Bank Resolution and Depositor Protection in India: Complete Notes

What happens when a bank fails is the question that the whole of banking regulation exists to avoid having to answer. This note brings together the law that applies when avoidance has not worked: the moratorium and the scheme of reconstruction or amalgamation, the voluntary merger and the acquisition, the winding up, and the deposit insurance that stands behind the small depositor whatever route is taken. It ends with what Indian law still lacks.

The ladder of intervention

Figure 1: The ladder of intervention

1. Moratorium and Reconstruction

Application (Section 45(1)): the Reserve Bank may apply to the Central Government for a moratorium, and since the Banking Regulation (Amendment) Act, 2020 may prepare a scheme without a moratorium at all.
The order (Section 45(2) and (3)): a moratorium stays all actions and proceedings for not more than six months, during which the bank may make no payment and discharge no liability, and since 2020 may grant no loans or advances.
The grounds (Section 45(4)): a scheme may be prepared where necessary in the public interest, in the interests of the depositors, to secure the proper management of the company, or in the interests of the banking system of the country as a whole.
Contents (Section 45(5)): the constitution, capital and management of the bank or transferee, the transfer of business, assets and liabilities, the continuance of employees, the continuation of legal proceedings, and the reduction of the rights of members, depositors and other creditors under clause (f).
Procedure and effect (Sections 45(6) to (11)): the draft is circulated for suggestions and objections, may be modified, is sanctioned by the Central Government, whose sanction is conclusive evidence of compliance, binds the banks and all their members, depositors, creditors and employees, and is laid before Parliament.

The three resolutions

Yes Bank: moratorium on 5 March 2020, with the board superseded by the Reserve Bank; the Yes Bank Limited Reconstruction Scheme, 2020 notified on 13 March 2020 under which the State Bank of India invested and could not reduce its holding below twenty six per cent for three years; moratorium lifted on 18 March 2020. The write down of about ₹8,415 crore of additional tier 1 bonds was set aside by the Bombay High Court in January 2023, stayed by the Supreme Court, and the appeal remained undecided in mid 2026.
Lakshmi Vilas Bank: moratorium on 17 November 2020; amalgamated with DBS Bank India Limited from 27 November 2020, with the entire paid-up share capital written off and depositors transferred without loss.
PMC Bank: all inclusive directions under Section 35A from 23 September 2019; amalgamated with Unity Small Finance Bank by a scheme of 25 January 2022, after depositors had been locked out for more than two years. That delay was a principal reason for the 2020 amendment.

2. Voluntary Amalgamation, Compromise and Acquisition

Section 44A: a voluntary amalgamation requires a draft scheme before the shareholders of each company separately, with notice published once a week for three consecutive weeks in two newspapers, approval by a majority in number representing two thirds in value, and sanction by the Reserve Bank, whose order is conclusive evidence of compliance. A dissenting shareholder may claim the value of his shares as determined by the Reserve Bank, and that determination is final.
Section 44B: no High Court may sanction a compromise or arrangement between a banking company and its creditors or members unless the Reserve Bank certifies that it is not incapable of being worked and not detrimental to the interests of the depositors.
Sections 36AE to 36AJ: the Central Government may, on a report of the Reserve Bank, acquire the undertaking of a bank that has more than once failed to comply with directions under Sections 21 or 35A or is managed detrimentally, after a reasonable opportunity of showing cause, with a scheme under Section 36AF, compensation under Section 36AG on the principles in the Fifth Schedule, and a Tribunal under Section 36AH. The power is not known to have been used.
Public sector banks: their mergers are effected by schemes under the Acquisition and Transfer Acts and the State Bank of India Act, not under Sections 44A or 45.

⚠ Note

The clearest way to tell Section 44A from Section 45 is to ask three questions. Who begins it? The shareholders, or the Reserve Bank. Whose consent is needed? A majority in number and two thirds in value, or nobody's. Who sanctions it? The Reserve Bank, or the Central Government. A dissenting shareholder is bought out under the first and may be wiped out under the second.

3. Winding Up

Choosing a route for a failing bank

Figure 2: Choosing a route for a failing bank

Suspension (Section 37): the High Court, on the company's own application, ordinarily supported by a Reserve Bank report, may stay proceedings against a bank temporarily unable to meet its obligations, for a total of not more than six months.
The obligation (Section 38(1)): the High Court shall order winding up where the company is unable to pay its debts or where the Reserve Bank applies.
The Bank's application (Section 38(2) and (3)): it must apply when directed under Section 35(4)(b), and may apply where there has been a failure of Section 11 capital, a loss of entitlement under Section 22, a prohibition on fresh deposits, or continuing non compliance, or where in its opinion a compromise cannot be worked, the returns show inability to pay, or continuance is prejudicial to depositors.
Deemed inability (Section 38(4)): refusal of a lawful demand within two working days where there is a Reserve Bank office, branch or agency, or five elsewhere, certified in writing by the Bank.
Liquidator (Section 39): the Reserve Bank, the State Bank or a notified bank may be appointed official liquidator, which is almost unique to banking.
Depositors (Section 43): every depositor is deemed to have filed and proved his claim for the amount in the bank's books, so he need lodge nothing.
Voluntary winding up (Section 44): permitted only where the Reserve Bank certifies that the company can pay all its debts in full.
Speed (Part IIIA): Sections 45A to 45X supply special provisions for the speedy disposal of winding up proceedings, including settlement of the list of debtors by the court itself.
Outside the insolvency code: financial service providers are excluded from the Insolvency and Bankruptcy Code, 2016, so a bank cannot be taken to the Tribunal as a corporate debtor.

