Bank resolution

Indian Economy glossary

Also called: Resolution regime, Resolution Authority · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

Bank resolution is a special legal process for dealing with a failing bank or other financial firm. A public body called the resolution authority runs it, outside ordinary bankruptcy courts. The authority uses tools such as transferring deposits, merging the bank into another, bail-in or liquidation. The goals are to protect depositors, keep essential banking services running and limit the cost to taxpayers.

It matters because a bank is built on trust. It borrows short-term through deposits and lends long-term through loans. If a failing bank is left to ordinary bankruptcy, depositors' money gets stuck for years. Panic can then spread to healthy banks. A resolution regime (the law, the authority and the tools together) lets the state deal with the failure quickly and in an orderly way.

Explanation

Why banks need a separate process from bankruptcy

Ordinary bankruptcy is too slow for a bank.
Under ordinary insolvency, the firm stops, a court freezes its assets and creditors wait to be paid in order of rank.
In a bank, the creditors are mostly ordinary depositors who need their money for daily life.
A freeze of months or years → depositors in other banks get scared → they withdraw too → a bank run (many depositors pulling money out at once) spreads across the system.
Resolution is regulator-led, not creditor-led.
The authority can step in early, often over a weekend.
It can override the bank's shareholders and management.
It assesses the bank's assets, moves the healthy parts to safety and closes only what is left. In resolution, deposits can be moved to other institutions and the remaining assets liquidated only if needed.
Main aims of a resolution regime:
Protect depositors, especially small ones
Keep essential services (payments, deposits, loans) running
Stop the failure spreading (systemic risk: one firm's failure setting off a chain of failures)
Make shareholders and creditors bear the losses, not taxpayers

The resolution toolkit

Purchase and assumption (P&A): a healthy bank takes over the failing bank's deposits, and some good assets move with them.
Someone must usually pay to fill the gap left by the bad assets.
IMF guidance says a deposit insurance fund should be allowed to pay for a P&A if it costs less than paying every depositor directly. This is the least-cost rule.
Merger or amalgamation: the whole failing bank is merged into a stronger bank.
Reconstruction scheme: the regulator puts fresh capital and new management into the bank so it keeps running.
Bail-in: the bank's own shareholders and creditors take the losses. Their claims are written down or turned into shares. This is the opposite of a bail-out, where outside money (usually taxpayers') covers the losses.
Contractual bail-in: AT1 bonds (a type of bank capital that is written down or turned into equity at the point of non-viability, i.e. when the bank cannot survive without help) are written off.
Bridge bank: a temporary bank set up by the authority to hold the good parts until a buyer is found.
Liquidation: the remaining assets are sold and creditors are paid in order. This is used only for what cannot be saved.

What makes resolution work or fail

Funding: a power to transfer deposits is useless if nobody pays to fill the hole. The FSB Key Attributes (the global standard for resolution regimes) say resolution needs a funding source, ideally a privately funded deposit insurance or resolution fund (Key Attribute 6).
Protection of insured deposits: under the Key Attributes, insured deposits are kept out of bail-in.
Strong foundations first: good deposit insurance and good supervision must exist before a resolution regime can work.
Clear legal objectives for the authority: without them, it cannot decide what comes first: small savers, low cost or system stability. The IMF flagged a lack of objectives for a Resolution Authority as a gap in 2024.
Early action: the later the regulator steps in, the bigger the losses. Bigger losses mean fewer buyers and longer freezes for depositors.

