IMany people would have been hard pressed to miss the words “deposit insurance” on their newsfeeds last month. It was shut down by the US-based Silicon Valley Bank. The Federal Deposit Insurance Corporation, or FDIC, initially announced that deposits with the bank would be repaid. This has led to discussions on the system of deposit insurance in India. Our experience shows that the pricing and payment process needs a lot of improvement. Depositors need to understand that bank security cannot be taken lightly.
deposit insurance in india
Deposit insurance in India is managed by Deposit Insurance and Credit Guarantee Corporation (DICGC). DICGC insures all bank deposits up to a maximum of Rs 5 lakh. This means that if your bank fails, you will have access to deposits of up to Rs 5 lakh. Any amount above this will be lost. Every bank has to pay an annual premium of 12 paise per Rs 100 on assessable deposits to the DICGC. That is, if a bank has a soft deposit of Rs 100 crore, it will pay Rs 12 lakh as premium. DICGC will be solvent when the insurance exceeds the premium paid.
There are two interesting features of such insurance in India. Firstly, it is rarely used in case of commercial banks. It’s not that banks don’t fail, they are not immune. India’s response has been to merge the failing bank with a larger bank, often a public sector bank (PSB), and move down the road. There is no prescribed procedure, RBI takes a decision based on the circumstances. For example, Yes Bank was taken over in 2020 by a consortium of banks led by State Bank of India. Lakshmi Vilas Bank was Merged With DBS Bank in 2020, Global Trust Bank In 2004 it was merged with Oriental Bank of Commerce, which along with United Bank of India was later merged with Punjab National Bank in 2020. Vijaya Bank It was merged with Bank of Baroda in 2019.
As a result, the question of closing the bank and paying deposit insurance does not arise. This is not to say that depositors’ accounts have not been frozen. There was a withdrawal in the case of Yes Bank Limited 50,000 for a period of time up to Rs. But if there is a strategy to never allow a commercial bank to fail, then why charge them an insurance premium?
Second, in the case of co-operative banks, it takes a long time for the depositors to receive their money. As of 2019, on an average, depositors got around six years to get their money. When a bank fails, the liquidator of the bank has to make a list of all the depositors, and hand it over to the DICGS. This process causes delay.
This imposes a huge cost, especially as depositors in co-operative banks are likely to be from the low to middle income group. For example, for the bank failures in 2017-18, if one assumes that the funds would have earned an interest of even 8 per cent, depositors effectively lost 26 per cent. The process of deposit insurance payment is not smooth, it imposes a lot of uncertainty on the depositors.
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rethink bank failures
There is a big philosophical question on deposit insurance. Does the existence of insurance make banks careless? Yes, as long as the insurance premium is not based on the risk of bank failure, and central bank supervision fixes the problems quickly. Does the current insurance pricing ensure that the DICGC fund would be able to pay deposit insurance claims if these banks were to be closed? It’s not clear, and there’s every chance that if we ever end up closing the banks instead of merging them, the premium will be higher. Insurance premiums for commercial banks need to be calibrated in such a way that they can be paid in the event of their failure.
The areas for improvement on deposit insurance are clear. There is a need to make transparent the cost of closing a bank and paying depositors versus the cost to the taxpayer of merging a bad bank with a good one. This may force us to rethink our strategy on bank failures. Bank failures are not uncommon, and a special resolution regime needs to be set up. The government withdrew the Financial Resolution and Deposit Insurance Bill (FRDI) in 2018 and the time has come to bring it back.
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Meanwhile, depositors need to understand that banks are not always safe. There is a possibility that the accounts may be frozen for some time due to bank failure. If the bank closes, deposit insurance will only be paid up to a specified amount, and may take a long time to materialize. A strategy of diversifying deposits across multiple banks, and investing funds in alternative asset classes such as money market mutual funds, private equity and real estate etc., may be the way forward.
Renuka Sane is Director of Research at TrustBridge, which works on improving the rule of law for better economic outcomes for India. Thoughts are personal.
(Edited by Ratan Priya)