India's proposed bank resolution regime faces test of political will: S&P

India's proposal for resolution of distressed financial institutions aims to provide a cohesive framework to manage any future financial crises that might occur. However, it's up to the legislature to act on the recommendations, and political considerations are likely to come into play, says a new report, titled The Indian Bank Resolution Regime: A Test Of Political Will that Standard & Poor's Ratings Services published on Wednesday.

"The proposal does not change our assessment that the Indian government is highly supportive of banks in the country," said Standard & Poor's credit analyst Deepali Seth. "We will reassess the tendency of the government to provide extraordinary support at a later stage of the development of the resolution regime. But for now, our ratings on government-owned banks continue to factor in a very high likelihood that the government will continue to support public sector banks."

Garnering political commitment for such sweeping changes will be difficult, the report noted. These changes will take a while to implement, making it tough for the country to meet the Financial Stability Board's key attributes of effective resolution regimes for financial institutions by the end of 2015.

The key legislative changes that would be required include forming a new, independent financial resolution authority and vesting it with the power to exercise some of the suggested resolution tools, which includes bail-in (allowing creditor-financed recapitalisation of a distressed bank).

"It will take political willingness to allow for the bail-in of creditors of large banks. A bail-in of creditors of a large systemic bank could have a contagion impact, such that the wholesale creditors may withdraw from other banks too and hurt system stability," said Seth.

The matter is further complicated by the presence of large number of government-owned banks. As a shareholder, the government has been providing these banks with support in the form of regular capital infusions, and to date it remains committed to ensuring appropriate capital, not just for existing business but also for growth to promote greater financial inclusion in the country. It's difficult to fathom the unavailability of government support for a distressed government-owned bank.