In India

No single, full resolution law for financial firms yet.
The FRDI (Financial Resolution and Deposit Insurance) Bill 2017 would have set up a resolution corporation.
Its bail-in clause caused depositor panic. People feared depositors could bear part of the losses. The Bill was withdrawn in August 2018.
In February 2020 the Finance Minister said the Bill would come back, but gave no timeline.
How India resolves banks today (case by case):
The Banking Regulation Act 1949 gives RBI powers to supervise banks, restrict them and frame schemes of reconstruction or amalgamation.
Yes Bank Reconstruction Scheme (March 2020): SBI-led capital came in, so this was a bail-out-type rescue. AT1 bonds were written down, which was a contractual bail-in.
Lakshmi Vilas Bank (2020): merged into DBS India.
Cooperative banks such as PMC Bank (2019) and New India Co-operative Bank (2025) were placed under RBI restrictions. Their failures show governance gaps and dual control (state registrars and RBI share oversight).
Early-warning layer: Prompt Corrective Action (PCA).
Introduced in 2002. Revised framework from 1 January 2022.
Triggers: CRAR, CET1, net NPA (thresholds at 6%, 9%, 12%) and the Tier 1 leverage ratio.
The aim is to fix a weak bank before it needs resolution. 11 PSBs were under PCA in 2017-18. All had exited by September 2022.
Depositor protection layer: DICGC.
Cover of Rs 5 lakh per depositor per bank from 4 February 2020. It was Rs 1 lakh from 1993.
Under the DICGC (Amendment) Act 2021, in force from 1 September 2021, insured depositors must be paid within 90 days once RBI restricts withdrawals.
The 90 days are split up: the bank files claims within 45 days, DICGC checks them within 30 days and pays within the next 15 days.
From September 2021 to November 2022, DICGC paid ₹4,055.10 crore to 3,06,146 depositors of 35 banks.
NBFCs and the IBC route: large financial-service providers can be taken to IBC under s.227. DHFL (2019) was the first.
Systemically important banks: SBI, ICICI Bank and HDFC Bank are D-SIBs (banks whose failure would seriously disrupt India's system). They hold extra CET1 because they are hard to resolve without wider damage.

Don't confuse with

Bankruptcy / IBC liquidation: a court-led, creditor-driven process that stops the firm and pays creditors in order. Resolution is regulator-led and keeps essential banking functions running, with liquidation only for what is left.
Bail-out vs bail-in: in a bail-out, outside money (taxpayer or state-directed) covers the losses, e.g. Yes Bank 2020. In a bail-in, the bank's own shareholders and creditors bear them, e.g. the FRDI Bill clause or AT1 write-downs. Both can be resolution tools.
Prompt Corrective Action (PCA): this is early supervision of a weak bank that is still running: limits on dividends, lending and branches. Resolution starts when the bank is failing or no longer viable.
Bad bank / ARC: this removes bad loans from a bank that is still alive. NARCL, for example, buys and holds bad loans. Resolution deals with the failing bank itself.

Prelims Hooks

India has no comprehensive financial resolution law. The FRDI Bill 2017 was withdrawn in 2018 over its bail-in clause.
DICGC cover is Rs 5 lakh per depositor per bank (from 4 February 2020). Interim payment comes within 90 days of RBI restrictions under the 2021 amendment, split 45 + 30 + 15 days. Trap: "DICGC covers NBFC deposits" is FALSE.
FSB Key Attributes: insured deposits are kept out of bail-in, and resolution needs a funding source (Key Attribute 6).
Least-cost rule: a deposit insurance fund may pay for a purchase-and-assumption deal only if it costs less than paying depositors directly.
Yes Bank (March 2020) = reconstruction scheme with SBI-led capital. Lakshmi Vilas Bank (2020) = merged into DBS India. DHFL (2019) = first financial-service provider taken to IBC under s.227.
PCA (revised from 1 January 2022) is an early-intervention tool, not a resolution tool. Its triggers are CRAR, CET1, net NPA and the Tier 1 leverage ratio.

Mains Points

India's case-by-case model and its limits: RBI-driven mergers and reconstruction schemes (Yes Bank, LVB) protected depositors. But each rescue relied on state-directed money and one-off decisions. A clear resolution law would set rules in advance, cut moral hazard (taking more risk when protected from the consequences) and end too-big-to-fail expectations. It would also cover cooperative banks, where dual control slows action (PMC 2019, New India Co-op 2025).
Designing an FRDI-type law that does not scare savers: the 2017 Bill failed on trust, not logic. It offered only government assurances on bail-in. A new law should put the Key Attributes into its own text: insured deposits outside bail-in and a privately funded resolution fund. Combined with DICGC's fixed 90-day payout, this would give depositors certainty.
The safety net works only as a chain: supervision and PCA catch weak banks early. Deposit insurance protects small savers. Resolution handles the failure without panic. Good deposit insurance and supervision must exist before resolution can work. A resolution power with no funding behind it leaves accounts frozen while regulators hunt for a buyer. Fast-growing digital lenders and NBFCs should be supervised by size, not just by licence type, so this chain covers them too.

Banking Regulation, NPAs and Financial Stability