Banks' deposit insurance hike may be on the anvil amid periodic review

Should deposit insurance revisits be episodic? Like after the collapse of Bank of Karad in 1992 and the Punjab and Maharashtra Cooperative Bank fiasco in 2019

The mess at the Mumbai-based New India Cooperative Bank has once again put the spotlight on deposit insurance. M Nagaraju, secretary in the Department of Financial Services, has said a hike in coverage is under consideration (speculated to be at ₹15 lakh from the current ₹5 lakh). This issue – among other matters – may figure at a meeting to be held with the chief executive officers of state-run banks on March 4. The Deposit Insurance and Credit Guarantee Corporation of India (DICGC) – a subsidiary of Mint Road – is the executing agency; and if an upward revision were to come through down the line, it would be the quickest in the post-reform period: After 1993, it has moved northwards only once (in February 2020) compared to the four times between 1968 (first hike) and 1980. DICGC was set up in 1962. 

 

Should such revisits be episodic? Like after the collapse of Bank of Karad in 1992 (which was merged with Bank of India after the Harshad Mehta scam) and the Punjab and Maharashtra Cooperative Bank fiasco in 2019 (now within the fold of Unity Small Finance Bank).

 

At present, there is uniform deposit insurance coverage capped at ₹5 lakh per depositor. But as M Rajeshwar Rao, deputy governor of the Reserve Bank of India (RBI), noted (August 19, 2024), a growing and formalising economy can naturally be expected to see a sharp increase in both primary and secondary bank deposits, “driving a wedge between the desirable insurance reserve requirement and the available reserve”. And considering multiple factors like growth in the value of bank deposits, economic growth rate, inflation and increase in income levels, “a periodical upward revision of this limit may be warranted”. 

 

Premium matters

 

It brings us to a deposit insurance architecture based on risk premium. The rate is now a flat 12 paise per ₹100 of assessable deposits in a year.

 

“When non-banks raise funds, credit rating is mandatory and made known to investors. This is the case even when banks float bonds. In the case of bank deposits, there’s no such regulatory requirement. If such ratings are to become mandatory, it may promote better governance,” says Ravi Bhadani, partner - SNG & Partners (insurance and funds practice). What’s the flipside to this? Ajit Velonie, senior director (financial sector and structured finance ratings) at Crisil Ratings, has it that risk-based deposit premium “has implications due to depositors' perception of the health of individual banks”.

 

Satish Marathe, director - central board, RBI, fleshes it out: “It brings its own issues. There could be a flight of deposits from weaker-rated banks to higher-rated ones. We can’t have instability.” His stance: “A better way is to give a roadmap for this transition. Again, have a system where better-rated banks’ deposit insurance premium also comes down as an incentive.”

 

What’s lesser known is that a risk-based deposit insurance architecture – radical as it may appear – is not a new concept. It was flagged by the Jagdish Capoor working group on Reforms in Deposit Insurance (1999), the Committee on Credit Risk Model (2006) set up by DICGC, and the Jasbir Singh Committee on Differential Premium System for Banks (2015). Incidentally, the Singh committee was set up after the issue of risk-based premium was discussed at the RBI’s board meeting held on October 16, 2014. It was felt that DICGC could “explore the possibility of putting in place a differential premium within the cooperative sector linking it to governance and risk profile of co-operative banks”.

 

C H Venkatachalam, general secretary of All India Bank Employees Association, has an entirely different perspective on deposit insurance. The amended Section 45 of the Banking Regulations Act (1947) – put through in 1960 – gave the government and the RBI powers to amalgamate banks to avert their closure; post this amendment, no commercial bank has been shut down. “Only cooperative banks run the risk of closure and liquidation. So, only their deposits need to be covered by DICGC,” he says. This may not find takers. 

 

Or will it? 

 

Protecting NBFC deposits

 

It leads us to another aspect: Deposit-taking non-banking financial companies (NBFCs-D) – these are not covered by DICGC. Public deposits remain an important source of funds even as asset sales and securitisation have emerged as important funding sources for them. As the Report on Trend and Progress of Banking India (T&P: 2024) observed, despite a reduction in the number of NBFCs-D to 25 in FY24 from 36 a year ago, their deposits grew 20.8 per cent to ₹102,994 crore during this period (and formed 22.49 per cent of their total borrowings). Now, what if there were to be a sudden fall in the key ratios of NBFCs-D and that led to panic withdrawal of deposits? The RBI is aware of this concern. The T&P: 2019 notes, “The strategy adopted of limiting the operations and growth of NBFCs-D is driven by the need to secure depositors’ interest, given that deposits are not covered by the DICGC.” The Capoor committee had held “a number of entities like financial institutions, NBFCs, etc., have been taking public deposits. The moot question is whether deposit insurance should cover liabilities of these entities as well.”

 

The bank deposit insurance story can get interesting.