It would seem so if the recommendation of the Damodaran Committee on customer service in banks is any indication. Indeed, a key and interesting recommendation of the Committee is that the deposit insurance cover should be enhanced to Rs 5 lakh from the present Rs 1 lakh (per customer per bank).

The Committee feels that the coverage enhancement can encourage individuals to keep all their deposits in a bank convenient to them. Going further, the Committee has even said that “a way should be found out to insure 100 per cent of deposits by making necessary amendments in the relevant Acts.”

Implicit view

Implicit in this statement is the view that the limited cover of Rs 1 lakh compels individuals to split their deposits amongst a number of banks and even possibly with non-banks.

That implicit view also seems somewhat supported by the data — according to the RBI, in terms of number of term deposit accounts of “individuals”, only some 20 per cent of the total number of accounts are in the greater than Rs 1 lakh category as of March 2010. This could mean either that deposits are getting split or that the fraction of individuals with above Rs 1 lakh deposits is quite small.

Now, one can wonder how a Committee tasked with looking into the operational aspects of how customer service is rendered in banks can make a recommendation on a policy issue.

Indeed, deposit insurance is a core macro policy issue in banking. It impinges on how the banking regulator can reconcile the objective of minimising risks of a bank-run with the need to not create or aggravate the moral hazard inherent in providing a liability-guarantee for lending institutions.

The recommendation is also interesting in that it comes in the backdrop of global regulatory efforts (at least efforts) of the past year or so to ensure that “TBTF” (too big to fail) does not happen again.

To make a recommendation on 100 per cent deposits coverage is certainly interesting in this context. This means all lenders will be ‘too big to fail'.

Be it as it may, one cannot but recognise that the Committee recommendation has the potential to spark off a larger debate on the concept of deposit coverage itself.

More pertinently, in India, given the organisational landscape of banking (and more generally financial intermediation) — marked by the significant presence of public sector banks and the notable presence of new and old private sector banks and an expanding non-bank financial institution sector — some brainstorming on deposit coverage could well be in order.

It can potentially generate ideas and proposals which can contribute to the policymaker's larger objectives — for instance, attaining higher and deeper financial penetration and inclusion. Indeed, if that larger objective is kept in mind, some fresh thinking on employing new tools — such as deposit insurance — to attain that objective could well be considered seriously.

It is well accepted that different types of financial intermediaries — large banks, small banks, public banks, local banks, private banks and, importantly, non-banks, too — are critical in expanding financial reach and penetration, be it on the savings side or on the credit side.

This recognition of the importance of different types of intermediation to achieve some broader economic objectives can be acted upon through various policy tools — one such tool seems to be the medium of deposit coverage.

For whom?

One wonders why the Committee made a broad-brush recommendation on increasing deposit coverage for all banks. Now, do we really need it for the public sector banks in India? Does not their public ownership character mean that the government fisc is backstopping all the creditors of such banks for all amounts?

More broadly, going beyond banking, for all public sector financial intermediaries, it is well understood that the government budget ultimately backstops them — like the US Treasury's backstop for Fannie Mae and Freddie Mac.

A clear example in recent times was when LIC was diagnosed with an actuarial deficit of some Rs 10,000 crore on some of its guaranteed return schemes. Now, does anyone believe that LIC — or more specifically the policyholders who purchased insurance from LIC — will be left to fend for themselves here?

A broad brush recommendation therefore does not appear necessary at all here. Indeed, experience shows that 100 per cent deposit coverage has been provided in India even in the case of (some) failing private sector banks. But, precisely for that reason — that the 100 per cent deposit protection in the case of private sector lenders could be selective — it does seem possible to think of alternative and different deposit coverage structuring for private sector banks or, more broadly, private sector financial intermediaries.

Positive discrimination

Now, it may not need much convincing to note that public sector financial intermediaries — given the 100 per cent deposit backstop they have — are in a “higher playing field”, so to say, vis-à-vis their private sector counterparts here.

In banking particularly, the private sector banks, and specifically the old private sector banks which have so far had a largely regional focus, certainly do not have a level-playing field. The new private sector banks with their recent entry and the benefit of starting with a fresh slate across all operational parameters do not seem to be that affected by this “playing field” syndrome.

The weak hand dealt to the old private banks is also broadly inferable from the financial data. In the past decade, their average cost of funds has been uniformly higher than that of public sector banks by a margin of some 60-70 basis points. That is not fully offset by higher returns from the asset side of the balance-sheet. That shows both in accounting and market based measures of return.

Also, deposits growth for the old private sector banks has consistently lagged behind that of government banks in the past decade — a possible pointer that higher deposits growth could have been attained only with much higher deposit rates than were posted hitherto.

Now, why cannot deposit coverage be enhanced only for the (old) private sector banks? More broadly, why cannot deposit coverage be provided even for non-bank financial intermediaries up to a certain limit based on some rigorous operational and prudential parameters?

The Committee has said (euphemistically) that deposit coverage should be enhanced given the “rise in general income levels”. Why cannot we say that there has been a serious decline in the real value of deposit insurance?

It is the decline in the real value of deposit insurance that should call for coverage enhancement, more particularly for small financial institutions for which deposits is the primary source of funding.

Going by the GDP deflator, inflation has averaged 12-13 per cent per annum in the past decade. That means coverage of close to Rs 4 lakh to keep the real value constant.

(The author is Vice-President (Economic Research), Shriram Group Companies, Chennai. The views are personal.)

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