Why your bank can’t go bust

All the number-crunching in the lead story ( Read: Is your bank on a short fuse? ) reveals that there are Indian banks that have inadequate capital to carry on operations and also banks that run a liquidity risk.

Does this mean that the weaker banks can go bust? Should you worry about it as a depositor?

The answer is no. In India, instances of commercial banks going bust are rare and the RBI has put in place many safety net mechanisms to protect depositors. Here they are.

Capital infusion In the case of public sector banks which face a shortfall in their capital, don’t forget who their key stakeholder is — the Central Government. Whenever PSU banks require capital, either to meet statutory norms or to fund lending activity, they look to the Government for further capital infusion. Hence, they enjoy the Government’s tacit backing at all times. The Government’s present equity stake in PSU banks varies between 55 and 82 per cent and it is expected to infuse close to ₹90,000 crore in new capital into its banking arms over the next five years.

Lender of last resort We read about the RBI being the ‘lender of last resort’ in all our school textbooks. What this means in practice is that whenever a bank faces a liquidity crunch, it can count on the RBI to provide temporary support to help it resolve asset-liability mismatches. Most banks have over a fourth of their deposits parked in Government securities as a part of their Statutory Liquidity Ratio requirements.

In the case of a liquidity shortfall they can pledge these with the RBI to raise cash.

Deposit insurance In spite of all these, if a bank does turn unviable, as a depositor you have yet another safety net to fall back on. Your deposits are insured under the Deposit Insurance and Credit Guarantee Corporation of India (DICGC), a wholly-owned subsidiary of the Reserve Bank of India. All deposits in a commercial bank, including branches of foreign banks functioning in India, local area banks and regional rural banks, all state, central and primary cooperative banks, also called urban cooperative banks, are covered by the DICGC.

To check if your bank is insured, you can look up the DICGC site, www.dicgc.org.in and check the list of insured banks.

Deposits up to a sum of ₹1 lakh covering both principal and interest are insured. If you own multiple bank accounts, each account is eligible for this cover.

But given that affluent investors often have much more than ₹1 lakh sitting in their bank deposits, they should know that only a third of the deposits in value terms today enjoys deposit insurance. Therefore, to ensure that you are fully covered, you need to apportion your deposits across different banks up to the ₹1-lakh limit, rather than put a huge sum in one single bank.

So far in India, beneficiaries of the deposit insurance system have mainly been the urban co-operative banks, which have had a high rate of failure.

During 2012-13, the DICGC settled claims worth ₹200 crore in respect of deposits with 63 co-operative banks.

Merging with a stronger bank In recent years, while many co-operative banks have failed, there have been no instances of a scheduled commercial bank actually failing in India and not repaying its depositors. When a bank is in trouble, there are enough early warning signals for the RBI to step in. What usually follows is a merger or consolidation of the bank’s operations into a larger, well-established bank. There were a number of commercial banks that failed in India in the 1900s. Between 1913 and 1955, for instance, 1,489 banks failed. But even after Independence, banks continued to fail.

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Some bigger banks such as the Palai Central Bank failed due to inadequate reserves and a high percentage of unsecured advances. The public outcry that followed gave birth to new legislation to tackle bank failures.

In the Sixties, the RBI was granted powers to consolidate, compulsorily merge and liquidate small banks. From 1980 to 2007, 27 banks were merged. Since the reforms in 1993, thirteen RBI-supervised bank mergers have taken place in India. Hence, no scheduled commercial bank has failed in India since the Nineties, as the RBI has always stepped in to safeguard depositor interest.

In 2003, Punjab National Bank took over Nedungadi Bank, the oldest private sector bank, after the bank’s net worth was completely wiped out due to accumulated losses.

The bank, at that point in time, had a capital adequacy ratio of a negative 2 per cent. In the case of Global Trust Bank, after various financial discrepancies came to light, the bank was merged with the Oriental Bank of Commerce. There have been several similar other instances. (see table)

While depositors’ interest has been safeguarded even in the worst of times, should a bank go bust, the wait until the entire money is returned can be nerve-wracking.

When a bank is in trouble, the RBI usually puts the ailing bank under moratorium, and limits the amount a depositor can withdraw during the period. You may end up spending sleepless nights until you get back your money. To avoid all the stress, it may be wise to stick with scheduled commercial banks rather than cooperative banks.

The list of commercial banks is available at the RBI site www.rbi.org.in . Also, avoid putting all your money in one bank. Apportion lesser amounts to some of the weak banks mentioned above.

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