Background
Post independence, Banking crises in Bengal in 1948, brought the concept of insuring bank deposits to fore. However, it remained in abeyance till 1960 when the Palai Central Bank Ltd, and the Laxmi Bank Ltd collapsed. Consequently, Deposit Insurance Act, 1961 was promulgated by the Parliament that was made effective from 1st January 1962. Initially, Deposit insurance scheme was extended to commercial banks, including foreign banks functioning in India. Subsequently, an amendment to DIC Act 1961 extended coverage to eligible cooperative banks where respective State Governments vested powers with Central Bank/RBI for closure, amalgamation or reconstruction of cooperative banks.
Though topic is risk-based premia on Bank deposits, yet it is essential to understand DICGC formation. GoI, in consultation with the Central Bank of the country, introduced a credit guarantee scheme in 1960 wherein RBI was designated as Credit Guarantee Organization (CGO) for guaranteeing advances granted to Small Scale Industries by Banks and other lending institutions. In 1971, RBI launched a Public Limited Company Credit Guarantee Corporation of India Ltd (CGIL). The focus of this company was to provide guarantee for advances granted to small and needy borrowers i.e. weaker sections of India, falling under priority sector advances definition. With the objective of integrating functions of deposit insurance and credit guarantee schemes, the DIC and CGCI were merged to form DICGC in July 1978. As a consequence, the name of Deposit Insurance Act, 1961, was amended to Deposit Insurance and Credit Guarantee Corporation Act, 1961.
Deposit Insurance Coverage
The Public Sector Banks, Private Sector Banks, Foreign Banks, Payment Banks, Small Finance Banks, Regional Rural Banks, Local Area Banks, State Cooperative Banks, District Central Co-operative Banks and Urban Cooperative Banks are covered for Bank deposits up to an amount of Rs 500,000/- subject to payment of premium on assessible deposits within 2 months from the end of preceding half year. The default in payment of premium attract interest penalty of 8% over bank rate till payment of premia is made by the insured bank. Default in making 3 consecutive half-year premium payments would render insured bank liable for cancellation of registration under DICGC Act, 1961.
The Deposit insurance coverage started with a measly sum of Rs 1,500/- in 1961. With the passage of time, the deposit insurance sum was gradually enhanced to Rs 100,000/- and currently to Rs 500,000/- w.e.f. February 4, 2020. Last available data suggest charging of Rs 0.05 premium per Rs 100/- on assessible deposits w.e.f. 1993, which was enhanced to Rs 0.08 w.e.f. 1st April 2004 and subsequently to Rs 0.10 effective 1st April 2005. With the increase in sum assured limit to Rs 500,000/- w.e.f. 4th February 2020, the premium rate stands enhanced marginally to Rs 0.12 per Rs 100/- on assessible deposits w.e.f. 1st April 2020.
Risk-based Premia (RBP) Rationale
According to RBI annual report, DICGC is contemplating charging risk based premium on deposits of banks and financial institutions for extending insurance coverage under the scheme. Though charging flat rate premium on deposits is simpler to understand, seamless and administer, yet it doesn't consider the level of risk a bank or financial institution poses to the insurance system. Strictly speaking, it is not fair to charge flat rate when A category of bank poses higher risk to insurance system than B or C or D category of the bank. Another objective of charging differentiated premium based on risk profile of banks or financial institutions would be to incentivize banks and thwart banks from taking excessive risks. Whenever this proposition is implemented the stronger banks would be able to offer higher risk adjusted returns whereas weaker banks will have to shell out higher premium.
Upon taking a look at empirical data, it could be construed that majorly particular category of banks have collapsed/closed down in the past from time to time due to lack of risk management policies whereas nationalized banks, private banks and foreign banks have managed the risks well or better ones took over ailing ones, thereby not invoking the DICGC cover available to depositors. In a nutshell, stronger banks were subsidizing the insurance coverage premium for weaker banks. The internal committee of RBI on risk-based premia (RBP) under chairmanship of Shri Venkata Chalapathy had undertaken the risk assessment of the banks based on CAMELS (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Systems & Controls) parameters and recommended for introduction of RBP. This step might bring down the differential in deposit interest rates between stronger and weaker banks and it would be prudent for the depositors to place deposits with stronger ones where risk is low.
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