The government is “actively considering” a hike in India’s deposit insurance limit beyond the current ₹5 lakh, according to M. Nagaraju, secretary, department of financial services.
This comment, made soon after the Mumbai-based New India Cooperative Bank was placed under a moratorium by the Reserve Bank of India (RBI), rakes up the issue of deposit insurance again. It was last raised when Punjab and Maharashtra Cooperative (PMC) Bank failed in 2019 and the Centre responded by raising the insurance cover from ₹1 lakh to ₹5 lakh per deposit.
Bank failures are few and far between in India, thanks to state ownership of a large chunk of the sector and prompt action by its regulator, RBI. However, as the New India and PMC cases have shown, banks do fail from time to time. Cooperative banks, especially.
Also Read: Mint Primer | Cooperative bank crisis: Has anything changed since PMC’s plight in 2019?
Given the hardship caused to depositors, the case for deposit insurance is beyond dispute. But is raising the quantum of coverage the right answer? Instead, it may be time to go in for root-and-branch reform of the scheme, so that even as we try to minimize the fallout of a bank failure on people whose savings it holds, we also address related issues that go beyond the maximum sum assured.
No less important are issues such as the premium paid (and how it is borne), whether deposit protection should vary by income and age groups, and, critically, the need for greater transparency in the risk profile of banks. A broad rethink is also prompted by the impact of technology. Financial services have gone online, which, coupled with the potentially harmful role of social media in amplifying fear, means that bank runs can happen faster and more easily.
Modern banking is based on the fractional reserve system, under which banks retain a fraction of their deposits and lend the rest. This model relies on trust—or the faith that the bank will repay deposits ‘on demand.’ If this confidence gets shaken, a bank could suffer a rapid withdrawal of deposits, which, if not nipped in time, would lead to its collapse.
Also Read: India’s deposit insurer is overcharging commercial banks
Full insurance cover for deposits may seem an ideal solution, but it is a sub-optimal one, given the associated moral hazard. If banks know that depositors will be repaid regardless of how they conduct their business, they would have an incentive to chase risky assets in pursuit of enlarged profits. A heads-they-win/tails-taxpayers-lose deal is far from ideal. This hazard cues a follow-up question. Why should the premium paid have no link whatsoever, as is the case today, with the risk profile of banks?
Varying the premium charged for deposit insurance in accordance with a standard risk gauge has been suggested by many expert panels in the past, but has not been acted upon so far. The primary objective of risk-based pricing is to make excessively risky lending costly for banks. Such a nudge to relative safety would also be more equitable.
Also Read: Budget 2025: Tax incentives, higher deposit insurance key asks for banks
According to the 2023-24 annual report of Deposit Insurance and Credit Guarantee Corporation, which provides this cover, of the ₹16,325.6 crore paid out to depositors since its 1962 inception till 31 March 2024, just ₹295.9 crore was for claims from commercial banks, while ₹10,670.4 crore went towards claims from 374 liquidated cooperative banks and ₹5,359.3 crore was used for shortfalls in 57 cooperative banks placed under special direction.
Clearly, the skewed payouts for cooperative banks, which differ sharply from commercial lenders, make a compelling case for risk-based premium payments.
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