OPINION | Risk-Based Deposit Insurance: Banking’s long-awaited adulthood?

RBI Central Board approves the risk-based deposit insurance framework

Highlights:

* RBI approves risk-based deposit insurance, ending long-standing debate in banking.

* Banks with better risk management will pay lower insurance premiums

* Weaker banks face higher premiums, but a ceiling limits the cost increase

With the RBI Central Board approving the risk-based deposit insurance framework, a debate that has shadowed Indian banking for decades has reached its logical conclusion. What makes it consequential is that it alters the relationship between banks, the regulator and depositors in a manner no supervisory instruction or moral persuasion could achieve on its own.

Institutions that demonstrate sound risk management, strong governance and balance-sheet discipline will face lower insurance premiums. Those that fall short will pay more, up to a defined-ceiling.

From Collective Comfort to Priced Responsibility

Until now, deposit insurance in India has functioned as collective reassurance. Under the existing arrangement, the Deposit Insurance and Credit Guarantee Corporation insures deposits up to Rs 5 lakh per depositor per bank, funded through a flat premium of 12 paise per Rs 100 of assessable deposits paid uniformly by all insured banks. This structure made no distinction between institutions that were prudently managed and those weakened by poor governance or fragile balance sheets.

The new framework breaks that uniformity. Banks with stronger capital adequacy, healthier asset quality, robust liquidity positions and credible governance will see their insurance costs decline. Risk-based pricing, long a defining feature of mature financial systems, discourages complacency, rewards prudence and strengthens systemic resilience. A flat premium regime offers comfort, but it is blunt. A risk-sensitive regime is sharper, and therefore unsettling. The discomfort, however, is deliberate.

Yet the design contains an unresolved tension. By retaining the current flat premium as the ceiling, even banks burdened with high non-performing assets, thin capital buffers or weak governance will not face a materially higher insurance cost beyond a point. The burden will continue to be absorbed through lower profitability or quietly passed on to customers, without transparency.

At present, risk-based deposit insurance strengthens regulatory discipline more than market discipline. Premiums may vary across banks, but depositors are unlikely to see or understand those differences. Without visibility, the signal remains inward-facing, influencing boards and management but stopping short of shaping depositor choice or competitive behaviour.

The more difficult question, therefore, is whether Indian banks are institutionally ready for such discomfort.

When Scale Outpaces Maturity

Despite their scale and sophistication, many Indian banks continue to exhibit the habits of prolonged institutional adolescence. Governance reforms are often reactive. For example, investments in cyber resilience, organisational capability and technology modernisation tend to follow regulatory nudges rather than board-led conviction. Boards frequently prioritise short-term calm over long-term resilience, postponing difficult conversations with management and settling for compliance rather than stewardship.

Risk-based deposit insurance implicitly assumes that boards will now act differently. That they will challenge management more firmly, invest ahead of crises and pursue genuine strategic differentiation. It is an assumption grounded in regulatory logic, but one not yet consistently reflected in institutional behaviour.

This challenge is compounded by the homogeneity of Indian banking. Products across institutions look strikingly similar. Pricing follows market leaders. Innovation remains cautious. On both sides of the balance sheet, imitation has often substituted for strategy. In such an environment, higher insurance premiums do more than penalise weak banks. They expose the absence of strategic depth.

Critics warn that risk-based premiums could further strain weaker institutions and destabilise them. The familiar analogy of the natural world is invoked, where the weakest members of a group are instinctively protected. But banking is not governed by instinct. It is governed by trust, capital and discipline. Shielding institutional fragility indefinitely does not protect depositors. It merely postpones adjustment and amplifies the eventual cost when correction becomes unavoidable.

There is also a recurring argument, particularly among elite commentators, that the deposit insurance framework has historically overcharged well-run banks, citing the accumulation of a surplus exceeding Rs 2 lakh crore. This framing misreads intent as inefficiency. What it describes as overcharging is better understood as a long-standing regulatory decision not to penalise weaker banks explicitly. The surplus did not arise from excessive extraction from strong institutions, but from a deliberate choice to keep insurance pricing flat in a system marked by uneven governance, varied capability and fragile confidence. Stability was prioritised over differentiation. Strong banks were not punished. Weak banks were protected.

Pricing Risk Without Preserving Old Mercies

At the same time, the new framework raises a legitimate concern. By retaining the current flat premium as the ceiling even for the riskiest banks, the regime risks carrying forward a vestige of the old comfort into a system meant to price risk more truthfully.

Risk is not linear. In banking, it is rarely incremental. It builds in layers, and once thresholds are crossed, the cost of correction rises exponentially. A marginally weak bank and a structurally fragile one do not impose the same threat on the system, yet a uniform ceiling compresses that distinction. The strongest banks are rewarded, average banks are nudged, but the weakest may still calculate that living at the ceiling is cheaper than undertaking deep reform. Regulatory mercy, while humane, can blunt deterrence if not calibrated carefully.

The intellectual case for this reform is neither new nor improvised. India’s Deposit Insurance Act of 1961 explicitly allowed for differentiated premium rates, recognising early that risk could not be priced uniformly. Subsequent reform efforts reinforced that logic. The Narasimham Committee argued for risk-based premiums in the late 1990s. The M Nachane Committee explored option-pricing models that proved impractical. The Jasbir Singh Committee favoured supervisory risk-based approaches more suited to India’s institutional realities. What delayed implementation was not hesitation of intent, but the need for supervisory systems and data frameworks to mature. That threshold has now been crossed.

It is precisely because the framework has matured that its impact will be unevenly felt. The earliest and sharpest pressure is likely to fall on cooperative banks, where governance standards vary widely and political interference has long complicated oversight. The credibility of the reform will therefore rest on its ability to remain technical in application and insulated from populist intervention. It is also worth asking, without presumption, whether retaining the current premium as a ceiling reflects a conscious effort to manage this transition cautiously, rather than price risk fully from the outset.

In a system marked by uneven governance and varied institutional capability, fully pricing risk overnight could itself become destabilising. Gradualism may therefore be intentional, even prudent. But caution must not harden into permanence. Risk-based premiums work best when complemented by credible resolution frameworks and boards that treat insurance cost as a governance signal rather than a compliance expense. Without these, pricing risk may expose weaknesses without reducing moral hazard. The reform’s success will depend not only on how risk is measured, but on whether institutions respond by strengthening decision-making, capital discipline and accountability at the top.

In time, the true measure of preparedness will not be compliance with a statutory limit, but whether banks are confident enough to insure the entirety of their deposit base under a genuinely risk-priced framework. Such confidence cannot be legislated. It must be earned through disciplined risk management, conservative capital choices and governance that privileges resilience over expansion. When depositors trust institutions not because protection is mandated by law, but because behaviour consistently warrants it, deposit insurance will have completed its transition from safety net to marker of credibility.

The Reserve Bank of India deserves recognition for prioritising long-term systemic strength over short-term comfort. With that choice made, responsibility now shifts decisively to banks and their boards.

A banking system matures not when risk is hidden, but when responsibility is priced honestly and accepted fully. At its core, banking is the continuous act of recognising risk clearly and pricing it in a manner that keeps depositor trust and systemic confidence intact.

(Srinath Sridharan is Author, Policy Researcher & Corporate Advisor, Twitter: @ssmumbai.)

Views are personal, and do not represent the stance of this publication.