BQ Explains: How Will The New Deposit Insurance Rules Work?

On Aug. 9, parliament passed the Deposit Insurance and Credit Guarantee Corporation Amendment Bill, paving the way for quicker payout to depositors of stressed banks in India.

The DICGC is a fully owned subsidiary of the Reserve Bank of India, which insures bank deposits across public, private, small finance, payments, local area and cooperative banks. Deposits worth Rs 5 lakh are now insured after the protected amount was raised last year from Rs 1 lakh.

The latest amendment will be applicable to banks currently under moratorium and those which may face restrictions in the future.

According to Union Finance Minister Nirmala Sitharaman, the new rules will help depositors get their funds within 90 days of a bank going into moratorium or restrictions by the RBI. Previously, depositors had to wait eight to 10 years before they could access their deposits from the point of a bank going into moratorium, she had said.

The need for such an amendment was made necessary after depositors of Punjab & Maharashtra Cooperative Banks continue to face restrictions on deposit withdrawals since September 2019. Currently, PMC Bank depositors are allowed to withdraw up to Rs 1 lakh from their bank accounts, even as a rescue plan is being finalised by the Reserve Bank of India and a consortium of Centrum Financial Services Ltd. and Bharat Pe.

Depositors of PMC Bank, and any future lenders that fall into distress, will now be able access their deposits within 90 days. How will this work? What is the application process? Can the DICGC manage these many settlements? BloombergQuint explains:

According to the procedure laid down under the amended bill, a bank under moratorium is required to create a full list of depositors with the outstanding deposits in their accounts within 45 days of the lender being placed under restriction.

Once the list is shared with the DICGC, it has 30 days to verify the data and ascertain whether the depositor would like to immediately receive the insured funds, through an online portal or any other method it deems fit.

After the confirmation process is completed, it has 15 days to make the payments directly to the depositor or transferred to any bank account of their choice.

If the RBI were to introduce any scheme of amalgamation or reconstruction for the stressed bank within the 90 day repayment period, the repayment period gets extended by another 90 days, according to the amendment.

Moreover, if the RBI were to remove its restrictions and the insured bank is capable to paying depositors their full dues, before the repayment period runs out, the DICGC will be free of any payment liabilities.

In 2020, two private sector lenders, Yes Bank Ltd. and Lakshmi Vilas Bank Ltd., were put under moratorium by the banking regulator. However, they were both rescued within weeks. The resolution plan for PMC Bank, in contrast, has lingered.

The amount paid by the DICGC to the depositor shall be reduced from the liability of the bank to the depositor, the amendment says. However, the insured bank then becomes liable to pay that amount to the corporation. These repayments will be made either during liquidation or rescue, on priority, within a stipulated period of time as decided by the corporation.

The amendment allows DICGC to further charge penal interest of 2% over the prevailing repo rate, if the bank is unable to pay the corporation within the stipulated time.

Before the amendment was passed, the DICGC would collect a flat annual premium of 12 paise per Rs 100 worth deposits from the insured banks. The premium was raised from 10 paise in April 2020. This premia is collected by the deposit insurance fund of the DICGC and used to settle any claims which may arise from depositors of a stressed bank.

As of March 2020, the deposit insurance fund stood at over Rs 1.1 lakh crore, up 18% on a year-on-year basis, DICGC said in its annual report. The annual report for financial year ending March 2021 is not available. During the financial year, the corporation settled aggregate claims worth Rs 70.85 crore, in respect of eight cooperative banks, according to the annual report.

R Gandhi, former deputy governor of the RBI, says that the outstanding funds available with the DICGC should be good enough to cover banks which are currently under moratorium, since these are cooperative banks which have a small base of depositors.

"Going ahead, we should expect to see the DICGC implement a risk-based premium pricing method soon, to incorporate higher payments to depositors. Technically, it is possible even today, but so far the corporation has been charging only a flat fee to all banks," Gandhi said.

The concept of risk-based premium for the DICGC was originally introduced in the Narasimhan Committee report on banking sector reforms in 1998, but is yet to be implemented.

The latest amendment allows for premium to be raised to 15 paise per Rs 100 worth deposits, with the prior approval of the banking regulator. However, it does not speak of differential premia.

While the relative pool of funds held by the Deposit Insurance Corporation is large, it has to be seen in context of the size of the banking system's deposits. As of July 16, scheduled commercial banks alone hold Rs 155 lakh crore in deposits, according to RBI's fortnightly data.

However, since the corporation only insures deposits up to Rs 5 lakh, the pool of protected deposits is smaller. The ratio of funds available for settlement to the total deposits insured by the corporation is given as the reserve ratio.

According to the FY20 annual report, the reserve ratio fell to 1.61%, the lowest since FY12. The highest reserve ratio was recorded in FY19, at 2.78%.

This reserve ratio could be materially altered in FY21 and FY22 by the higher pool of deposits being insured as also the higher premium collected.

Also, the time lags in paying out depositors immediately and waiting for a bank to be resolved to get dues back may require DICGC to rethink appropriate levels of reserves. Else bank failures will need to be resolved quicker.

The DICGC will need policy support from the government to ensure that the resolution of a stressed bank is wrapped up quickly, said Gandhi.

"We can expect policies like insolvency for financial institutions to become the norm or even the FRDI (Financial Resolution and Deposit Insurance) Bill to make a comeback to ensure quicker recoveries," Gandhi said. "Additionally, like in the case of PMC Bank, the RBI could look at sale processes where investors are invited and given the carrot of a small finance bank licence to increase quicker resolution of stressed cooperative banks."