Banking pads up to cover a new ground with risk-based deposit insurance

Shifting to a system of risk-based deposit insurance may over time force banks to become even more prudent and mindful of their finances

Of the 22 additional measures announced by Mint Road after its Monetary Policy Committee’s deliberations, the shift to risk-based deposit insurance framework is one of the most significant in the post-reform period. Think of it as tightening the screws on banks’ liability side. What’s less known is that this 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 the Deposit Insurance and Credit Guarantee Corporation (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 a Reserve Bank of India (RBI) board meeting 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.” 

So, what is one to make of this approach to deposit insurance after all these years? Says Anand Sinha, former deputy governor of RBI (and senior advisor, Cyril Amarchand Mangaldas): “This is more equitable as it will require riskier banks to pay more (deposit insurance premium) than those which are sound. Importantly, it will provide an incentive to lower-rated banks to improve their health reflected in their ratings. These ratings, like supervisory ratings, will not be public. While risk-based deposit insurance has been discussed for a long time, the timing of its introduction is opportune as the banking system is in much better shape.” A point has to be made clear: It is not that weaker-rated banks will pay more than the current uniform premium of 12 paise for every ₹100 of deposits. But this will be the cap, and the better-rated banks will pay lower. 

Glide path 

What is tricky is if this new architecture will be all too sudden for banks. Satish Marathe, director, central board of RBI, agrees it brings its own issues (there could be a flight of deposits to the better-rated ones). The way out? “A glide path of at least 2-3 years for implementing risk-based deposit insurance premium slabs is desirable and may be necessary so that banks get time to improve their financials and are able to adjust to the new approach,” he feels.   

But what if it is to be argued that confidential ratings serve no public interest? As Ravi Bhadani, partner at SNG & Partners (insurance and funds practice), sees it: Public disclosure of relative risk scores could spark self-fulfilling runs, which will be particularly harmful to cooperative and smaller regional banks that already face liquidity fragility. “Internationally too, regulatory risk assessments used for premium differentiation are confidential — for instance, both the US’s Federal Deposit Insurance Corporation and the European Deposit Insurance Scheme keep supervisory ratings and risk categories non-public to avoid destabilising depositor behaviour.” Confidential ratings allow RBI and DICGC to take corrective action quietly through prompt corrective frameworks rather than triggering public confidence crises. 

Should all banks be under the ambit of deposit insurance cover? “The RBI feels a risk-based approach to deposit insurance will force banks to improve their standards. Now, while that view is valid, my point is Section 45 of the BR Act (Banking Regulations Act, 1949) — put through in 1960 — ensures that no bank will fail; a troubled bank will be merged with another bank,” says C H Venkatachalam, general secretary, All India Bank Employees Association (Aibea). “I think at one level deposit insurance is not needed for commercial banks, but only for cooperative banks. The deposit insurance premium paid by banks to DICGC every year is huge. This is overkill.” 

The total premium received by DICGC in FY25 was ₹26,764 crore (₹23,879 crore in FY24); banks contributed 94.72 per cent and cooperative banks accounted for the rest. The total claims settled by DICGC since inception is ₹16,940.7 crore, while the premium received in FY25 alone was ₹26,764 crore. 

Lest you think Venkatachalam is scoring a debating point, it was Aibea which had played a key role in foregrounding deposit insurance in its current avatar. Notably, Prabhat Kar, its general secretary and Lok Sabha member (1957-1967). After the crash of Palai Central Bank and Laxmi Bank in 1960, the government introduced the Deposit Insurance Corporation Bill, which was approved by Parliament in December, 1961. Accordingly, the Deposit Insurance Corporation Act came into being with effect from April 1, 1962. Initially, the government proposed to cover bank deposits up to ₹1,500; Kar argued for the limit to be hiked to ₹3,000. But what’s the rationale for banks not to be paying the kind of amounts they do to DICGC as on date as Venkatachalam makes a case for it? He adds: “While all deposits are taken as assessable and premium is collected on them, the insurance scheme covers you only up to ₹5 lakh. Thus, banks are paying a premium even for deposits which are not insured (as in above the ₹5 lakh ceiling)”. Or overkill, as he put it earlier. 

Let us parse the numbers again. Banks pay advance insurance premia to DICGC semi-annually within two months at the start of each financial half-year, based on their deposits at the end of previous half year. This premium is borne by banks and is not passed on to depositors. The DICGC’s annual report for FY25 has it that the number of fully protected accounts stood at 2,865 million (accounts with deposit balance up to ₹5 lakh) in FY25 and constituted 97.6 per cent of the total number of accounts (2,937 million). Insured deposits at ₹100.05 trillion made for 41.5 per cent of assessable deposits at ₹240.96 trillion. The insured-deposit ratio — defined as the ratio of insured deposits to total assessable deposits (also termed coverage ratio in terms of value of deposits) — stood at 41.5 per cent in FY25 (43.1 per cent in FY24); it has fallen from 50.9 per cent in 2020 reflecting that the assessable deposits have been growing at a faster pace vis-à-vis insured deposit. 

 

Time for review 

What this tells you is that deposit ticket sizes are increasing, and the ₹5 lakh limit deposit insurance limit needs to be revised, too. It’s another matter that whatever be the revised upper limit, large depositors — be it retail or institutional — will always have reasons to feel let down. To illustrate: An individual with ₹10 lakh as deposit in a bank will get 50 per cent if it were to go belly-up, but another with ₹1 crore will only get 5 per cent. There are no easy answers to this aspect, “as for the absolute amount of deposit insurance cover which is currently at ₹5 lakh, I think this should be reviewed periodically, say every three years, after studying the increase in average size of deposit,” says Marathe. This would be better than being 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).

The cover story just got to be more interesting.