Should RBI oversee deposit insurance?

One of the signature reforms of the Modi Government has been to legislate an exit policy, and ushering in global confidence in the debt resolution process. However, a major segment of the economy — financial institutions, including banks — remains uncovered. The earnestness of the government and the RBI pushed the DHFL case to the IBC (Insolvency and Bankruptcy Code) route, albeit in a modified form.

It is understood that in a recently held FSDC (Financial Stability and Development Council) meeting, the FRDI (Financial Resolution and Deposit Insurance) Bill was discussed. However, the recent meltdowns in the NBFC (non-banking finance company) and HFC (housing finance company) space call for a pragmatic approach for an early extension of an exit policy to the financial sector.

Former Finance Minister Arun Jaitley first spoke of bringing a similar law in his 2016-17 Budget speech while outlining the gap in resolving bankruptcy situations in financial firms. Eventually, the FRDI Bill was introduced in Parliament. But vociferous appeals against the Bill prompted the government not to pursue its enactment. The fundamental issue was the “bail-in” principle, which was perceived as going against the interests of common depositors in case of a bankruptcy situation.

Banks and deposit-taking financial institutions, among others, operate and sustain on the foundations of ‘faith’ and ‘trust’ — that the depositors’ money is safe in their hands and will be returned on demand. The deposits in banks and interest thereon up to a sum of ₹1 lakh (since proposed to be raised to ₹5 lakh) are guaranteed by the Deposit Insurance and Credit Guarantee Corporation of India (DICGC).

The DICGC functions under the overall supervision of the Reserve Bank of India and one of the nominated Deputy Governors supervises the management as the ex-officio chairman of the Corporation. In effect, it is owned and run by the RBI. The initial coverage of ₹1,500 only per depositor was enhanced to ₹5,000, ₹10,000, ₹20,000, ₹30,000 and ₹1 lakh in January 1968, April 1970, January 1976, July 1980 and May 1993 respectively. Now it is proposed to be raised to ₹5 lakh.

The DICGC currently charges a flat rate of 0.05 per cent of the deposit amount per annum as a premium. A look into the balance-sheets of the corporation suggests that it has been settling claims mostly relating to co-operative banks. While there is no questioning the need for insurance cover, a few other issues come to mind: Why should the DICGC, run under the supervision of RBI, undertake the business of insurance? Why should the premium ( de facto , a levy) be charged at a flat rate without taking into consideration the risk of failure of an individual bank? And, why should insurance cover be limited to ₹5 lakh?

Low cover

Even if the inflation trajectory over the years is factored for covering the real value of ₹1 lakh in May 1993, the amount of nominal cover should now be several times over ₹5 lakh.

What about the coverage of other deposit-taking institutions like NBFCs, HFCs, et al . In fact, such risk coverage should be entrusted to the insurance industry, which should develop ‘deposit insurance’ as a line of business and tailor products to suit the market ethos; the premium should reflect the risks involved. The DICGC can be exclusively devoted as a resolution corporation.

This transition will have several beneficial consequences: banks and other institutions offering a higher rate of interest on deposits will contribute a higher rate of premium for the coverage of risk; the insurance industry would undertake an independent assessment of the risk of the institution’s sustainability, which will be a public information and, thus, reduce the opacity of the financial condition of banks and NBFCs, in particular; will push financial institutions to build a stronger risk-management framework; independent financial advisers will be better armed to render efficacious advice to their clients; and customers will have a greater possibility of taking informed decisions.

The RBI, like most banking industry supervisors globally, has an approach of comprehensive superintendence over banks and shadow banks. Hence, even if the RBI does not want to concede the space of providing deposit insurance cover to the insurance industry, it could at least run DICGC as an insurance company. It could make coverage available at whatever level depositors of financial institutions want and charge premiums based on risks underwritten rather than levy a cess, where well-run banks subsidise the laggards, particularly cooperative banks.

Periodic review

Further, the sum at risk limit should be on a dynamic platform and reviewed periodically with reference to increases in GDP per capita and inflation so that individual depositors are, by and large, immunised from the risk of failure of deposit taking financial institutions and “bail-in principle”.

It is unfair to penalise the good banks with sound balance sheets with a flat premium. Ultimately, the investors pay for it. If the RBI feels that the premium, which is currently paid by the banks from their earnings, will become a burden for raising the amount of coverage beyond ₹5 lakh, it can well be charged to the individual depositor’s account.

The premium rate charged will indicate the risks that the depositors undertake in parking their money in financial institutions with vulnerable balance-sheets. The RBI cannot be providing a safety valve to inefficient and mismanaged entities like PMC Bank by providing a flat coverage and charging a flat rate of premium for insuring only a limited amount of the risk that too only of banks’ depositors.

Once the interest of individual depositors is secured through adequate, appropriate and commercially priced insurance, the exit policy (FRDI) can be tailored to cover all financial institutions as well.

Banks are not allowed to fail in India to uphold, and rightly so, the ‘faith’ and ‘trust’ in the banking system. In order to protect the interest of depositors, failing banks have in the past been merged mostly with public sector banks. And, finally, taxpayers have been made to foot the bill for the wrongdoings of the managers of banks. The liberalised market philosophy must deal with the bankruptcy situation of these institutions as well.

The writer is a former Chairman SEBI and LIC

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