Last week, what possibly disappointed the markets wasn’t the expected 0.25 percent rate hike by the US Federal Reserve but the seemingly contradictory comments from chairman Jerome Powell and treasury secretary Janet Yellen on deposit insurance as a banking storm raged.
Powell said all depositors were safe but Yellen commented that guaranteeing entire deposits (blanket cover) wasn’t possible. Yellen later backtracked from the statement.
These comments came in the middle of a banking sector crisis, which has been roiling markets across the globe, adding to the panic. Yellen’s comments couldn’t have come at a worse time—three US banks have failed in recent days and more are staring at a crisis.
The case for a bigger cover
Now, let’s look at the merit of a higher deposit insurance cover.
Certainly, full deposit insurance isn’t an easy decision. It will significantly add to the cost of deposit insurance. There is also the question of who will bear the cost.
If all deposits are guaranteed, it can inject a level of recklessness into the way banks handle public money. Careless deployment of funds in unworthy credit and investments and oversight of risks are some of the likely problems that can crop up.
But the idea isn’t entirely impossible.
If the banks drop the ball, it is the regulator’s job to ensure that they don’t go rogue. It can lay down strict rules on where the depositors’ money is deployed and to who is it lent.
The higher cost of insurance should either be borne by the bank —because they use the deposits for lending business— or the customer, who wants a bigger cover.
Share the burden
In my view, the higher cost of deposit insurance needn’t necessarily be borne by the bank alone, as is the case now.
It can be left to the customer to choose as an option. That way, a higher deposit insurance cover won’t hurt the system. It will be a customer’s choice, just like any other insurance product.
The customers who want a higher cover beyond what is on offer should pay for it, pretty much like insuring any other assets.
Several experts have argued in the favour of this move. Billionaire hedge fund manager Nelson Peltz suggested to CNBC the government should guarantee all bank deposits but customers should be charged for insurance.
“You’re creating income for the Fed, and in exchange for that they insure the overage,” Peltz said.
Why the need for bigger deposit insurance cover?
The answer is simple. One of the biggest fallouts of the collapse of small banks will be money moving to bigger banks as depositors seek safety. The remedy lies in providing a full cover to the depositor.
The right size of deposit insurance is an issue not just confined to the US but India as well.
In the US, the Federal Deposit Insurance Corporation rules depositors are offered protection up to $250,000 (against Rs 5 lakh in India). But, in collapsed banks like SVB, the ratio of uninsured deposits was as high as 94 percent.
What about India?
The Deposit Insurance and Credit Guarantee Corporation covers deposits up to Rs 5 lakh in all RBI-regulated banks. This covers the majority of customers (in terms of number) but only a fraction when it comes to the size of deposits.
This amount is inadequate, considering the reliance of senior citizens, who can’t risk the volatility in equities and related instruments, on bank fixed deposits.
India used to have just a Rs 5,000 insurance cover till 1970 before it was revised to Rs 10,000. In 1976, the cover was raised to Rs 20,000, to Rs 30,000 in 1980, Rs 1,00,000 in 1993 and to Rs 5 lakh in 2020.
It is the customer’s call
What if I, as a bank depositor, want to insure my entire deposit? Shouldn’t I be given an option?
One big takeaway from the crisis is that if the confidence of customers has to be restored, insurance needs to cover a larger percentage of deposits. What should that level be? Should it cover the entire deposit? These are questions that need to be debated.
The US crisis offers an opportunity to governments across the world, including India, to rework their deposit insurance model and also restore depositors' faith in the system.
(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)
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