The Reserve Bank of India’s (RBI) proposal to move to a risk-based premium (RBP) framework, from the long-standing flat-rate premiums banks are paying now, marks a landmark shift in deposit insurance. The move will reward safer banks with lower insurance cost and, thereby, foster a more robust banking system.
A detailed notification outlining the mechanics of the new model is expected shortly, with the framework scheduled to take effect from next fiscal.
What is the proposal?
The core idea, as outlined in the RBI’s recent statement, is to move away from a system that "does not differentiate between banks based on their soundness."
Under the existing guidelines, the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the RBI that provides insurance protection to depositors in case a bank fails, insures all bank deposits, including savings, fixed, current and recurring deposits, up to Rs 5 lakh per depositor, per bank.
The system covers all commercial banks, branches of foreign banks in India, local area banks, regional rural banks and co-operative banks.
To fund the system, all insured banks pay a flat-rate premium to the DICGC, currently set at 12 paise per Rs 100 of assessable deposits per annum.
The ‘one-size-fits-all’ approach means a bank with a strong risk profile and one with a weaker risk profile pay the same rate.
The RBI has now proposed to shift to a system where banks will be required to pay premiums to DICGC based on their financial health instead of the current system, which, though simple, does not differentiate between banks.
The proposal’s stated goal is to "help banks that are more sound to save significantly on the premium paid". In other words, banks demonstrating strong financial health and robust risk management will be rewarded with lower insurance costs, while riskier institutions will have to pay a higher premium.
Impact on banks
The introduction of RBP will have positive as well as negative consequences.
On the positive front, the framework creates a direct financial incentive for banks to strengthen their capital buffers, improve their asset quality and liquidity, and enhance the governance framework to qualify for lower premiums, leading to cost savings for well-managed institutions and boosting their profitability. It will also encourage banks to be more disciplined when lending and investing.
On the flipside, banks with high non-performing assets, low capital adequacy ratios, weak liquidity or governance could face higher premiums, which could strain their profitability and capital base. This increased cost burden on weaker banks may also make it harder for them to compete with healthier peers in pricing loans and deposits.
How banks could manage the costs
The financial implications of the new premium structure will compel banks to make strategic decisions regarding cost and pricing.
Banks qualifying for lower premiums will benefit from reduced cost of funds, providing them a competitive advantage that can be used to either offer more attractive deposit and lending rates to customers, or boost profitability and strengthen capital reserves.
In contrast, banks facing higher premiums will see their cost of funds increase, forcing them to either absorb the additional expense, which would directly reduce their net interest margin and profitability, or pass on the costs to customers through less competitive deposit rates or higher fees, risking their market position.
Potential parameters for the risk-based premium model
While the final parameters will be detailed in an upcoming RBI notification, an RBP model could be built on a combination of quantitative and qualitative factors, reflecting a bank’s overall health.
The framework could assess a bank’s liquidity position, where strong buffers, measured by the liquidity coverage and net stable funding ratios, could justify a lower premium—funding stability from a high current account, savings account ratio and longer-tenure deposits could be viewed favourably, whereas reliance on volatile wholesale deposits could increase the premium risk.
Additionally, the model could incorporate external credit ratings which evaluate the CAMELS (capital, asset quality, management, earnings, liquidity, and sensitivity) framework, with banks with strong ratings (e.g., AAA/AA) qualifying for lower insurance premiums.
Our take
The RBI's proposal to introduce RBP is a significant and welcome reform. It marks a crucial evolution from a simple, uniform system to a sophisticated model that accurately prices risk and promotes financial stability.
By rewarding prudent behaviour and penalising excessive risk-taking, the new framework is poised to strengthen discipline and encourage banks to build more resilient balance sheets.
While the move aligns with global best practices, its ultimate success will hinge on the precise calibration of the risk parameters.
Banks will be keenly awaiting the detailed guidelines from the RBI.
(Siddharth Shah and Kaushal Bhatia are Director, Crisil Intelligence, and Consultant, Crisil Intelligence, respectively.)
Views are personal and do not represent the stand of this publication.
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