakh crore and in the current accounts, by a whopping 38 per cent to Rs 6.10 lakh crore in FY17. That means public money totalling Rs 72.57 lakh crore is now with the banking system and it is equal to nearly 50 per cent of the country’s GDP.

But this unwavering faith in our banking system seems to be in peril now thanks to a contentious clause in the proposed Financial Resolution and Deposit Insurance (FRDI) Bill which is awaiting Parliament’s nod. Introduced in Lok Sabha during the Monsoon Session and referred to a Parliamentary standing committee, the Bill has a ‘bail-in’ provision which empowers a bank to push bank deposits into non-priority list of liabilities when it is on the verge of collapse. That means depositors will get the last right to share the spoils.

But it is very unlikely that the harmful provision is feasible in India, the world’s largest democracy where political parties vie with each other to waive off farm loans worth multiple thousands of crores to stay in, retain or recapture power.  Moreover, no major bank has so far been allowed to fail in the country.  RBI steps in immediately if it notices any structural weakness in any bank and paves way for its merger with a stronger bank.  That had happened several times in the past.

For instance, when Global Trust Bank, a private bank, faced crisis in 2001, it was merged with Oriental Bank of Commerce three years later.  There is no reason why this strategy will not continue in future. But that doesn’t mean that there is no harm with the new provision.  It will undermine the people’s faith in banking system. 

If that happens, there will be dangerous consequences for the economy and banks because people may rush to withdraw their deposits. Finance Minister Arun Jaitley and Prime Minister Narendra Modi were quick to douse the concerns of the worried bank depositors, but they should get the draconian clause removed from the Bill. Otherwise, people’s confidence in banks will get eroded further.