Deposit guarantee insurance - Indian Scenario

A farmer went to the bank for a loan. He met the manager and requested for the loan. Manager asked him” why you want a loan?” for my child’s higher education” answered the farmer.  Manager given him a list of documents and securities he needs to furnish to his bank’s satisfaction for the loan. Manager explained him that these are required because the bank want guarantee that the repayment will happen in time.

Farmer arranged all documents, bank sanctioned his loan. The tenure of the loan was 5 years but just after 5 months the farmer turned back and repaid in full. The manager was surprised asked him, “how can you pay this fast?” “the crop was good as the rates” was the answer from farmer. When the farmer was leaving after payment, the manager went to him and asked, “can you deposit some amount with us as FD, we pay 7% per annum” the farmer shot him back with a counter question” what are the security you are ready to give for deposit” he explained if the bank fails? Cartoon I read somewhere, but coming back to mind repeatedly. Investors are worried, whether their bank will survive? Or give a nightmare! After Jandhan Yojana and mandatory banking, most of the people have account with bank and people started depositing their money in those accounts and started using electronic banking. There come the news scams in Punjab National Bank, King Fisher fall out, real estate problems affecting the banks and so on. Investors were confident that let anything happen their money is safe as the banks are under Reserve Bank of India regulations. But on September last week 2019, the news of one of the largest cooperative bank failures broken out, Punjab and Maharashtra cooperative bank, failed. On 24th September, RBI limited the maximum amount which can be withdrawn from an account to 1000 rupees, then increased to 10000 and then 25000. Then the newspapers carried news that the maximum amount which can be expected from the bank if it is failed is just One lakh rupee.  Investors were confused and worried, what is going to happen on their deposits.

Many questions came into their minds

Are they going to lose their money?

There is no government or RBI guarantee!

What they need to do now? Etc.… The reality is that either the RBI or Government is not guaranteeing any payment from a bank if it fails. Every bank is an independent business unit and if they fail the government cannot take that responsibility. But there is a great need to safeguard the interests of investors if a bank fails. To increase the confidence level of investors as well safeguard the interests and deposits of the public, in the event when a company fails, Centre has set up Deposit Insurance and Credit Guarantee Corporation. This particular deposit insurance is mandatory for all banks and no bank can withdraw from it. It is worth noting here that the DICGC safeguard the interests of ordinary investors to a great extent as majority of investors are small investors.

Let us try to understand how DICGC deposit insurance work for the benefit of depositors. DICGC is an organisation under RBI to protect depositor if a bank fails. It is an insurance plan where the premium will be paid by the bank for coverage.  All banks are mandatorily required to be under this and cannot withdraw from it.

DICGC coverage It covers all commercial and cooperative banks, except in Meghalaya, Chandigarh, Lakshadweep and Dadra and Nagar Haveli. Primary cooperative societies are not insured by DICGC. It covers all types of bank deposits like savings, fixed, current, recurring etc. payable in India. It does not cover the following

1. Deposits of foreign governments.

2. Deposits of state or central government.

3. Interbank deposits.

4. Deposits of state land development bank with State cooperative banks.

5. Any amount due on account of any deposit received outside India.

6. Any amount specifically exempted by the DICGC with previous approval of RBI

Limit will a depositor get as insurance. Insurance limit for each depositor in a bank limited to Rs 1,00,000, included both principal and interest. This is the maximum amount an investor gets from bank from one or more account or in different branches will be treated as one and only one payment is made. This insurance will come to play when a bank fails, or a failed bank amalgamated, merged or reconstructed. If the account is in single name and kept in different branches of the same bank, all accounts will be treated as one and one payment will be made. But if the accounts are in different types of ownership, they will be treated separately. If the person has account in different banks, then both will be treated separately and paid separately. If the money is kept in joint accounts in one or more branches in same bank, then these accounts will be considered one, but if the order is not same these will be treated separately. Now the big question is how can we know that the bank is covered under DICGC insurance? No worry the scheme is mandatory and no bank can withdraw voluntarily from this. There are chances the covered bank is not paying the premium in time, if the bank fails to pay the premium for three continuous half years, then the registration under the scheme will be cancelled. If the bank is no more under the insurance coverage, there will be notification through newspapers.

Whether this one lakh per person is enough? That is the real catch, if we compare the global standards we have one of the low deposit insurances. The 2018 annual survey of International Association of Deposit Insurers reported the issue of low deposit insurance in India when we compare to other countries. The deposit insurance coverage in India is one lakh which roughly comes to 1450 dollars. But the report says a country like Malaysia have a deposit insurance of 250000 Malaysian Ringgit, which roughly around 60000 dollars. In Indonesia it is 2 billion Indonesian Rupiah which is roughly 140000dollars. In some European countries it is between 75000 dollars to 111000 dollar and in US it is 2,50,000 dollars. If we take volume wise coverage in most of the countries the insurance will cover around 70% of the deposits whereas in India it is around 30%. After 1993 the coverage was not increased. In 1993 it was increased from 30000 to 100000. Even if we compare the consumer price index by RBI, the deposit insurance should have been around 550000.

Why the coverage is not increasing? The main problem is the resultant increase in insurance premium, which is paid by the banks. As this is mandatory insurance, the banks have a fixed expenditure on deposits, and if the insurance coverage is increased, then the premium also will be increased. At present the DICGC charges 10 paisa per Rs 100 per annum. If we take an actual look at the compensation paid by the DICGC, since 2002 no single commercial bank failed in India resulting in claim.  During 2017-18, there was a settlement of more than Rs 43 crores, in respect of 18 cooperative banks. So just by increasing the coverage, bigger banks need to shell out more premium and bigger banks are commercial banks where there is no settlement risk is comparatively low. In other way, if we look it, the bigger banks need to pay for the risk in weaker banks. In 2015 Jasbir Singh committee report suggested for a risk-based premium for banks. This is still under consideration which may make a big difference. The good thing for the depositors is that not even a single commercial bank failed in decades. The Reserve Bank of India has been given powers for compulsory amalgamation, consolidation and liquidation of small banks in 1960.  From that period there were more than 40 forced mergers of commercial banks happened in India.  Examples weaker Nedungadi Bank taken over by Punjab National Bank, Centurian Bank case, Global Trust Bank case are examples. Finance Act 2019 also recommended merger of banks like Punjab National bank, Oriental Bank of Commerce and United Bank, also Canara Bank and Syndicate Bank, also Union Bank of India, Andhra Bank and Corporation Bank, and Indian Bank and Allahabad Bank. In the past LIC bailed out cash strapped IDBI Bank.

It does not mean the deposit insurance coverage need not go up. As most of the weaker banks are operating in the rural areas where the coverage of commercial banks is minimal still. The weaker bank for the sake of business and profitability, tempted not to follow the regulations in spirit and result in failures. PMC bank is not the first or last, if this continues, the innocent depositors will definitely feel the heat. There is a real need for either implementing Jasbir Singh committee recommendation or finding some other alternative way were the funds from the depositor flow into the system. Fear of loss may make the investors to shy away, and even if they need, they may not be able to reach commercial banks. In a country like India, survival of smaller banks with increased compliance and efficiency is very much important for growth.