On 3 October, the Federal Deposit Insurance Corporation, or FDIC, an independent agency of the US government that protects against the loss of insured deposits in case a bank fails, raised the insurance cover of each depositor from $100,000 (about Rs47 lakh today)to $250,000.
FDIC insurance covers savings and checking accounts, money market deposit accounts and certificate of deposits. With effect from 14 October, all non-interest bearing deposit accounts too have been fully insured for the entire amount. This unlimited insurance coverage will remain in effect until 31 December 2009.
The US is not the only country that is doing everything to soothe the frayed nerves of the depositors, fearing collapse of banks. In the UK, the Financial Services Authority raised the compensation limit on deposits with failed banks, building societies and credit unions from £35,000 to £50,000 per depositor in the first week of October.
Elsewhere in Europe, the Danish Financial Supervisory Authority has guaranteed all bank deposits against an earlier cover of up to Danish kroner 300,000 per depositor. Germany has offered a blanket guarantee for bank deposits covering some euro 568 billion in savings and chequing accounts as well as time deposits.
Till September, when the Wall Street investment bank Lehman Brothers Holdings Inc. collapsed, plunging the global financial system into a deep liquidity crisis, the compensation scheme of German banks covered 90% of the outstanding deposits and was capped at euro 20,000 per depositor.
Among other European nations, Ireland is putting in place a guarantee arrangement to safeguard all deposits; Austria offered unlimited protection to individuals’ bank deposits until 2009; Sweden doubled the deposit insurance cover to kronor 500,000; and Greece has proposed to raise the limit of deposit insurance fivefold to euro 100,000 for the next three years.
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In Asia, the Philippines plans to raise the deposit insurance cover fourfold to peso 1 million while Malaysia, Singapore, Hong Kong, Australia and New Zealand are offering blanket government guarantee to all deposits.
India has not done anything yet and is unlikely to do. Under current norms, the Deposit Insurance Credit Guarantee Corporation, or DICGC, covers up to Rs1 lakh worth of deposit for an individual. Apparently, the government is in favour of taking a relook at the DICGC cover but the banking regulator, the Reserve Bank of India, or RBI, is resisting it.
Why is RBI resisting such a move?
The concept of insuring bank deposit was explored first in 1948 after a banking crisis in the undivided Bengal but it came into force in 1962 and by 1968 cooperative banks, too, came under this umbrella.
Currently, depositors of all banks operating in India, including foreign banks as well as regional rural banks, enjoy DICGC protection. In 1968, the deposit insurance cover was available for up to Rs5,000. This was raised to Rs30,000 in 1980 and Rs1,00,000 in 1993. The limit has not been raised in past 15 years despite the failure of many banks, particularly in the cooperative sector.
In case of a bank failure, the money is paid from a deposit insurance fund, created out of the premium paid by insured banks and the income generated by investing the fund in government bonds. The size of the fund as on 31 March was Rs13,362 crore.
According to RBI, it is 0.74% of the total insured deposits. Under the US’ Federal Deposit Insurance Reform Act of 2005, for FDIC, it must be 1.15 to 1.50%. An RBI panel on reforms in deposit insurance in India in 1999 had recommended that such a fund should be 2% of insured deposits.
The only way to do this is by raising the premium for such a cover, paid by the banks. Indeed, the premium for deposit insurance has been on the rise. In 1962, the premium for every Rs100 was Rs0.05 (half a paise). By 2005, it rose to Rs0.10 (10 paise). But the premium is charged uniformly on all banks and it has no correlation with the risk that a bank carries. There lies the problem.
The cooperative banks, the most vulnerable among all financial intermediaries, pay the same premium that others pay, but have been claiming the maximum cover as they collapse often. Since the inception of the scheme, some 27 commercial banks have claimed Rs296 crore from the deposit insurance pool. In contrast, 199 failed cooperative banks have claimed Rs2,460 crore.
So, if India follows the example of the US and other nations and rushes to raise the insurance cover for depositors, the weak cooperative banks will reap the benefit and this will encourage their inefficient boards, often run by politicians, to mismanage the banks and even kill them as there is a wider safety net.
There is no need to increase the deposit insurance cover for Indian banks as none of them is on the brink of a collapse. They are adequately capitalized and less exposed to the global credit crisis compared with the US or European banks. Besides, relatively higher cash reserve ratio, or the portion of deposits that banks in India need to keep with RBI, and statutory liquidity ratio, or the part of deposits that they need to invest in government bonds, are also comfort factors for depositors as these reserve requirements can generate instant liquidity.
However, RBI should raise the premium for deposit insurance by linking it to the risk profile of banks. A larger deposit insurance fund will offer a cushion to the depositors in times of crisis.
Why should India’s large state-owned banks with sovereign backing and small cooperative banks in remote villages, mismanaged by non-professional boards, pay the same premium to protect depositors’ money?
I will be away on a vacation and this column will resume after a fortnight. Merry Christmas and a very happy and safe New Year.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org