Why India Still Lacks a Credible Framework to Resolve Failing Banks

In 2017, India attempted something bold: the Financial Resolution and Deposit Insurance (FRDI) Bill, a modern framework for resolving failing banks, insurers and financial institutions. Conceptually inspired by post-2008 regimes such as the United Kingdom’s Banking Act 2009, it aimed to bring India closer to global standards in handling financial distress.

Yet within a year, the Bill was withdrawn amid public fear and political backlash. Ironically, a reform intended to protect depositors from disorderly collapses triggered panic withdrawals from private banks. The FRDI saga was not just a communications failure; it exposed deeper political, economic and institutional constraints that still prevent India from building a credible mechanism to manage financial failures.

Public Mistrust
The FRDI Bill proposed a Resolution Corporation—independent of regulators—to assess risk, classify stressed institutions, and deploy tools such as mergers, bridge institutions, asset sales, and the most controversial option: bail-in, which allows certain liabilities to be written down or converted into equity.

On paper, this framework could have avoided the chaos seen in failing cooperative banks or NBFCs, while reducing the need for perpetual taxpayer-funded bailouts. But two provisions inflamed public sentiment:

1. Bail-ins could, under specific conditions, extend beyond insured deposits.
2. Deposit insurance limits would no longer be fixed in statute but set by the Resolution Corporation.

For policymakers, this signalled flexibility and modernisation. For the public, it looked like the state was asking for permission to use people’s life savings to rescue banks. Small depositors, central to India’s savings system, felt deeply vulnerable.

Ironically, the Bill protected insured deposits and ranked the remainder above unsecured creditors and government dues, a better position than depositors ordinarily enjoy. But in a country where depositors assume banks cannot fail—an entrenched moral hazard—poor communication proved fatal.

The government withdrew the Bill in August 2018, conceding that it could not overcome fears around the bail-in clause. Technocratic ambition collapsed under the weight of mistrust.

Why the UK Can Use Bail-in and India Cannot
Although the FRDI architecture mirrored the UK’s Special Resolution Regime (SRR), the comparison highlights why global norms cannot be transplanted wholesale into India.

 

*(Many continue to argue that the AT1 bond cancellation in the case of Yes Bank was the right move, given the circumstances and the provisions of law, forgetting this nuance).

In the UK, both the state and the public trust the system. India enjoys neither. Most Indian savers rely overwhelmingly on bank deposits, lack diversified assets, and distrust markets’ ability to safeguard their money. Any hint of discretionary authority over deposits triggers alarm.

The lesson is stark: you cannot build a resolution regime in a low-trust environment by demanding more trust.

Hidden Cost
Leaving the FRDI reform unfinished may have been politically popular, but it carries significant long-term risks. India now faces three structural vulnerabilities:

1. Perpetual Bailouts and Fiscal Strain
Weak institutions, especially public-sector banks, continue to depend on government equity injections. Taxpayers repeatedly absorb the cost of managerial failures and politically influenced lending.

2. Shadow Banking Contagion
NBFC collapses (e.g., IL&FS) transmit risk across banks, insurers and money markets. With no legal resolution mechanism, authorities are forced into ad-hoc emergency interventions.

3. Incentivised Risk-Taking
If banks expect rescue and depositors expect full protection, neither has an incentive to price risk correctly. Recklessness becomes rational, and stability becomes illusory—until a crisis breaks the façade.

Credible Reform
India needs a resolution regime, but it must be politically credible as well as technically sound. Four principles are essential:

1. Guaranteed Protection for Small Depositors
Statutory, unambiguous protection for all retail deposits below a clearly defined limit—no discretion, no surprises.

2. Build Capacity Before Creating a Corporation
Existing regulators must develop trained resolution teams, simulation capabilities and “living wills” for major financial institutions before any new body is empowered to act.

3. Deep, Sustained Public Communication
India lacks not legal authority but public trust. Any new regime must involve transparent debate, outreach, and meaningful engagement with consumer groups, academia and the media.

4. Mandatory Resolution Planning and Drills
Just as stress tests became routine after 2008, “resolution tests” must be institutionalised. Financial firms must prepare credible recovery and resolution plans, and regulators must routinely run war-games.

State Capacity
The collapse of the FRDI Bill was not a mere policy misstep; it was a political-economy failure. Reformers treated resolution as a technical exercise. The public interpreted it as an attack on their savings. Policymakers underestimated how deeply trust, savings behaviour and financial stability are intertwined.

As India’s financial system expands with larger NBFCs, fintech-driven deposit pools, rising concentration, greater interconnectedness, and ambitions to join the ranks of global banking powers, the stakes will only grow. India cannot rely indefinitely on improvised rescues. A crisis without a credible resolution mechanism will either strain the state’s finances or endanger public savings—the very outcome the FRDI Bill sought to prevent.

Ultimately, the real question is not whether India will create a resolution regime, but whether it will build trust first. Indians trust banks largely because they have no alternative. A modern financial state rests not just on regulation but on belief. No resolution law will work until depositors can trust the system designed to protect them.