📖 Joseph Kuruvilla Vellukunnel v. Reserve Bank of India, AIR 1962 SC 1371

Facts: A banking company was wound up on the Reserve Bank's petition under Section 38(3)(b)(iii), founded on the Bank's opinion that its continuance was prejudicial to the interests of its depositors, which the court was bound to act upon. A director challenged it under Articles 14 and 19(1)(g) as conferring unguided power and denying banking companies the protections other companies enjoy.

Held: The provision was upheld. Banking companies are a reasonable class because they hold public money and their failure affects the system. The Reserve Bank is an expert body whose satisfaction rests on periodical inspection and statutory duty, and the restriction was a reasonable restriction in the public interest.

Ratio: Where a statute entrusts a technical financial judgment to a specialised regulator, courts will not substitute their own assessment. Review survives on jurisdiction, natural justice, mala fides and manifest arbitrariness, since the Bank is State under Article 12.

4. Deposit Insurance

Deposit insurance and the recent resolutions

Figure 3: Deposit insurance and the recent resolutions

The Corporation: the Deposit Insurance and Credit Guarantee Corporation, a wholly owned subsidiary of the Reserve Bank, under the DICGC Act, 1961. Deposit insurance began on 1 January 1962; the credit guarantee function was merged in 1978 and has been in abeyance since 2003.
Banks covered: all commercial banks, including foreign bank branches, regional rural banks, local area banks, small finance banks and payments banks, and all cooperative banks. Primary cooperative societies and non-banking financial companies are not covered.
The limit: ₹5 lakh per depositor per bank, from 4 February 2020, covering principal and interest together, aggregated across branches but separate for each right and capacity.
Exclusions: foreign Government deposits, Central and State Government deposits, inter-bank deposits, deposits of a State Land Development Bank with the State cooperative bank, deposits received outside India, and amounts specifically exempted.
The premium: paid by the bank, at a card rate of twelve paise per hundred rupees of assessable deposits from 1 April 2020, half yearly in advance, and it may not be passed on to depositors. From 1 April 2026 a risk based premium framework gives sounder banks discounts on the card rate.
Payment (Section 16) and recovery (Section 21): the Corporation pays on a winding up order or where a scheme does not provide for payment in full, and is then repaid out of the realisations by the liquidator or transferee bank, in effect standing in the depositor's place.
Interim payment (Section 18A): from 1 September 2021, where a bank is under all inclusive directions, the depositor must be paid within ninety days, the bank furnishing the list of claims within forty five days. This was the answer to the PMC Bank experience.

5. Financial Stability and the Resolution Gap

Macroprudential regulation addresses risk to the system, as against microprudential regulation of the individual firm, because prudence in each bank can be imprudence in all.
The Council: the Financial Stability and Development Council, set up in 2010, is non statutory, chaired by the Union Finance Minister, with a sub-committee chaired by the Governor and a Financial Stability Report published twice a year.
Systemically important banks: identified annually under the Reserve Bank's framework of July 2014 on size, interconnectedness, substitutability and complexity, placed in buckets and required to hold additional common equity tier 1. The identified banks have been the State Bank of India, HDFC Bank and ICICI Bank.
The toolkit: counter cyclical capital buffer, sectoral risk weights and provisioning, loan to value ceilings, the large exposures framework, the liquidity coverage and net stable funding ratios, and the leverage ratio.
What is missing: a single resolution authority, mandatory recovery and resolution plans, a statutory creditor hierarchy for financial firms, and a bridge institution mechanism.
The FRDI Bill, 2017: proposed a Resolution Corporation with powers of transfer, merger, bridge institution and bail-in. The bail-in provision caused public alarm about deposit safety and the Bill was withdrawn in August 2018. The raising of cover to ₹5 lakh in 2020 and the ninety day rule in 2021 can be seen in part as the response.

6. How the Regime Holds Together

The provisions form a single ladder. At the top the Reserve Bank corrects, by directions under Section 35A and the prompt corrective action framework. If correction fails it rescues, by a scheme under Section 45, which is now the normal route and which has protected depositors' principal in every recent case. If no acquirer can be found it closes the bank, by winding up under Section 38, with the Reserve Bank itself as liquidator and the depositor's claim deemed proved under Section 43. Behind all of this stands deposit insurance, which pays the small depositor whichever route is taken and, since Section 18A, pays him within ninety days rather than at the end of a liquidation.

