The recently released Financial Stability Report (Issue No 27) of the RBI has accorded enhanced coverage to ‘deposit insurance’ (DI). For instance, ‘Deposit insurance’ occurs 27 times in the latest FSR as against zero to 18 times in Issue No 7 (June 2013) to Issue No 26 (December 2022).

The background to this welcome feature is sourced from the recent bank failures in the US — Silicon Valley Bank and Signature Bank — which were resolved quickly with interventions from the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board. This could be accomplished because the US has established systems and procedures to resolve the problem banks. However, the failures did raise issues on which the US started thinking, as evidenced from the FDIC’s May 1, 2023, publication ‘Options for Deposit Insurance Reform’.

Paragraph 3.4 of the current FSR is devoted to the reform approaches deliberated in the FDIC report, which implies a positive change in mindset.

The Indian Deposit Insurance System is the second oldest sovereign-backed system in the world having been set up in 1962 after the FDIC was established in 1933. The Deposit Insurance and Credit Guarantee Corporation of India (DICGC) is a wholly-owned subsidiary of the RBI, but, comparatively, its operations are low-profile and, more importantly, it is practically untouched by any reforms hitherto, despite recommendations by many committees.

But this should not mean that DI reforms should be kept in abeyance. Besides the traditional risks, banks are becoming increasingly vulnerable to new and emerging risks. No doubt, the recent US bank failures were primarily driven by their inappropriate management of interest rate and concentration risks as well as ineffective internal control and systems. But the impact could have been contained, if the uninsured depositors, who were competent to track their banks’ affairs, had abstained from digital transfers of their deposits from the weakening banks, and tom-tomming about it on social media. This prompted the small depositors to follow suit, which triggered the runs.

Certainly, the Indian banking system is stronger today than before. However, from the DI viewpoint, the trend in the number and incidence of uninsured depositors and their deposits, particularly after the DI limit was hiked to ₹5 lakh in 2020, evokes concern.

Over the three years — that is, from 2020-21 to 2022-23 — while the total number of accounts grew by 18.8 per cent, the number of accounts not fully protected [amounts above ₹5 lakh] by DICGC grew by 25 per cent, from 48 million to 60 million. As proportion to the total number of accounts, it rose from 1.9 per cent to 2 per cent (Table 1).

Further, the uninsured deposits (UDs) are increasing rapidly as can be observed from Table 2, according to which both UD and its ratios to assessable deposits (ADs) increased during the three years. (AD is the total deposits less the ‘specified’ deposits as mentioned in Section 2(g) of the DICGC Act, 1961).

While the total UD grew by 33.7 per cent — public sector banks (26.8 per cent), private banks (46.3 per cent) and co-operative banks (22.5 per cent) — the UD/AD ratios went up by 490 basis points in total: PSBs (460 bps), private banks (310 bps) and co-op banks (450 bps). In addition, the cyber risk has become paramount, as the current FSR emphasises (especially in III.1.5 and III.4.3).

So what does one do? Should there be unlimited coverage, or a high DI limit and simultaneous levy additional premium, ex post, on those accounts made good over and above the DI limit, in case of a failure? Or, should DI be denied to some high-value deposits like the Certificates of Deposits which the RBI Report on Reforms in Deposit Insurance in India (1999) had recommended? There are many other questions on coverage that necessitate deliberation.

Risk-based premium

In addition to the coverage issue, two other prominent issues should have been addressed in the current FSR. One relates to adoption of a risk-based premium system. For instance, asking D-SIBs (Domestic Systemically Important Banks) to pay the same premium as fragile co-operative banks is illogical and acts as a tax on the former. Several committees have recommended a risk-based system, and globally an increasing number of jurisdictions are adopting risk-based models. Moreover, the DICGC Act, 1961 allows for a ‘variable’ system.

The second issue is about protecting the sacrosanctity of the Deposit Insurance Fund (DIF). The reserve ratio (ratio of DIF to insured deposits), which stood at 2.78 per cent at March-end 2019, declined sharply and remained below 2 per cent till March-end 2022. March 2023 saw it improving a shade to 2.02 per cent. The RBI 1999 Report considered 2 per cent as “reasonably adequate.”

Despite several criticisms, increasing number of countries have adopted DI, and countries already having the system are modernising it. If the Utkarsh 2.0’s (that is, the RBI’s Medium-term Strategy Framework 2023-25) vision of sustaining financial stability and enhancing the trust of citizens in the RBI is to be accomplished, then DI reforms need urgent attention.

The writer is a former senior economist of SBI, and author of ‘Deposit Insurance and Resolution in India’. Views are personal

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