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Do Indians need insurance for bank deposits?

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December 24, 2021

What is the issue?

India needs to move to a risk-adjusted premium model so investors are more aware of the risks

What is Revamped Deposit Insurance Scheme?

  • The revamped deposit insurance scheme was upgraded through the Deposit Insurance and Credit Guarantee Corporation (DICGC) Amendment Bill, 2021,
  • It guarantees to compensate depositors up to a limit of Rs. 5 lakh within a period of 90 days from when a bank fails.
  • So far Rs. 1,300 crore has been paid to depositors in troubled cooperative banks.

Why should we raise the value of the deposits that will be insured?

  • Rs. 1 lakh limit was set in 1990s.
  • Considering the inflation rate this has become extremely inadequate.
  • Compared to international standards our insurance limit is much lower ( 6 to 10 times) than several comparable economies like South Korea and Brazil.
  • We are also way below U.K. and U.S.A.
  • Though we cannot compare figures across countries in isolation due to differences in purchasing power we still have a lower amount of deposit insurance than other countries.
  • So, by raising the limit to Rs. 5 lakh, we are going in the right direction.

Why do we need insurance for bank deposits?

  • History - Discussion on deposit insurance began in India after a number of bank failures.  Attempts were made to stabilise the banking system.
  • In the 1930s, the U.S. set up deposit insurance. India set it up in the 1960s to deal with bank failures.
  • So each time your banks fail in large numbers, the central bank does something about deposit insurance.
  • Confidence Building Measures - We want to give confidence to depositors that if a bank does go down, they don’t need to run to the bank.
  • Instead they can keep their money in the bank, and the bank can continue operating without any financial trouble. It is a combination of these things.
  • Cost of Delayed Payment – Investors are not able to figure out good banks and bad banks. They generally invest in banks where returns are high.
  •  But no one has lost money in any scheduled commercial bank in India.
  • There may be a liquidity risk but no credit risk because the government always comes in and rescues banks. It means there is 100% insurance.
  • However there may be a delay in case of bad banks and that can be pretty costly. The sooner we get there, the better it is.
  • So we need risk-based deposit insurance premiums, which is simply absent in India.

Can Private insurers provide confidence during a crisis?

  • It comes into play when panic sets in, like in 2008.
  • Everybody was panicking about the financial sector and wanted their money back, fueling a self-fulfilling crisis.
  • In that scenario, private insurance might not work because people might think that the private insurer will become bankrupt.
  • This is where the might of the government comes in because the government has the ability to be the lender of last resort.
  • We saw in the 2008 crisis that the U.S., which is generally seen as a more market-driven financial system, had to be eventually bailed out by the government.

What should RBI do beyond insurance for bank deposits?

  • The DICGC is basically owned by the RBI.
  • But when it comes to bank failures, it is the RBI and not the DICGC that is playing a major role
  • In U.S.A the Federal Deposit Insurance Corporation also plays a role in the resolution of troubled banks
  • The Federal Reserve doesn’t play an active role in the resolution process other than lending to the troubled institution.
  • When these bank failures happen there are a lot of signs of the failure that build up leading to the crisis.
  • Regulators are always a few steps behind the banks. They are still playing the catch-up game in figuring out the true level of risk that banks have.
  • RBI should disclose risk information and take quick action before a bank fails. For this you need to have a good model to figure out which bank is under stress.
  • Depositors discipline has to go hand in hand with improvement in risk management system across the board.

Reference

  1. https://www.thehindu.com/todays-paper/tp-opinion/do-indians-need-insurance-for-bank-deposits/article38024606.ece

 

 

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