Deposits with banks have somehow been the mainstay of Indian household’s financial savings, perhaps due to their simplicity and the implicit safety. Though mutual funds, insurance and other alternative assets have been making inroads, Indian households still park 45 per cent of their financial assets in their friendly neighbourhood banks.

Deposit insurance, therefore, assumes importance in helping the regulators retain the trust of the masses in the financial system. India was the second country after the US to start a Deposit Insurance Corporation, in 1962. This was in response to the banking crisis in Bengal and the closure of the Laxmi Bank and Palai Central Bank in the post-Independence period. DICGC was formed with the merger of the Credit Guarantee Corporation in 1978.

Globally too, deposit insurance has moved into the spotlight since the global financial crisis in 2008, which witnessed many large banks going under. The collapse of the Silicon Valley Bank in 2023 and the erosion of the assets of all US banks, further underlined the need to provide a safety net for depositors.

Fortunately, in India, larger commercial banks, where 93 per cent of household bank deposits are parked, have been on a relatively steady footing. The last of the commercial banks for whom deposit insurance was paid were Sikkim Bank in 2000 and Benares State Bank in 2002. Since then, RBI has been adroit in rescuing troubled banks by either merging them with other financial institutions such as Lakshmi Vilas Bank and IDBI or giving a plan to reconstruct their dues and to continue operations such as YES Bank.

The problem however persists with cooperative banks which attract deposits from large number of urban dwellers and currently account for 7 per cent of household bank deposits.

What works

The long-overdue increase in the deposit insurance coverage in February 2020, from ₹1 lakh to ₹5 lakh has helped improve the insurance coverage ratios in the country. Though the coverage limit has been revised six times since inception, the limit had been left unchanged since 1993. With this revision, the percentage of fully protected accounts improved from 92 per cent to almost 98 per cent. This makes Indian deposit insurance match other countries which have similar proportion of fully insured deposits.

Similarly, the percentage of insured deposits to total assessable deposits too witnessed a large improvement from 27.4 per cent in 2019 to 50.9 per cent in 2020. This ratio is currently at 43.1 per cent, which is lower than the global average of 47 per cent, but it is far better than the 30 per cent in other lower middle-income countries.

The deposit insurance fund of the DICGC which is made of the premium collected and the return on the investments made from this fund, stood at ₹1,98,753 crore towards the end of March 2024.

The ratio of the fund to insured deposits stood at 2.11 per cent, which is in line with the global median of fund sizes of other deposit insurers of 2 per cent in the last decade.

The insurance coverage in India is, therefore, largely in line with the philosophy of IADI (International Association of Deposit Insurers) which states that deposit insurance coverage should be “limited, credible and cover the large majority of depositors but leave a substantial amount of deposits exposed to market discipline.”

The UCB conundrum

That said, the Indian banking landscape with large number of tiny cooperative banks which are operating with relatively lighter regulations and carry higher risk creates unique challenges in deposit insurance. Of the 1997 banks registered with the DICGC towards the end of March 2024, there were just 140 commercial banks but 1,857 cooperative banks.

And failures have been more among cooperative banks in recent years. The RBI has cancelled the licences of 78 urban cooperative banks since 2014; 10 of these licences were cancelled in 2024. Since inception, ₹295.9 crore has been paid towards insurance claims of 27 commercial banks. In contrast, around ₹16,000 crore has been paid to settle the claims of depositors of urban cooperative banks.

But despite the higher risk in cooperative banks, the insurance premium charged to them is the same as other commercial banks — 12 paisa on every ₹100 of assessable deposits. There is a strong case for charging premium based on risks in the business.

This will address the moral hazard in charging a flat premium. It will call for an assessment of the risks in banks’ books based on granular data on their credit book, governance practices, capital adequacy and asset quality.

According to the IADI, approximately half of deposit insurers globally levy differential premiums which consider additional risk measures and thus price risk on a more granular basis; the share was just 30 per cent in 2010.

Other issues

The time taken by the DICGC to settle claims can also be shortened to meet global standards. The IADI recommends reimbursement of the claims of most depositors within seven working days. Around 70 per cent of European deposit insurers and 40 per cent of their Asian counterparts commence payouts within seven days.

This timeline mandated for DICGC is, however, quite generous. The Corporation must pay depositors of the banks placed under All Inclusive Direction (AID) within 90 days from the date of imposition of AID. In case any scheme of amalgamation or other scheme, this period could be extended by 90 days.

These timelines may have been set keeping in mind the lower technology adoption by cooperative banks. But depositors should not be penalised for the bank’s tardiness in digital adoption. Finally, the DICGC needs to review the coverage limit per depositor at 5-year intervals to account for inflation and growing bank deposits. The share of insured deposits to total deposits has already moved down from 50.9 per cent in 2020 to 43.1 per cent now.