Niranjan Krishnan: 'Insuring' private banks do well

How many of us would make a spirited dash to the nearest ATM at the first whiff of a shady rumour about the new-age bank that houses our salary account? The answer is, probably a lot of us.

How many of us have heard of the Deposit Insurance and Credit Guarantee Corporation (DICGC)? The answer is, probably only a few of us. And therein lies the rub.

Neither the Reserve Bank of India (RBI) nor the new-age banks appear to tap the potential it offers for cultivating a sense of security and stability among depositors as well as shareholders.

While everyone knows that their deposits in public sector banks are secure because they have the government behind them, not every customer is so sure about private sector banks albeit up to a certain amount, thanks to DICGC.

The reason is that every bank operating in India is required by the banking regulations to register and insure itself with DICGC.

The banks do so by paying DICGC a premium based on the various deposits they accumulate from their customers.

In case a bank thus insured collapses and has to be liquidated, the DICGC compensates the depositors by repaying the principal and interest due to them from all their accounts, subject to a maximum limit of Rs 1 lakh.

This insurance system works somewhat on the lines of the arrangement between Federal Deposit Insurance Corporation (FDIC) in the US and the banks operating in that country. However, the comparison stops there.

Unlike the US where banks publicise their FDIC insurance and use that status as a value proposition in marketing their products, private sector banks in India do not effectively communicate this to the customers, which could actually help dampen some of the panic and chaos during exigencies that raise questions on the soundness of our financial system and lower public confidence.

There are two conceivable reasons why private sector banks may feel tempted to deliberately downplay the idea of deposit insurance:

The very mention of insurance tacitly acknowledges the possibility of the bank's failure and could turn off customers, a little like what the mention of mortality by a life insurance agent does to prospective clients.

The coverage ceiling of Rs 1 lakh could send a signal that any deposit above that level may involve risk and trigger customers into limiting their savings in each bank to that level, as it commonly happens in the US.

On the flip side, there are many consumers who love the service provided by private sector banks but would think twice about building even a small part of their nest-egg in such banks.

Awareness of deposit insurance can bring in sizeable deposits from such customers and offset any loss in business due to the reasons just mentioned.

The RBI, DICGC's promoter, has some critical issues to address in order to enable the corporation to play a more effective role in fortifying the banking system in the country.

The first issue is the skimpiness of the Rs 1-lakh coverage ceiling on the DICGC insurance. This ceiling eerily mirrors the coverage limit adopted by the FDIC in the US in their currency.

However, the domestic purchasing power of Rs 100,000 is far smaller than the domestic purchasing power of $100,000.

The second issue is that DICGC presents a curious case of an insurance company that does not adopt a risk-based pricing policy for its premium calculations.

It is common knowledge that the premium for insurance policies cannot be uniform for all instances and has to vary based on the risk of the specific situation.

DICGC charges premium at a flat rate of 10 paise for every 100 rupees in deposit, irrespective of the financial health of individual banks, thus, unnecessarily penalising those institutions that perform well.

A performance-based deposit insurance premium can actually be used as an incentive for promoting prudence and diligence in the conduct of individual private sector banks.

For this to happen, the premium should be set at levels that can influence decision-making in banks and make a perceptible impact on their performance.

This leads to the third issue that concerns the sufficiency of the deposit insurance premium.

A premium of 10 paise for every 100 rupees in deposit appears too paltry, especially for private sector banks that have the set precedent of getting bailed out by the government in case of failure as in the case of the erstwhile Global Trust Bank.

Even the cash withdrawal tax intended as a money flow tracking mechanism is levied at 0.1 per cent of the amount withdrawn. Charging the same rates for the purpose of insuring deposits appears far from being sufficient to cover the risk of bank failure let alone have a tangible influence on the behaviour of banks.

Raising the deposit insurance coverage ceiling from Rs 1 lakh to a realistic level, adopting a more meaningful premium structure and disseminating the knowledge of deposit insurance among the public can create a win-win scenario for both private banks and their customers and further reinforce the foundations of the banking system in the country.

Such a revamp would be in line with the recommendations of the Basel committee on international banking supervision which is transforming the face of the financial industry globally.

The question is how soon we can expect to see the revamp happen?

The author can be reached at niranjan.krishnan@gmail.com