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Informist, Thursday, Feb. 20, 2025

 

By Abhijit Doshi

 

MUMBAI – Last week's action by the Reserve Bank of India to supersede the board of New India Cooperative Bank for 12 months on the grounds of poor governance standards has brought the focus back on the question of deposit insurance reforms in the banking system. The system is outdated and in dire need of an overhaul.

 

At the end of 2023-24 (Apr-Mar), New India Cooperative Bank had deposits of INR 24.36 billion and reported a loss of INR 228 million for the year. It has 130,000 depositors, 90% of whom have deposits under INR 500,000.

 

The RBI has banned the cooperative bank from granting or renewing loans, making investments, incurring liabilities, including borrowing of funds, and accepting fresh deposits, without the prior approval of the central bank. It has also banned the bank from selling or transferring any of its properties or assets. The restrictions would be in place for six months, the RBI said. However, eligible depositors would be entitled to receive the deposit insurance claim amount on deposits up to INR 500,000, the RBI said. 

 

Along with these steps, the central bank also directed the bank to stop withdrawal of any amount from a savings bank or current account, thus freezing individual deposit accounts.

 

This raises issues around the insurance of bank deposits and brings into focus the need for reforms. While the current insurance scheme may seem adequate in terms of the number of accounts, it doesn't seem so in terms of the amount insured. The RBI has raised the insured amount over a period, but very slowly. The last time it raised the amount was in February 2020, when it was increased to INR 500,000 from INR 100,000.

 

At a recent event in Mumbai, Department of Financial Services Secretary M. Nagaraju said the government was working on enhancing the insurance cover on deposits to protect the trust of depositors in the banking system.

 

Given that deposit insurance affects millions of depositors, it would be much better for the central bank to take a methodical approach to the subject rather than the knee-jerk reactions that it has been taking – raising the amount of deposits insured after every other bank crisis or failure. A regular increase in the amount under insurance would be more reassuring, given the rise in people's income and increase in individual savings, as also inflation.

 

There are other points to consider here. Let us not forget that bank deposits are insured by the Deposit Insurance and Credit Guarantee Corp., which is a fully-owned subsidiary of the RBI. The central bank is, thus, at freedom to take decisions affecting deposit insurance and can raise the amount of deposits so insured. Banks pay only INR 0.12 per INR 100 of deposits for insurance. As this amount is rather puny, cost cannot be the reason for the low threshold. 

 

In reality, this cost is lower, probably because all deposits may not be insured. Perhaps, deposits made by companies or the government may not be insured. For quick reference, State Bank of India, the country's largest lender, paid insurance premium of INR 49 billion to the Deposit Insurance and Credit Guarantee Corp. in 2023-24 (Apr-Mar). At the end of that year, the bank had total deposits of INR 49.16 trillion – the premium paid was barely 10 paise per INR 100 of deposits.

 

The premium paid was also a mere 8.0% of the bank's net profit of INR 610.76 billion for that year, and only 5.8% of its net profit for the year including profit of the previous year brought forward, which totalled INR 851.75 billion. As a percentage of the bank's total revenue of INR INR 4.67 trillion for FY24, all of which is generated because it has these deposits in the first place, the premium paid to the Deposit Insurance and Credit Guarantee Corp. was just 1%. Surely, banks can afford to pay more for a higher threshold for deposit insurance?

 

The RBI has done a very good job on many fronts, including regulation and ensuring that banks have enough liquid assets to manage shocks. Why then has it not pushed banks to buy higher deposit insurance?

 

As a regulator of the banking system and the monetary authority of the country, the RBI should also ask the government why the insurance industry, despite its liberalisation and development, does not offer an individual depositor the option to buy insurance for her bank deposits over and above the minimum on which she automatically gets insurance, as long as she is willing to pay the premium for such additional insurance? Such a scheme will give many bank depositors more confidence in banks, and help banks garner more deposits. Indeed, it will also give relief and peace of mind to several depositors who may have large savings accumulated in banks over years and for whom even a freeze on withdrawals – forget a bank failure – is likely to cause a heart attack! This may also do away with the tendency of depositors to open multiple accounts in different banks, to help keep the deposits below the threshold for deposit insurance. 

 

For workers in the organised sector, deposit insurance should cover the entire amount of bank deposits, as long as the deposits are from tax-paid monies. Isn't this the least a depositor can expect from a country that aspires to the staus of a developed country? Having paid tax to the government, the depositor has every right to expect that the government will protect her money.

 

Such and other measures will go a long way in making bank deposits attractive for savers at a time when deposit growth has slowed down, partly due to negative returns that these generate net of inflation, and partly due to the increasing preference of retail investors for other avenues of generating returns on their savings, such as the stock market.

 

The RBI must move urgently to reform deposit insurance in a more meaningful manner than just raise the threshold of insurance, and work in unison with the other authorities concerned. Reform of deposit insurance will greatly help the banking sector, as also its customers. There could not be a better customer service than expanding the insurance net to a much larger number of depositors and for a larger amount than under the current dispensation.  End

 

Edited by Avishek Dutta

 

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