By Anusha Chari & Amiyatosh Purnanandam
The failure of the Punjab and Maharashtra Co-operative Bank (PMC) in September 2019 shone a light on the limitations of India’s deposit insurance coverage program. With more than Rs 11,000 crore in deposits, PMC bank was one of the biggest co-op banks. That the Deposit Insurance and Credit Guarantee Corporation (DICGC) insurance coverage covered depositors, supplied small solace when the realisation hit that the insurance coverage amounted to a mere Rs 1 lakh per deposit.
The predicament of PMC depositors is, regrettably, not an anomaly. Several bank failures more than the years have severely strained RBI and central government sources. While co-operative banks account for a predominant share of failures, other prime examples involve the Global Trust Bank and Yes Bank failures. These failures entail a direct expense to the taxpayer—the DICGC payment or a government bailout. More importantly, bank failures impose lengthy-term indirect charges. They erode depositor self-confidence and threaten monetary stability, presenting an urgent need to have for deposit insurance coverage reform in the nation.
A sound deposit insurance coverage program needs balancing two opposing forces: preserving depositor self-confidence although minimising deposit insurance’s direct and indirect charges. At one intense, the regulator can insure all the deposits, which will undoubtedly strengthen depositor self-confidence. But such a program would be incredibly pricey.
A bank with complete deposit insurance coverage has minimal incentive to be prudent although producing loans. Taxpayers bear the losses in the eventuality that risky loans go terrible. Depositors also have small incentive to be cautious. They can merely make deposits in the banks providing higher interest prices regardless of the dangers these banks take on the lending side.
Boosting depositor self-confidence and decreasing direct and indirect charges call for cautious structuring of each the quantity and pricing of deposit insurance coverage. Some reasonably fast and simple fixes could assist alleviate the public’s mistrust although enhancing the deposit insurance coverage framework’s efficiency.
India has created some progress on this front more than the final couple of years. First, the insurance coverage limit enhanced to `5 lakh in 2020. Second, the 2021 Union Budget amended the DICGC Act of 1961, permitting the instant withdrawal of insured deposits without the need of waiting for full resolution. These are incredibly welcome moves. Several added measures could bring India’s deposit insurance coverage program in line with finest practices about the planet. Even with the enhanced coverage limit, India remains an outlier, as the accompanying graphic shows.
The government’s incentive to step in and bail out depositors when banks fail is clear from previous practical experience. However, these ex-post bailouts are expensive. The bailout method also tends to be lengthy, difficult, and uncertain, additional eroding depositor self-confidence in the banking program. A improved option would be to boost the deposit insurance coverage limit substantially and, at the exact same time, charge the insured banks a danger-based premium for this insurance coverage. Under the present flat-charge based program, the SBI pays144 the exact same premium to the DICGC—12 paise per one hundred rupees of insured deposits—as does any other bank!
A danger-based strategy will attain two objectives. First, it will assure that the deposit insurance coverage fund of the DICGC has adequate funds to make fast and timely repayments to depositors. Second, the danger-based premia will curb excessive danger-taking by banks, provided that they will be needed to spend a greater expense for taking on danger.
India is not alone in attempting to address the situation of enhancing the efficiency of deposit insurance coverage. The Federal Deposit Insurance Corporation (FDIC) recognizes that the regulatory framework governing deposit insurance coverage is far from ideal and the United States is moving towards danger-based premia. The idea is related to pricing car or truck insurance coverage premia according to the danger profile of the driver. The FDIC computes deposit insurance coverage premia based on components such as the bank’s capital position, asset high quality, earnings, liquidity positions, and the forms of deposits.
In India, as well, banks can be placed into buckets or tiers along these distinctive dimensions. The deposit premium can rely on these components. It is quick to see that a bank with a worsening capital position and a higher NPA ratio should really spend a greater deposit insurance coverage premium than a effectively-capitalized bank with a healthful lending portfolio. The notion is not dissimilar to a risky driver paying more for car or truck insurance coverage than a protected driver.
Risk-sensitive pricing can go hand-in-hand with the boost in the insured deposit coverage limits bringing India in line with its emerging industry peers. In a credit-hungry nation like India, these moves would construct depositor self-confidence, possibly growing the volume of deposits and attaining the delighted outcome of the banking program channeling more savings to productive use.
Chari is professor of economics and finance, and director of the Modern Indian Studies Initiative, University of North Carolina at Chapel Hill and Purnanandam is the Michael Stark Professor of Finance at the Ross School of Business, University of Michigan