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Explainer | Why a higher insurance cover is big deal for smaller depositors

The government's decision to make available deposit insurance within 90 days is big news for smaller depositors across banks. A series of bank failures and imposition of moratorium by the Reserve Bank of India had resulted in a widening trust deficit among depositors.

July 28, 2021 / 06:34 PM IST
Nirmala SItharaman. File image.

Nirmala SItharaman. File image.

After a long wait, the government has cleared a Bill that offers more protection to smaller depositors in the event of bank failures. On July 28, Union Finance Minister Nirmala Sitharaman said the Cabinet has cleared the Deposit Insurance Credit Guarantee Corporation (DICGC) Bill, which would insure an amount of Rs 5 lakh stored in bank accounts. The law will protect 98.3 percent of the bank accounts, Sitharaman said.

"Deposit Insurance Credit Guarantee Corporation was created in case people faced difficulties after the RBI imposes moratoriums on banks. Today's Cabinet meeting has decided that within 90 days, depositors will receive Rs 5 lakh of their money," Sitharaman said.

The scheme is significant for the Indian financial system to regain the lost trust of smaller depositors in many failed banks.

When was the hike to Rs 5 lakh first announced?

The plan to hike deposit cover was first announced in the 2020 Union Budget. This scheme is provided by Deposit Insurance and Credit Guarantee Corporation (DICGC), which accepts a premium from banks to offer the cover. In the event of a bank collapse, the DICGC compensates the customers providing the agreed amount.

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Why it is a big deal for depositors?

The government's decision to make available deposit insurance within 90 days is big news for smaller depositors across banks as it will ensure a timebound recovery of money in cases of bank failures. A series of bank failures and imposition of moratorium by the Reserve Bank of India (RBI) had resulted in a widening trust deficit among depositors.

Particularly, the crisis at the Punjab and Maharashtra Co-operative Bank (PMC Bank) last year had shaken the trust of customers in the country’s smaller banks. Some of the PMC depositors are still fighting to get their money back.

Relief for co-operative banks...

There have been several cases where the RBI clamped down on erring co-operative banks and imposed business restrictions. Often, depositors will have to wait for a long period to get their money back in such cases. But now, even if a bank is placed under moratorium, the customers can get their money back in 90 days. This will help co-operative banks to regain some lost trust.

A higher insurance cover is a big relief for customers, especially depositors of co-operative banks, which are lightly regulated by the central bank when compared with bigger commercial banks.

What should be the ideal threshold?

There are varying views about the quantum of deposit cover required for Indian banks. An SBI research report, in October 2019, called for a minimum Rs 2 lakh deposit insurance cover for term depositors and Rs one lakh for savings bank depositors and a separate threshold for senior citizens.

“The higher Deposit insurance cover will be a confidence-building factor for small depositors,” said veteran banker Naresh Malhotra. “Earlier, there was no assurance what happens if a bank goes into a crisis or put under moratorium. There is some comfort now. The bigger depositors will be still worried,” said Malhotra.

When was the scheme set up?

The deposit insurance guarantee scheme was set up in 1961 to ensure depositors are guaranteed at least some amount in the event of a bank collapse. This amount was enhanced to Rs 1 lakh only in 1993 from Rs 30,000. The DICGC enhanced the cover to Rs 1 lakh per depositor in May 1993 for deposits of Commercial Banks, RRBs, Local Area Banks (LABs) and Co-operative Banks and the rest of the deposit amount is forfeited in the rare event of a bank failure.

What are the numbers...

At the end of FY19, the number of registered insured banks stood at 2098, comprising 157 commercial banks and 1,941 cooperative banks. In 2017, the government introduced “The Financial Resolution and Deposit Insurance (FRDI) Bill” in Parliament but withdrew it in 2018 due to the bail-in clause and mass protests across the country. The FRDI bill contemplated a mechanism of deposit insurance up to a specified limit (at least Rs 1 lakh) for not only banks but also for the NBFCs, insurance companies, pension funds, stock exchanges, and depositories.
Dinesh Unnikrishnan is Deputy Editor at Moneycontrol. Dinesh heads the Banking and Finance Bureau at Moneycontrol. He also writes a weekly column, Banking Central, every Monday.
first published: Jul 28, 2021 06:33 pm
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