India’s deposit insurance framework needs an urgent recalibration. The threshold of Rs 5 lakh is inadequate in the current economic landscape where deposit sizes have grown substantially.
A report by CareEdge Ratings suggests that the optimal range for deposit insurance should be between Rs 5.2 lakh and Rs 21 lakh. The recommendation comes after modelling various approaches to determine the ideal level of protection and it warrants serious consideration.
The insurance deposit scheme is once again in focus after the Reserve Bank of India earlier this month superseded the board of New India Cooperative Bank over its financial health and governance issues, triggering panic among depositors.
The Mumbai-based lender has been barred from taking new deposit, and customers and extending loans for at least six months. Its former CEO was recently arrested for allegedly embezzling Rs 122 crore, pointing to the larger menace of poor governance in the co-operative banking sector, as this column wrote the previous week.
The inadequacy of India’s deposit insurance is evident when compared globally. In US dollar terms, the Rs 5 lakh ceiling remains low, offering insufficient protection to depositors, particularly those who rely on banks as a haven for their life savings.
As of March 31, 2024, insured deposits stood at Rs 94.1 lakh crore, covering 43.1 percent of all assessable deposits. While a high 97.8 percent of accounts are covered, the absolute protection level remains far from enough.
The flaws in the system are not limited to the coverage amount. A fundamental issue lies in the blanket flat rate charged for deposit insurance premiums.
Commercial banks bore the lion’s share, contributing 94.4 percent of the total premium in FY24, while co-operative banks — historically more prone to failures — have disproportionately benefitted from insurance payouts. The imbalance highlights the need for a risk-based pricing model that aligns insurance premiums with the risk profile of different banks.
A one-size-fits-all approach is outdated and inefficient. Beyond these structural issues, the case for higher insurance gains further merit in light of rising bank failures.
More banks are failing
In 2024 alone, the RBI cancelled licences of at least a dozen co-operative banks due to regulatory violations.
The trend is alarming — 15 cooperative banks lost their licences in 2023 and 43 in the past four years. Each failure erodes depositor confidence and fuels concerns about the safety of their funds.
It is against this backdrop that RBI deputy governor Rajeshwar Rao’s suggestion of full deposit insurance coverage for certain depositors, such as senior citizens and small depositors, is relevant.
Rao proposed an alternative model that ensures complete protection for vulnerable depositors, acknowledging the need for a stronger safety net. This is a welcome step but a piecemeal approach may not be enough.
The failures of co-operative banks have already triggered a shift in depositor behaviour, with many moving funds to larger, more stable banks.
The lessons from the Silicon Valley Bank (SVB) crisis in the US is a stark reminder of the consequences of financial instability.
While India has, so far, avoided large-scale bank collapse, the increasing number of co-operative bank failures suggests that a trust deficit is emerging. If this continues, smaller banks will struggle to attract deposits, weakening their position in the financial system.
Historically, India has response to the need for enhanced deposit insurance has been slow. The deposit insurance guarantee scheme was set up in 1961 but the insured amount was raised to Rs 1 lakh only in 1993. It took nearly three decades for the next revision when the coverage was increased to Rs 5 lakh in 2021. This pace of reform is insufficient even as the economic environment is changing at a much faster rate.
A more dynamic approach is required — one that periodically reassesses deposit insurance levels in line with economic growth and depositor needs.
Who will foot the bill?
The key question is who will bear the cost of expanded deposit insurance? A higher coverage limit undoubtedly comes with financial implications. However, a well-structured model could distribute this cost effectively.
Risk-based premiums, where banks pay according to their risk exposure, can ensure fairer pricing. Additionally, offering depositors the option to pay a premium for full coverage could be explored. The Deposit Insurance and Credit Guarantee Corporation (DICGC) must find a balance that protects depositors without overburdening banks.
India’s deposit insurance framework needs an urgent overhaul. A higher coverage threshold, a risk-based premium structure and a mechanism to ensure swift payouts in case of bank failures are crucial.
Without these changes, depositor confidence will continue to erode, forcing people to look beyond the banking system. This will be disastrous for financial stability. The RBI and policymakers must act decisively before trust in the banking sector is further undermined.
Source: www.moneycontrol.com
