The global financial crisis underscored the importance of having a robust deposit insurance system (DIS) for the banking system across the world. A 2014 IMF paper estimated that nearly 112 countries (59% of 189 countries covered in the study) had a DIS. It was in 2008, that Australia and New Zealand introduced guarantees for the first time, whereas a significant majority of other countries increased their insurance coverage.
Three issues in the DIS merit special attention. First, DIS is asymmetric in nature, with 84% of high income countries having a system in place. In contrast, explicit deposit insurance is less widespread among low income countries, at about 32% of countries (India included). Second, by and large the DIS has fulfilled its primary objective of preventing open runs on bank deposit during and after large shocks to the global financial system. Third, the DIS, though largely effective in preventing large-scale depositor runs, has not priced the risk correctly. Interestingly, there are analytical papers by Viral Acharya on this issue of pricing deposit insurance premiums.
The concept of insuring bank deposits in India received attention as early as 1948 after the banking crises in Bengal. The Deposit Insurance Corporation (DIC) Bill and the subsequent Act finally came into force on January 1, 1962. With the integration of the Credit Guarantee Corporation of India Ltd., in July 1978, the title of the Act was changed to The Deposit Insurance and Credit Guarantee Corporation Act, 1961.
You may also like to watch:
In India, at present, all deposits except (i) Deposits of Foreign Governments, (ii) Deposits of Central/State Governments, (iii) Inter-bank deposits, (iv) Deposits of the State Land Development Banks with the State Co-operative Banks, and (v) Any amount due on account of any deposit received outside India, are insured by DICGC. Though banks are required to pay advance premium on assessable deposits (demand plus term) on half-yearly basis, the liability of DICGC is limited to only `1 lakh per depositor or $1,538 ($2.5 lakh in the US). Moreover, deposits of Commercial Banks (ASCBs), Regional Rural Banks (RRBS), Local Area Banks (LABs) and Co-operative Banks are covered by deposit insurance with the premium being charged at a flat rate of 10 paisa for `100 on the entire assessable deposits of the banking system!
Claims under the DIS in India have been few and far between. Mostly, such claims too have arisen only due to failure of a few Co-operative Banks. India has had only very minor episodes of commercial bank failures till date. One reason often cited for this is that banks in India largely fund themselves through retail deposits rather than wholesale funding, which has often been identified elsewhere as a source of vulnerability to external contagion in other countries.
Now coming to the core issue of pricing deposit insurance worldwide, it has evolved over time through reforms adopted by various jurisdictions based on experience and international developments. Most DIS initially structure an ex-ante flat-rate premium system/one-size-fits-all approach for all banks as they are simple to design, implement and administer. However, the problem with such systems is that they are invariant to the level of risk that banks pose to the deposit insurance system. Flat-rate premiums are also unfair in practice as low-risk banks are required to pay the same premium as higher-risk banks. Thus, on this account, there is no incentive for higher risk banks to improve their risk profile, which is completely counter intuitive.
As discussed earlier, in the Indian context we have a flat premium rate with a static insurance cover of `1 lakh per depositor (since May 1993). Over the last 25 years, there has been a paradigm shift in the profile of customers and the conduct of business by banks. In particular, over the years, the level of insured deposits as a percentage of assessable deposits has declined from a high of 75% to 30% in FY16, due to such shift. In fact, on the basis of RBI data as on March 2015 (latest available), term deposits of ASCBs of less than `1 lakh were only 9.1% of total term deposits, 58% of term deposits being more than `15 lakh. Effectively, the latter get even less than 2% of their deposits insured, though the premium is paid by the banking system on the entire value of deposits held by them.
So, what would be the ideal deposit insurance premium structure in India in line with international best practices? It may be noted that most countries in the world including south Asian countries now adopt a risk-based premium for deposit insurance. For example, Federal Deposit Insurance Corporation (FDIC) in USA adopts a risk-based pricing model that is determined by (i) capital ratios based on financials and (ii) CAMELS ratings derived from on-site examinations. Given that banks in India are already being monitored by RBI under Risk Based Supervision (RBS) it would be prudent and sound to introduce a risk-based pricing model for deposit insurance in India with premium tied to risk rating of the bank. Additionally, to be fair to banks, the premium payable by them should be calculated on the amount of cover available and not the entire assessable deposits of customers. Further, with hardly any claims, there is room for the premium rate itself to be reduced. The insurance expense being significant, this is yet another area where profitability of banks is adversely impacted without adding commensurate value to customers. Introducing such fairness into the system will definitely bolster industry support for the DIS.
Clearly, the time has now come to move ahead with a risk based and fair DIS in India!