Beyond deposit insurance

Mechanism should be economically viable

The central board of the Reserve Bank of India (RBI) is expected to raise the deposit insurance limit from Rs 1 lakh to Rs 5 lakh. This should be welcomed as it will cover most retail depositors of banks. As reported by this newspaper, a new scheme is also likely to be considered to cover wholesale deposits up to Rs 25 lakh. Besides, two other important proposals are expected to be examined. First, it could allow banks to obtain deposit insurance over and above the enhanced limit for both individual and institutional depositors. If implemented, it will help boost confidence, especially in the private sector banks, and help strengthen financial stability. Second, the Deposit Insurance and Credit Guarantee Corporation (DICGC) will create a separate reserve to protect depositors of banks hit by frauds, such as in the Punjab & Maharashtra Co-operative (PMC) Bank. However, it has been reported that the premium paid for deposit insurance will not be increased from the current level of 10 paise per Rs 100 worth of deposits. The banking regulator should examine the proposal carefully and make sure the insurance mechanism remains economically viable.

It is reassuring that the central bank is looking for ways to protect the interests of depositors. However, it is also important to address other issues related to deposit insurance. The biggest beneficiaries of deposit insurance are cooperatives banks, while over 90 per cent of the premium is paid by commercial banks. What this essentially means is commercial banks are paying for the failures of state governments in regulating cooperatives banks. For instance, between 2009-10 and 2018-19, over 400 claims from cooperative banks were settled, compared with only one from commercial banks. Now with the increase in deposit insurance, the payout might go up significantly. It is also likely that a class of depositors would want to keep more money in cooperative banks because of higher interest rates.

Thus, it is important to review the regulatory architecture of cooperative banks. The present system of dual regulation by state governments and the central bank is not working. Also, it is worth reassessing whether the Indian financial system needs so many cooperative banks. They served a purpose in the past, but are perhaps not relevant anymore with the expansion of commercial banking and adoption of technology. In fact, with a lack of expertise and capital, it will become increasingly difficult for cooperative banks to compete and survive in the changing financial landscape. Therefore, the presence of cooperative banks must be reassessed and reforms should be implemented in an orderly fashion. Some of the better-run cooperative banks could be merged and converted into small finance or commercial banks.  

The central bank must also strengthen its own regulatory and banking oversight capabilities, so that vulnerabilities in the banking system are addressed in time. For example, the fraud in PMC Bank remained undetected for years and was known only after the management itself wrote to the regulator. Therefore, to protect the interests of depositors, the government and the banking regulator need to do a lot more than just raising the deposit insurance limit.