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To usher in a differential premium system for deposit insurance for banks, a Reserve Bank of India panel has made a slew of recommendations, including classifying banks into four risk categories, and a rising premium rate structure as a bank’s rating deteriorates.
In India, commercial banks, regional rural banks, local area banks, and co-operative banks are covered by deposit insurance with the premium being charged at a flat rate of 10 paisa for ₹100 of deposit.
The flat-rate premium system has been viewed as being unfair, as ‘low-risk’ banks are required to pay the same premium as the ‘higher-risk’ ones. With no inbuilt incentive for ‘higher risk’ banks to improve their risk profile, a flat rate system would accentuate the moral hazard problem.
Moral hazard implies that the parties to the deposit insurance, that is, a bank and its insured depositors get an incentive to take more risk because the cost of risk, in whole or in part, is borne by others, generally a deposit insurance agency.
Reward point The panel on ‘Differential Premium System for Banks in India’, headed by RBI Executive Director Jasbir Singh, came up with a Comprehensive Risk Assessment Module, whereby for each risk factor a bank is given a reward point (RP) based on the risk assumed in respect of that risk factor. A bank will get a higher RP for lower risk exposure.
It has classified banks into low risk, moderate risk, medium risk and high risk categories and assigned reward points to each category.
Based on the risk category a bank falls in, the effective premium rate could rise — 9.5 paise per ₹100 deposit for a low-risk bank; 10 paise for moderate risk; 11 paise for medium risk; and 12.5 paise for high risk. To promote the sanctity of the differential premium system, the committee recommended that there should not be any forbearance for non-receipt or late receipt of model-related information from a bank and any such default should earn the bank a straight downgrade of rating by a notch and, accordingly, premium be charged at the corresponding rate.
Seeking a hike In India, there has been persistent demand from stakeholders and public representatives in the recent past for a hike in deposit insurance cover from the current level of ₹1 lakh.
The committee observed that a hike in cover without calibrating the premium rates to the risk profile of the insured banks only exacerbates the moral hazard.
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