Time to scale up deposit insurance

With the proposal of deposits being used for bail-ins thankfully scrapped, it’s time for the Centre and the RBI to turn their focus back on the long-pending issue of woefully low deposit insurance cover, if depositors’ interests are to be truly served. The coverage under the Deposit Insurance and Credit Guarantee Corporation (DICGC) was last raised in 1993, from ₹30,000 to ₹1 lakh. Also, less than a third of bank deposits in value terms are insured by the DICGC.

Much has been said on the abysmally low cover in India vis-à-vis other countries. The question then is: Why has there not been a strong move to correct the anomaly in over two decades?

The answer may lie in the fact that in India, beneficiaries of the deposit insurance system, up until now, have mainly been urban cooperative banks. The last claim settled in respect of a commercial bank was way back in 2002. Hence, raising deposit cover, which will imply stronger banks coughing up more premium, mostly for the benefit of weaker banks, has created a perception of cross-subsidisation in the operation of deposit insurance.

To counter some of these issues, a committee headed by Jasbir Singh in 2015 made recommendations for the introduction of risk-based premium for banks. It is time the RBI pushed forth some of these changes to strengthen our deposit insurance system.

Fair pricing

In India, deposit insurance covers all commercial banks, local area banks, regional rural banks and co-operative banks. If a bank goes belly up, then the DICGC pays back the insured amount to the depositor. But the insurance limit is restricted to just ₹1 lakh per depositor per bank. According to the 2017 annual survey by the International Association of Deposit Insurers (IADI), in India, the deposit insurance is just $1,543 (at a conversion rate of ₹64.8 to a dollar).

Indonesia has a deposit-insurance cover of $1,47,000, Brazil $76,700, and Malaysia $55,700. Mexico too has insurance coverage of over $100,000. Canada, Switzerland and France provide cover upwards of $70,000 per depositor. In the US, the Federal Deposit Insurance Corporation offers an insurance coverage of $250,000. Most of these countries cover 60-70 per cent of total deposits.

Against this backdrop, there can be little debate on the need to increase the strikingly low insurance cover in India. But an increase in cover would mean an increase in premium. Currently, the premium is borne by banks and not the depositors. The DICGC charges a maximum premium of up to 10 paise per ₹100 per annum. This is computed on the total assessable deposits — insured banks pay advance premium to DICGC semi-annually, based on their deposits as at the end of previous half-year. Hence, any increase in premium rates would add to the burden of larger banks with higher deposit base.

So far in India, beneficiaries of the deposit insurance system have mainly been urban co-operative banks, many of which fail every year. During 2016-17, DICGC settled claims for ₹56 crore in respect of nine co-operative banks. There was no claim from commercial banks.

A risk based premium structure as against a flat based one, can address this issue to a large extent.

 

Bucketing banks

Jasbir Singh’s report talks of assigning reward points to banks based on five parameters (CAMELS approach) — capital adequacy, asset quality, profitability, liquidity and others (adoption of technology, regulatory penalties, etc.). Higher the reward point, lower the risk.

The effective premium rate will be determined by multiplying the base rate by a multiple (a multiplicative factor) representing rating.

On, say, a base premium rate of 10 paise, a bank falling within the topmost category (with least risk) will have a multiple of 0.95, which would imply an effective premium of 9.5 paise. The multiplicative factor goes up to 1.25 for the highest risk category of banks.

Given that the CAMELS approach has been deployed by various deposit insurance agencies across the world, implementing the same in India should not be difficult. Of course, given the steep deterioration in financials of banks since the publication of the report, the thresholds for reward points may need a re-think.

For instance, there is no public sector bank that carries a net NPA (non-performing asset) of less than 2.7 per cent (levels put out in the 2015 report) that will earn it at least one reward point. Nonetheless, taking stock of the current state of affairs and tweaking the rules for assigning reward points should do the trick and set the ground for raising insurance cover.

Scrapping the Financial Resolution and Deposit Insurance (FRDI) Bill altogether has left a void in the legal framework for resolution of financial firms.

Effective bank insolvency laws include a special resolution regime (SRR) for banks that is separate from the general corporate insolvency laws. Under the latter, as shareholders or creditors are allowed a longer time to challenge the action, there is a “de facto deposit moratorium, and potential for depositor runs”, according to IADIs’ core principles for effective deposit insurance systems.

IADI survey suggest that some form of special resolution regime for banks exists in around three quarters of jurisdictions.

Given the deteriorating state of affairs at public sector banks and weak governance norms, strengthening our deposit insurance systems and legal framework for bank resolution cannot be put on the back-burner any longer.

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