Deposit insurance needs overhaul, not tweaks

Manas R Das | Updated on August 31, 2021

Aggrieved lot A file picture of protesting PMC Bank depositors   -  Emmanual Yogini

The Financial Resolution and Deposit Insurance Bill needs to be revived, without the controversial ‘bail-in’ clause

The Deposit Insurance and Credit Guarantee Corporation (DICGC) (Amendment) Bill, 2021, was passed by Parliament on August 10 with a view to ensuring that the insured amount of ₹5 lakh is paid to the eligible depositors within 90 days of RBI placing the bank under moratorium.

The amendment sprouts from the PMC Bank failure which is under moratorium for almost two years. Since the amendment is not applicable retrospectively completely, this will ‘immediately’ benefit the eligible PMC Bank depositors.

Sections 17 and 18 of the DICGC Act, 1961 (hereafter Act) govern payments to the depositors of a bank under liquidation and a bank under amalgamation, respectively. In either case, the total time to be taken for paying the depositors of the bank in question shouldn’t exceed five months, but the actual time taken has been far more, mainly due to the liquidator/transferee bank not furnishing the required details within the stipulated three months. As far as DICGC is concerned, the average period for settlement of main claims after receipt from liquidators stood at 11 days in 2019-20, same as during 2018-19, and has remained within two months, as stipulated in the Act.

This implies that the appointment of liquidator, establishment of his office, etc., should be hastened. So is the case for supply of list by transferee banks.

At March-end 2021, at ₹5 lakh limit, 98.1 per cent of the bank accounts were ‘fully protected’ and 50.9 per cent of the ‘assessable’ deposits were ‘insured’. However, such high coverage limits may lead depositors with more than ₹5 lakh deposits in a bank either to split their accounts into separate legal entities, i.e., with ‘different right and capacity’ in the same bank, or migrate the ‘excess’ deposits to another bank/s. In both the cases, such depositors will enjoy multiple coverage, which, theoretically, can be unlimited.

Deposit Insurance isn’t intended to provide such unlimited coverage. Moreover, this thwarts ‘depositor discipline’ on the excessive risk-taking behaviour of banks. Accordingly, future increases in the coverage limit must be based on objective criteria, instead of being ‘bullet’ hikes, in order to leash this overexpansion of the safety net.

There are two ‘thumb rules’ for setting the coverage level: (a) on an average, the coverage levels should amount to twice per capita GDP and (ii) the coverage level should fully cover 80 per cent of the number of depositors but 20 per cent of the value of deposits. During 2020-21, at the current level, the insurance cover was around four times the per capita income.

Institutional coverage of Deposit Insurance should exclude the three RBI-designated Domestic Systemically Important Banks (i.e., SBI in the public sector banks group, and the ICICI Bank and the HDFC Bank in the private banks group) and the nationalised banks. Status quo is to be maintained in respect of coverage of the ‘eligible’ cooperative banks.

Depositor group coverage

Deposit Insurance coverage should be limited to the deposits of the ‘household sector’ and ‘Non-Residents’ only. This, in turn, would save the covered banks substantial sums on account of premium payment. The same would apply if Certificate of Deposits are excluded.

These rationalisations will mitigate to some extent the safety net being criticised as an “anachronistic subsidy”.

With the advent of e-money, indirect or ‘pass-through’ Deposit Insurance may be explored to protect the customers’ digitally stored value.

The second part of the amendment relates to pricing of the premiums to be paid by the insured banks which is now fixed at ₹0.12 per ₹100 of ‘assessable’ deposits per annum. Pricing of Deposit Insurance has been a vexing issue for DICGC despite Section 15 of the Act allowing ‘variable’ premium system and several prominent committees, including those of RBI and DICGC per se, vouching for it.

It’s high time risk-based pricing of premiums was brought in. This may monetarily benefit many banks who may belong to risk cells with the premium rate below ₹0.12. Instead of going in for complicated bivariate models of risk-based pricing, DICGC may start with univariate models with gross non-performing assets of banks as the determinant.

DICGC should base the premium on ‘insured’ deposits, instead of the current practice of ‘assessable’ deposits, which, again, will save considerable sums for the covered banks.

The recommendation by the 1999 RBI Report on Reforms in Deposit Insurance in India for instituting two Deposit Insurance Funds (DIFs) — one for the commercial banks and the other for the cooperative banks — needs to be implemented.

The capital of DICGC needs to be augmented, in a calibrated fashion, or at times of crises, as recommended by the RBI Report on Reforms in Deposit Insurance in India and the DICGCI’s Prasad-Gopalakrishna Internal Working Group.

Capitalisation of DIF through a line of credit or collateralised borrowing from the government at the times of crises was also recommended.

Comprehensive reforms needed

Does this amendment mean that a revised Financial Resolution and Deposit Insurance (FRDI) Bill is on the anvil? Instead of having a piecemeal approach to an important subject like Deposit Insurance and resolution of troubled banks, the FRDI Bill needs to be revived, without, of course, the controversial ‘bail-in’ clause.

The Bill had some positive aspects. It was for the first time that a Bill focused, in great detail, on resolution of troubled financial services providers. The procedures eschewed abruptness and allowed optimum forbearance to the financial services providers in trouble before weeding them out for resolution. Combining receivership and liquidation in one institution was healthy and would have accelerated the resolution process. Integrating Deposit Insurance and resolution in one law and bringing both under one institutional framework was another positive.

However, there should be two Resolution Authorities — one for banks and the other for non-banks, as both are genetically different.

DICGC should be designated as the deposit insurer and resolution authority for banks only and be independent of RBI.

Given the safe status of Indian banking system, the need for a separate Resolution Fund is not called for, at present. Therefore, transitioning the current DIS from ‘Pay-box’ to either ‘Pay-box Plus’ or ‘Risk Minimizer’ or ‘Loss Minimizer’ mode would suffice. In Pay-box plus, the DIS, in addition to the pay-out, carries out the resolution of failed banks and/or supervision and/or macro-prudential regulation, even including replacement of the management.

In Loss Minimizer, the DIS actively engages in selection of least-cost resolution strategies. In Risk Minimizer, the DIS actively engages in comprehensive risk minimisation functions including risk assessment/management, early interventions and resolution powers, and in some cases, prudential oversight responsibilities.

In sum, the DIS in India needs to be overhauled.

The writer is Former Senior Economist, State Bank of India

Published on August 31, 2021

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