What is a bank moratorium, and when does it come into play?

Context

• The Centre, on the recommendation of the Reserve Bank of India (RBI), imposed a moratorium on Lakshmi Vilas Bank (LVB)for a period of 30 days.

What is a moratorium?

• A moratorium is a temporary suspension of activity until future events warrant lifting of the suspension or related issues have been resolved.
• Moratoriums are often enacted in response to temporary financial hardships.
• The RBI has the power to ask the government to have a moratorium placed on a bank’s operations for a specified period of time.
• Under a moratorium, depositors will not be able to withdraw funds at will.

What is limit on the withdrawals?

• There is a ceiling that limits the amount of money that can be withdrawn by the bank’s customers.
• In the case of LVB, depositors cannot withdraw more than Rs25,000 during the one-month moratorium period.
• In most cases, the regulator allows for funds of a larger quantum to be withdrawn in case of an urgent requirement, such as medical emergencies, but only after the depositor provides the required proof.

When does it come into play?

• If RBI thinks that a bank’s net worth is fast eroding and it may reach a state where it may not be able to repay its depositors.
• When a bank’s assets decline below the level of liabilities, it is in danger of failing to meet its obligations to depositors.

How does a moratorium prevent a ‘run’ on the bank?

• A moratorium helps prevent what is known as a ‘run’ on a bank, by clamping down on rapid outflow of funds by wary depositors.

How it is beneficial?

• A moratorium gives both the regulator and the acquirer time to first take stock of the actual financial situation at the troubled bank.
• A key objective of a moratorium is to protect the interests of depositors.

Is the safety of funds assured?

• It depends on whether the struggling bank or the regulator is able to find acquirers or investors to save the day.