Financial Resolution and Deposit Insurance Bill has generated a lot of debate in the country on what will be the fate of depositors in case a deposit taking company like banks loses its ‘going concern status’ on some fateful day. Should the government bailout the bank and ensure that depositors’ money is safe or will depositors get some insured amount and the bank will go for insolvency proceedings? But let us for a minute leave aside what will happen to the fate of depositors and ask ourselves a more fundamental question: Can we let our banks go to the stage of insolvency in the first place?

HBO’s ‘Too Big to Fail’ movie may provide interesting insights on why we can’t let our banks fail especially those which are already very large in size because their failure may impose major risks to financial system as a whole. The recession of 2008 is most remembered for the collapse of Lehman Brothers, one of the major investment bank of United states. While its collapse was not stopped by the US government because it felt that it cannot bailout investment bank with public money but it realized soon after that it is just not about bailing out some bank but about reposing the public’s faith in financial system.

After the collapse of Lehman brothers, every bank stopped lending to each other. Depositors and lenders started withdrawing their money from the banks.The whole financial system was staring at collapse. What followed was US government’s immediate intervention to rescue AIG with an $85 billion loan. Also, there were a series of mergers like Bank of America was merged with Merrill Lynch, JP Morgan Chase was merged with Bear Stearns so that these banks remain adequately capitalized and their risk of failing is minimized.

The important point is that US which is completely against government intervention in private sector had to intervene and bail out its institutions. The example of US government’s intervention is not to advocate that government should payout for excessive risk taken by Banks but what is important to remember that banks are not like other companies and their failure can have catastrophic effect on the faith of public in the financial system. The solution to make financial system resilient does not lie in FRDI bill but lies in improving the governance standards that are followed in the banks and other financial entities.

The recent NPA problem has exposed how poor are the corporate governance standards in India. Many banks like Yes bank ,Union bank have under reported their NPA’s for years together till it was later on discovered by RBI. The co-operative banks remain symbolic of poor governance standards and Punjab and Maharashtra Co-operative Bank is the recent example of it. Is it so tough to monitor our financial institutions? It is not. What we need is more technological integration of our financial institutions with the regulators and a ruthless discipline among the banks to strictly adhere to reporting standards.

Also, the socio-cultural milieu of India is very different from that of the developed nations where people better understand the concepts of deposit insurance whereas India is still striving for basic level of financial literacy. More importantly, India’s agenda of financial inclusion is highly dependent on the level of trust people have in the financial system. The trust will come from robustness of the system and not from thinking of what will happen to depositors if our banks go bankrupt. Our aim should be to make our financial system more and more robust by improving the level of governance and the quality of regulatory oversight because we just cannot let our banks fail.