Bank Resolution Mechanism

Bank resolution is the orderly handling of a failing bank so that essential banking services continue without keeping its shareholders or management protected from losses. When a bank becomes non-viable, resolution seeks to preserve critical financial functions, such as access to deposits and payment services, while allocating losses and restructuring or transferring its business.

Why ordinary liquidation may be disruptive

Banks connect depositors, borrowers and payment systems. Abruptly closing a bank can interrupt transactions, restrict access to money and spread fear to otherwise sound institutions.

• A liquidity problem means difficulty meeting payments when due; a solvency problem arises when losses undermine the bank’s ability to meet its obligations.
• Resolution becomes relevant when the bank is no longer viable, or is likely to become non-viable, and private recovery measures cannot restore viability.
• The objective is to preserve essential services, not necessarily the bank’s existing ownership or legal identity.

How resolution maintains continuity

International resolution frameworks provide several tools. Their availability depends on domestic law and the bank’s circumstances.

• A transfer of business moves deposits and suitable assets to a sound bank, allowing customers to continue receiving services.
• A bridge bank temporarily receives critical operations until a permanent purchaser or restructuring solution is available.
• A bail-in writes down eligible liabilities or converts them into equity, absorbing losses and recapitalising the continuing bank.
• Separating impaired assets from continuing operations can support restructuring, but does not itself eliminate the underlying losses.

Safeguards against contagion and unfair loss allocation

Effective resolution combines operational continuity with a credible allocation of losses. Otherwise, intervention may merely transfer private losses to the public.

• Shareholders bear losses first, followed by creditors according to the applicable legal hierarchy.
• The no creditor worse off safeguard means creditors should not receive less than they would have received in the relevant liquidation counterfactual.
• Deposit insurance protects eligible depositors within statutory limits, while advance resolution planning helps identify critical functions and obstacles to their continuity.

India’s institutional arrangements

India uses statutory powers for reconstruction and amalgamation rather than assuming that every international resolution tool is available domestically.

• Under Section 45 of the Banking Regulation Act, 1949, the Central Government may order a moratorium on the RBI’s application; the RBI can prepare a reconstruction or amalgamation scheme.
• DICGC insurance covers eligible deposits up to ₹5 lakh per depositor per bank, including principal and interest, in the same right and capacity.