This will help take pressure off sound cooperative banks and instil confidence among small depositors
It’s much easier to define financial or banking instability than stability. A strong pointer of banking instability is whether deposit insurance is becoming part of the public narrative. If so, it means people are worried about safety of their deposits.
The PMC (Punjab and Maharashtra Co-operative) Bank case and a string of banking frauds have highlighted the matter like never before. The worries are taking hold as rumour mills are working overtime on WhatsApp and the social media. To be fair, the Reserve Bank (RBI) and the government have taken some steps to dispel the fears.
All said and done, people get the signals. It’s not without reasons that historians say crisis related to banking, and that too on public deposits, is one of the toughest to resolve.
This piece reviews the history of deposit insurance in India to make sense of the issues plaguing the system.
It all started in the US
Cut to the Great Depression. Close to 9,000 US banks failed during 1930-33, shaving off $1.3 billion of depositors' money. In 1933, one of the first decisions of the newly-elected US President F D Roosevelt (FDR) was a “bank holiday’ where banks were closed for a week (March 6-12, 1933) to give the new government and financial regulators space to evaluate lenders before allowing them to reopen.
The next step was to prevent bank runs in future. The US economy has a long history of bank failures. That explains why US states had experimented with deposit insurance in early 19th century -- NY was first in 1829 -- where depositors were protected for a certain amount. However, these policy experiments did not last. There were 150 proposals from 1886 to 1933 for creation of a Federal deposit insurance, but were just ignored.
There is a classic problem of moral hazard with deposit insurance, like any other insurance. The fact that deposits are insured even partly can make banks take higher risks, leading to private profits and social losses. The cover also leads depositors not doing their homework before putting their money.
But large-scale banking failures and loss of depositors’ trust have forced a rethink and there was no choice but to start deposit insurance. At first, a temporary agency named Federal Deposit Insurance Corporation (FDIC) came into being in June 1933 which insured bank deposits up to a limit of $2,500. Under deposit insurance, the banks pay a premium to the FDIC to protect and pay the deposits in the case of any failure. Looking at the public response, the government quickly made it a permanent body in just six months.
India was next
During 1913-65, a staggering 2,000 banks failed in India, with nearly 50 per cent in the southern region alone. Former Deputy Governor Usha Thorat in a 2007 speech had said the idea to start deposit insurance came up after the failure of TNQ Bank in 1938 and similar banking failures in Bengal in 1948. It was realised that before deposit insurance, the RBI needs adequate powers to inspect and regulate banks, which became a reality with the Banking Regulation Act in 1949.
RBI History Volume II (1951-67) gives a detailed account of deposit insurance. In 1954, the Shroff Committee recommended going for such a cover, leading to differences of opinion between the government and the central bank. The RBI believed that before adopting the new model, the banking system should be cleaned, or otherwise insurance would have to be paid for banks which were going to fail. The government differed and suggested that deposit insurance and the cleaning operation could go hand in hand as the former would provide confidence to depositors.
The subsequent discussions centred on whether non-licensed banks should be left out or it should be made voluntary for them. The banks were also divisive over the initial proposals as some were not happy to pay the insurance premiums.
But the regulator and the banks soon got a reality check. They were pushed to starting deposit insurance urgently following the failure of Palai Central Bank and Laxmi Bank in 1960. The proposed cover was of Rs 1,000 per depositor which would fully protect nearly 80 per cent of account holders. The premiums were fixed at a lowly 2 paise per Rs 100 of total deposits to convince large banks to sign up for the scheme.
Despite assurances from the IBA (Indian Banks' Association), its members, particularly large ones, had their reservations saying it would subsidise the banking system and wanted an organisation outside of the RBI.
Eventually, the frictions were resolved and it was decided to establish the DIC as a subsidiary of RBI. The Parliament passed the DIC Bill by November 1961 and it came into being on January 1, 1962.
Indian Deposit Insurance: The story so far
India’s deposit insurance is a paybox system, where the main role is to give insured funds to depositors, whereas in some countries (like the US), authorities have an extended mandate which includes resolution or dissolution of banks.
Under the DI Act, all functioning banks were to be categorised as insured banks. The Insurance protection was limited to Rs 1,500 per depositor and the premium was fixed at Re 0.05 per Rs 100 of total deposits. The corporation started with a capital of Rs 1 crore (currently Rs 50 crore) and all the proceeds of the DIC were to be invested in government securities. The Board was chaired by one of the RBI Deputy Governors, a nominee of RBI, and two non-officials nominated by the government.
