Hike in deposit insurance cover welcome, but more deep-rooted reforms are needed

| Updated on February 10, 2020

A resolution process for troubled banks on the lines of the Bankruptcy Code for defaulting corporates now brooks no delay.

The decision by the Centre/RBI to substantially hike the insurance cover for depositors in scheduled banks from ₹1 lakh to ₹5 lakh is a welcome move that is likely to mend bruised public confidence in banks, lift financial savings and level the unequal playing field between State-owned banks and their private counterparts in their access to CASA deposits. With the ₹1 lakh deposit insurance limit set way back in May 1993, the impact of inflation and rising income levels had ensured that nearly 72 per cent of bank deposits by value remained unprotected by end-March 2019. The five-fold hike in insurance limit now ensures that the lion’s share of retail deposits by value are shielded from bank failures.

While this hike in insurance cover is positive no doubt, for it to truly deliver better depositor protection, the Centre and the RBI will need to act swiftly on three other follow-up measures. One, though deposit insurance in India covers banks with varying degrees of risk (public sector banks have a zero failure rate, while many co-operative banks fail each year), it is funded through uniform premiums levied on all banks, irrespective of their financial position. This is patently iniquitous and poses a moral hazard, because depositors in scheduled commercial banks, particularly PSBs, end up footing the bill for frequent payouts towards co-operative bank failures. Since the inception of DICGC (Deposit Insurance and Credit Guarantee Corporation), just 27 commercial banks have failed absorbing ₹296 crore, while 351 co-operative banks have turned turtle requiring payouts of ₹4,822 crore. Yet, it is the former that contribute 93 per cent of the premium collections. Quite a few committees, including the Jasbir Singh committee in 2015, have recommended differential risk-based premiums that will prevent such cross-subsidy and send out more realistic signals to stakeholders on the riskiness of the banks they’re dealing with. A second factor that substantially reduces the utility of deposit insurance in India, is the multi-year delays suffered by depositors in receiving claims from failed banks. An average of 4-6 years went by between a bank’s de-registration and the payout of depositor claims in FY18 and FY19, DICGC data show. Setting finite time-lines to the resolution/liquidation process for co-operative banks is critical to reducing these delays.

A final factor that results in many a slip between the cup and the lip for depositors, is the lack of an orderly resolution process for commercial banks when they are found to be short of assets to repay liabilities. In such cases, worries about systemic impact often prompt the RBI to try out various jugaad modes of resolution, including shotgun weddings, which prevent the expeditious liquidation of a troubled bank which then allows deposit insurance to kick in. Such a resolution process was discussed in the shelved FRDI Bill. But with a higher insurance cover in place, a resolution process for troubled banks on the lines of the Bankruptcy Code for defaulting corporates now brooks no delay.

Published on February 10, 2020

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