India’s deposit insurer is overcharging commercial banks
Summary
- Commercial banks pay bulk of the premiums that DICGC, an RBI subsidiary, collects, but their claims are low and thus they end up effectively subsidizing cooperative banks. We need premiums set based on the risk profile of banks.
The Deposit Insurance and Credit Guarantee Corporation (DICGC), a unit of the Reserve Bank of India (RBI), insures deposits across the banking system. As of March 2023, it insured 2,026 banks.
In 2022-23, it collected gross premiums of ₹21,381 crore, with investment income at ₹11,908 crore, and revenue surplus after tax at ₹24,559 crore.
As an insurance company, it has an actuarial valuation for liability as of 31 March 2023 at ₹12,174 crore, but surplus collection to date beyond actuarial liability totalled ₹1,57,427 crore. The total funds available with the Deposit Insurance Fund are ₹1,69,602 crore, or 2.02% of the total insured amount.
With these impressive surpluses, the key issue to be examined is whether DICGC is overcharging banks for premiums to collect a surplus? Can the premiums be reduced and based on the risk profiles of the insured bank, which will reduce the overall costs of compliance in the banking system?
Also read: Indian banks are staring at worrisome savings and investment trends
Commercial banks have lower risk profiles: Insurance premiums rose from 5p per ₹100 insured in 1962—when DICGC was set up—to 10p in 2005 and 12p in 2020. Insurance coverage was capped at ₹1,500 in 1962, which increased to ₹1,00,000 in 1993 and ₹5,00,000 in 2020.
Today, DICGC collects insurance premiums at 12p per ₹100 insured for all deposits up to ₹5 lakh per person. This premium is uniformly applied, irrespective of whether the bank is commercial or cooperative, despite the differing risk profiles and management structures.
Of the 2,026 insured banks, 139 are commercial and 1,887 cooperative banks. Insured deposits totalled ₹83,89,470 crore, of which ₹77,00,667 crore were deposited with the commercial banks and the rest ₹6,88,803 crore with the cooperative banks.
Accordingly, of the total premiums collected in 2022-23 of ₹21,381 crore, ₹20,104 came from commercial banks and ₹1,277 crore from cooperative banks.
However, the claims profile is reverse, with cooperative banks requiring 98%-plus of the total claims to date. Since 1962, gross claims of ₹295.85 crore have been filed towards 27 commercial banks. Against cumulative recoveries of ₹157.54 crore, the net claims for commercial banks total ₹138.31 crore.
On the other hand, ₹14,735.25 crore have been filed in gross claims towards 410 cooperative banks. Against cumulative recoveries of ₹4,602.26 crore, the net claims for cooperative banks stood at 10,133 crore.
DICGC collects 94% of premiums from commercial banks, which account for a mere 1.3% of net claims. Cooperative banks contribute only 6% of premiums but claim 98.7% of the net claims.
Also read: India’s bank deposit slump: Time for radical new ideas?
The skew of premiums to net claims totally distorts the sector because well-managed banks are being made to pay for the huge defaults prevalent in cooperative banks. It imposes high costs on good management, contrary to the risk evaluation theory of insurance.
Reevaluation of premiums: DICGC does not need to carry these big surpluses on its balance sheet. It invests them in government securities, which are stable investments. Additionally, as a wholly owned subsidiary of RBI, it has in-principle access to liquidity support from RBI in case of need.
In 2022-23, revenue surpluses after tax totalled ₹24,559 crores. It is safe to assume that there will be a surplus of at least ₹26,000 crore in 2023-24 and another ₹30,000 crore in 2024-25.
Adding these will take the fund surplus to ₹2,13,427 crore plus the actuarial valuation, which will be close to the oversized target of 2.5% of the insured deposits that DICGC has set. It is especially outrageous in the case of commercial banks.
DICGC and RBI must reevaluate premiums paid by commercial banks, which hold a majority of the insured deposits but have significantly lower risk profiles than cooperative banks.
If the insurance premium of 12p per ₹100 insured is reduced to 3p for commercial banks, this will provide them a relief of about ₹20,000 crore in 2025-26. The premium for cooperative banks can be lifted up to 15p, the maximum the law allows.
This will reduce DICGC’s gross 2025-26 revenue by about ₹20,000 crore and revenue surplus after tax by about ₹15,000 crore. However, with balance premium revenue along with investment income, DICGC will get an estimated ₹24,000 crore in pre-tax revenue, which is still a significant surplus.
Reducing the premiums for low-risk banks will send a clear message to the economy that premiums must be based on the risk profile of the insured entity, and larger banks do not have to subsidize the claims of cooperative banks.
In case of bank failure, RBI has demonstrated alacrity in working out a safety net, as seen in the case of Yes Bank. The probability of public sector banks requiring bailouts is almost nil as the government owns them.
Also read: Conduct deposit mobilization drives, FM tells state-run banks
The likelihood of private sector banks requiring bailouts is also relatively low, as evidenced by data. Still, if one is in trouble, RBI has enough tools to ensure it is safely reset. High insurance premiums are not required.
Excessive regulation and compliance costs in banking must be reduced to improve efficiency. RBI and the government have done exceptionally well in developing tools to manage bank failures.
They must ensure that commercial banks do not bear the high compliance costs, which are ultimately passed on to depositors and good borrowers and drag down the economy.