In 1962, there were 55.42 lakh fully protected accounts, which made up 78.5 per cent of all deposit accounts. By 2017-18, the number of depositors covered had gone up to 1.94 billion, but the total amount of protected deposits had declined to 29 per cent due to non-revision of deposit insurance limit for a long time. Since 1962, the insurance cover was revised periodically, but has not been revised since 1993 (Table 1). We can see how insurance cover as a ratio of per capita GDP has declined over the years (Graph 1).
In 1971, the RBI promoted the Credit Guarantee Corporation of India (CGCI) that guaranteed a cover to loans and advances granted by credit institutions to small and needy borrowers covered under the priority sector. In 1978, the CGCI was merged with the DIC to form the DICGC (Deposit Insurance and Credit Guarantee Corporation), as we know today.
On the other hand, deposit premiums which were not touched initially have been revised upwards in recent years (Table 1). Under the Section 15A of the DICGC Act, the Corporation has the powers to cancel the registration of an insured bank if it fails to pay the premium for three consecutive half-years.
In 1986, the RBI formed an expert committee with M N Gorparia as chair to review the deposit insurance scheme. The committee was of the view that deposit insurance had contributed to the growth of the banking sector, with the public keeping their savings in the banking system. The committee also made the suggestion to revise the deposit cover to Rs 1 lakh from Rs 30,000, which was implemented after 1991 reforms.
In 1999, another committee led by Jagdeesh Capoor was set up to study deposit insurance. It recommended that while the deposit insurance cover for banks would continue to be compulsory, it would not be obligatory for the Corporation to provide the same. It also advocated a capital advocacy criterion for banks to remain members of the DICGC. As DFIs (Development Finance Institutions) are converted to banks, they should be made part of deposit insurance, went another proposal. The coverage should not be extended to the NBFC sector immediately but over time as they are cleaned up. It also recommended keeping Certificates of Deposit and funds mobilised by mutual funds to be out of the coverage.
In 2011, RBI then DG Subir Gokarn in his speech reflected on the achievements of deposit insurance. According to Gokarn, the 2008 crisis has reinforced the thinking that deposit insurance can only address a relatively small number of individual failures. For addressing systemic failure as was the case in 2008, central banks need to infuse liquidity on a large scale. His assessment was that the coverage has remained static and needed to be raised.
The DIC started with covering commercial banks and in 1968, its scope was extended to cooperative banks. Currently, deposit insurance includes branches of foreign banks in India, Local Area Banks (LABs), Regional Rural Banks, Small Finance Banks and Payment Banks.
In 2017-18, a majority of the banks under the coverage were cooperatives (Table 2). Within the banks, the most insured ones (Rs 1 lakh and below) are RRBs followed by LABs. The cooperative banks whose health has come under the scanner of late, 47 per cent of deposits are insured. The insurance percentage in private and public banks is really low, which puts the overall insured deposits percentage at 29.2 per cent.
DICGC pays up when banks fail
The prime concern of depositors is this: If their bank fails, how much money will they get back? First, they have to ensure their money is in an insured bank (Please visit https://www.dicgc.org.in). Once an “insured bank” is declared insolvent and liquidated, the DICGC prepares a list of claimants and is required to pay them within two months.
During 1962-2018, the DICGC has settled claims of 372 banks. These include 27 commercial banks with settled claims of Rs 295.9 crore and 345 cooperative banks with a corresponding figure of Rs 4,782.3 crore. This implies that average settlement for commercial banks stood at Rs 11 crore and for cooperative banks, it came in at Rs 14 crore.
The above analysis was an attempt to trace the history of deposit insurance in India. In the past decade or so, cooperative banks have been at the centre of deposit insurance story. The DICGC has been silently settling the claims of these failed cooperative banks.
However, this time around, the problems at PMC Bank have come with larger issues, putting a big question mark on deposit insurance and the role of DICGC.
The essence of the matter is deposit insurance can at most protect small depositors’ money and cannot resolve a larger banking crisis. For this, we need the government and the regulator going that extra mile providing systemic liquidity and putting rumours to rest.
Also, the limit of deposit insurance is way too low and needs to be raised. This will help ease pressure on some of the sound cooperative banks and instil confidence among small depositors.(Amol Agrawal is faculty at Ahmedabad University. Views are personal.)
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