Fixing deposit insurance: Charge different premium depending on bank quality

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Updated: November 20, 2019 2:42:43 AM

Since not all commercial banks are as sound as HDFC Bank, say, and they too will have to pay higher deposit insurance, this will also give them an incentive to improve their functioning.

fix deposit, insurance, different premium, bank quality, RBI , DICGC, SBIIdeally, of course, DICGC should insure all deposits, or RBI should encourage banks to do this beyond the levels that DICGC insures.

Apart from a generous hike in the value of bank deposits that are insured by the RBI-owned Deposit Insurance and Credit Guarantee Corporation (DICGC)—India’s GDP has risen 25 times since the Rs 1 lakh limit was set in 1993—one of the first things DICGC must do is to charge differential premiums based on the riskiness of the bank whose deposits are being insured. For several decades, almost all the money paid out by DICGC when a bank fails has been to deposit-holders of cooperative banks; to that extent, since the bulk of the premium paid to DICGC is by the deposit-holders of commercial banks—that is where the bulk of bank deposits are—they are really giving a free ride to the cooperative banks. If, instead, the DICGC starts charging the premium based on riskiness, deposit-holders of better banks like HDFC Bank or SBI will pay a lower premium than those of, say, a Punjab & Maharashtra Co-operative (PMC) Bank Limited; these banks, then, will pass on this charge to their deposit-holders by giving them a lower interest rate on their deposits. And, since cooperative banks really attract deposit-holders by their higher interest rates, this will curb some of that. Since not all commercial banks are as sound as HDFC Bank, say, and they too will have to pay higher deposit insurance, this will also give them an incentive to improve their functioning.

Ideally, of course, DICGC should insure all deposits, or RBI should encourage banks to do this beyond the levels that DICGC insures. But, it is not clear if there are insurers/reinsurers who would like to take on such a large liability even if the default risk is low; and even if they do, the premiums may become too high. Of course, since the credit risk really depends on how well RBI is regulating these banks—it is, hopefully, to finally get complete powers over cooperative banks—the premiums will decline once RBI regulation is seen as more effective.

While fixing the new level of deposit insurance, the government would do well to keep in mind that, if a large number of depositors—or depositors with large deposits—don’t feel their money is safe and move it to post-office accounts or to the stock markets or somewhere else, interest rates will rise and this will hurt the economy. Politicians are happy not to insure big deposits on grounds these are owned by the well-heeled, but as SBI data shows, while just 0.2% of bank deposits are of more than Rs 1 crore, these comprise a third of the value of all bank deposits. And while it is true that, in the last several decades at least, there has been no failure of a commercial bank—RBI has ensured several weak private banks were taken over by other banks—it is worth keeping in mind that when US-64 collapsed around two decades ago, all but the small investors took a 30% hit; so, if big depositors are worried about the safety of their deposits, it is not without reason.

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