Budget 2020: Bank Deposit Insurance To Be Hiked To Rs 5 Lakh
A closed PMC Bank ATM at Nahur West (Source: BloombergQuint)

Budget 2020: Bank Deposit Insurance To Be Hiked To Rs 5 Lakh

The government said the quantum of deposits insured in the event of a bank failure would be raised to Rs 5 lakh from the current Rs 1 lakh.

“There is a robust mechanism to monitor the health of all scheduled commercial banks and we want to assure depositors that their deposits are absolutely safe,” Finance Minister Niramala Sitharaman said in her Union Budget 2020 speech.

The decision comes after the collapse of Punjab and Maharashtra Cooperative Bank that led to restrictions on deposit withdrawals. According to the Reserve Bank of India’s Financial Stability Report, the Deposit Insurance and Credit Guarantee Corporation has received total claims of about Rs 14,100 crore across defaulting cooperative banks.

It’s important to see whether the deposit insurance cover is ever actually used for Indian banks, said former RBI Governor C Rangarajan. “So far, the RBI has managed it in such a way that no scheduled, commercial banks really fail,” he told BloombergQuint. “When they have a difficulty, some kind of a merger or some arrangements are made that will help to overcome the problem.”

According to Rangarajan, it’s not the guarantee of the deposit insurance mechanism that’s going to reassure the depositors, but what the regulatory system and what the monetary system is going to be in situations where a bank has collapsed.

A Long Overdue Change

The insurance cover of Rs 1 lakh has been in place since 1993. This is paid out in the event that a bank is liquidated.

Between 1993 and 2019, as the base of deposits across the Indian banking system has increased, the extent of protection has changed. The number of fully protected accounts is still high at 92 percent. However, the proportion of deposits protected has come down to 28 percent as of March 2019.

Budget 2020: Bank Deposit Insurance To Be Hiked To Rs 5 Lakh
Budget 2020: Bank Deposit Insurance To Be Hiked To Rs 5 Lakh

Funding The Increased Insurance Cover

Since 2005, banks have been paying a flat-fee premium rate of 10 paise for every Rs 100 worth of deposits to maintain an insurance cover of Rs 1 lakh per depositor. With the extent of insurance raised, banks would have to increase the premium payment, which would eventually be passed on to customers in some form.

A debate has erupted on whether each bank should be asked to pay the same premium or whether banks seen to be at a higher risk of failure should be asked to pay more. An RBI committee in 2015 had suggested differential premium for banks based on their risk profile.

“Along with the Rs 5 lakh deposit insurance, depositors must be aware that this will result in much larger premiums being paid by banks, therefore the costs of servicing the accounts will rise accordingly,” Arundhati Bhattacharya, former chairman at State Bank of India, told BloombergQuint after the budget announcements.

She said the premiums would rise five times, which is not a small rise in cost for the banks, which will eventually be passed on to customers. The premiums will also have to be paid on the entire deposit amount and not just Rs 5 lakh, which is covered under the Deposit Insurance and Credit Guarantee Corporation.

Pratip Chaudhuri, former chairman at SBI, said differential premium had been tried in certain advanced economies but had to be withdrawn. “The moment you say that certain banks have to pay a higher premium on deposits, it sends a signal to the market that the bank is riskier than the other in the system,” he told BloombergQuint. “This may cause too much confusion among depositors, which is not good for the system.”

By hiking the payout, Chaudhuri said the premium would also go up, which could result in higher cost to customers or lower deposit rates offered by banks.

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