What the ladder depends on is the availability of a willing and capable acquirer at short notice. That has been found each time, because the failing banks were small relative to the system and the system itself was strong. The untested case is the failure of a large bank, and it is that case which the absence of a dedicated resolution statute leaves unprovided for.

⚠ Key point

Section 45 allows the Reserve Bank to seek a moratorium of not more than six months and to prepare a scheme of reconstruction or amalgamation, since 2020 without a moratorium, on four grounds, which the Central Government sanctions and which binds everyone, and which may under clause (f) of Section 45(5) reduce the rights of members, depositors and creditors. Section 44A governs voluntary amalgamation by a majority in number and two thirds in value, sanctioned by the Reserve Bank, with dissenters valued out; Section 44B requires the Bank's certificate for a compromise; Sections 36AE to 36AJ permit acquisition by the Centre, not used so far. Section 38 requires winding up where a bank is unable to pay its debts or the Bank applies, Section 39 permits the Reserve Bank as liquidator, Section 43 deems depositors' claims proved, Section 44 permits voluntary winding up only on a certificate of solvency, and Part IIIA provides for speedy disposal. The DICGC Act, 1961 insures ₹5 lakh per depositor per bank from 4 February 2020, funded by a premium paid by the bank at a twelve paise card rate, risk adjusted from 1 April 2026, payable within ninety days under Section 18A since 1 September 2021. Banks are outside the Insolvency and Bankruptcy Code, and the FRDI Bill, 2017 was withdrawn in August 2018.

7. Quick Revision

✦ Points worth fixing

Correction, rescue, transfer and closure are the four stages of intervention.

Six months is the outer limit of a moratorium, under Section 37 and under Section 45 alike.

Four grounds for a scheme: public interest, depositors, proper management, the banking system as a whole.

Section 44A is sanctioned by the Reserve Bank; Section 45 by the Central Government.

Majority in number and two thirds in value, in each company separately.

Two working days near the Bank, five elsewhere. Deemed inability to pay.

Section 43 deems the depositor's claim filed and proved. He files nothing.

₹5 lakh cover, a twelve paise card rate and payment in ninety days under Section 18A.

Per bank, not per branch. Per capacity, not per account.

Shareholders and subordinated investors bear losses before depositors, the pattern of recent Indian resolutions.

Banks are outside the insolvency code, and FRDI was withdrawn.

8. Frequently Asked Questions

What happens to depositors when a bank fails in India?

In recent cases their principal has been protected, because the bank has been reconstructed or amalgamated under Section 45 and the depositors transferred to the acquiring bank, though repayment may be phased, as in the PMC Bank scheme. If that is not possible, deposit insurance pays up to ₹5 lakh per depositor per bank, and the balance ranks as a claim in the winding up, where Section 43 deems the depositor's claim already proved.

What is the difference between a stay under Section 37 and a Section 45 moratorium?

A stay under Section 37 is granted by the High Court on the banking company's own application, where it is temporarily unable to meet its obligations. A moratorium under Section 45 is ordered by the Central Government on the Reserve Bank's application, as a step towards a scheme of reconstruction or amalgamation. Both are limited to six months in total.

Can a scheme under Section 45 write off bondholders?

Section 45(5)(f) permits a scheme to reduce the rights of members, depositors and other creditors, so in principle yes. Whether a particular write down was validly effected depends on the terms of the sanctioned scheme. The Bombay High Court set aside the Yes Bank additional tier 1 write down in January 2023 on the ground that the scheme as sanctioned contained no such clause; the Supreme Court stayed that decision and the appeal remains to be decided.

How much deposit insurance cover is available, and who pays for it?

₹5 lakh per depositor per bank, covering principal and interest, from 4 February 2020. The bank pays the premium, twelve paise per hundred rupees of assessable deposits since 1 April 2020, and is forbidden to pass it on to depositors.

Why can a bank not be taken to the National Company Law Tribunal?

Because financial service providers are excluded from the definition of a corporate person under the Insolvency and Bankruptcy Code, 2016, and may be brought within it only by rules notified in consultation with the regulator. Those rules have been used for non-banking financial companies, not for a bank. Banks are resolved under the Banking Regulation Act instead.

What is the resolution gap in Indian banking law?

The absence of a dedicated resolution framework: there is no single resolution authority, no requirement that large institutions prepare recovery and resolution plans in advance, no statutory creditor hierarchy for financial firms and no bridge institution mechanism. The FRDI Bill, 2017 would have supplied these but was withdrawn in August 2018 after public concern about its bail-in provision.

9. Related Topics and Provisions

Inspection, directions and penalties
Management of banking companies
Non-performing assets and the recovery statutes
Basel norms and capital adequacy
Structure of the Indian banking system
Cooperative banks and the 2020 amendment