Risk Based Premium for insured deposits to be introduced

RISK BASED PREMIUM FOR INSURED DEPOSITS:
NEED OF THE HOUR

INCREASE IN INSURANCE COVER:
DICGC, which insures bank deposits of eligible customers of commercial/cooperative banks, has increased its coverage per depositor from Rs. 1 lac to Rs.5 lacs with effect from 4th February 2020. The Act has been amended recently to stipulate, among other things, that the claims of depositors, in the case of invocation of insurance, should be settled within a time period of 90 days. Since the cover is per depositor, DICGC has also given some examples, in its website, as to how the cover can be maximised by holding the deposits in joint names in different styles/capacities.

With the increase in insurance amount, 98.1% of the total deposit accounts and 50.9% of the total eligible (assessable) deposit amounts of the covered banks are insured as on 31st March 2021. PMC Bank depositors may be the first set of beneficiaries to receive the claim under DICGC, after the increase in insurance cover and reduction in claim period. For DICGC, which has settled Rs.5760 cr. as claims of depositors in 57 years since inception in 1964, the settlement of claims for PMC Bank depositors may be the highest. (Total deposits of PMC Bank was Rs.10,535 cr. as on 31.03.2021, which includes eligible and ineligible depositors and eligible depositors holding in excess of Rs.5 lacs. Exact amount of claim on DICGC is not yet known). 

DICGC Claim invocation in the recent past: PMC Bank is fourth in the list of stressed banks, which had to be rescued by the government/regulator in the last four years. While IDBI Bank was rescued by the government with capital infusion from LIC of India, Yes Bank was rescued by RBI by persuading other SCBs to participate both in the fresh equity exercise and the change in board and management. DBS Bank was allowed to take over LVB as a normal acquisition. In the above cases, the insurance claim invocation from DICGC was not required as the liabilities were carried on by the transferee bank. However Unity Small Fiance Bank (USFB), which propose to take over PMC Bank, is allowed to use the funds of DICGC to settle the claims of PMC Bank depositors first and as per draft scheme proposed, a time period of twenty years is given to USFB to pay back the money settled by DICGC. With the stress in the banking sector likely to remain for the next three to five years due to COVID affected economy, the last word on bank failures, other than that of co-operative banks, is not written down yet. 

I. Whether DICGC has adequate buffer to meet the increased liability on account of increase in insurance cover?
After the increase in insurance coverage, the assessable deposits (deposits eligible for cover up to Rs.5 lacs) has gone up by just 11% over 31st March 2020. (stood at Rs.149.67 lac cr. as on 31.03.2021). However the insured deposits has gone up by 106%, the amount increasing substantially from Rs.36.96 lac cr. as on 31.03.2020 to Rs.76.21 lac cr. as on 31.03.2021. 

As against the above, Deposit Insurance Surplus Fund* (available for meeting the claims of depositors in case of bank failures) has gone up by just 18%, the surplus going up from Rs.1,10,380 cr. as on 31.03.2020 to Rs.1,29,900 cr. as on 31.03.2021. 

(*Consists of actuarial fund and fund surplus)

The above comparison makes sense, when one look at the following:
After the increase in insurance cover, Deposit Insurance Surplus Fund to assessable deposits has improved from 0.82% to 0.87%, whereas in relation to insured deposits, it has come down from 2.99% to 1.70%. In short, the surplus fund available for every insured deposit of Rs.100 has come down from Rs.2.99 to Rs.1.70.

II. Increased risk to DICGC due to quantum leap in insured deposits of PvSBs:

The risk based pricing, offered earlier by private sector banks (PvSBs), is slowly replaced by market related pricing, as perception on default risk is mitigated by the insurance coverage. The increase in insurance coverage has helped  PvSBs to improve their market share in deposits at reduced interest rates (savings bank rates above Rs.1 lac command lesser pricing (6-7% earlier) and the average term deposit interest rates have come down by more than 150 bps in the period March 2020 to October 2021). While the increase in insured deposits of public sector banks (PSBs) apparently causes no concern to the insurer, apparently on account of perceived sovereign guarantee, the same cannot be said about the increase in insured deposits of PvSBs. Due to the increased coverage, the insured deposits of PvSBs has gone up by Rs.9.80 lac cr. and that of SFBs has gone up by Rs.21,000 cr.@.

(@ PvSBs insured deposits coverage has gone up from Rs.6.84 lac cr. to Rs.16.66 lac cr. and that of SFBs went up from Rs.9900cr. to Rs.32100 cr.)

As said earlier, the number of private banks under stress is on the increase in the recent years. Four PvSBs (includes SFBs) have reported net losses in the current quarter due to stress in retail with particular reference to credit cards and micro finance. IDBI Bank, which was a PSB earlier, no longer enjoys the accredited status now.  The government also announced its intention to privatise some of the PSBs in the current or next FY. RBI has introduced 'on-tap' licence for setting up universal, small finance and payment banks. 

Hence the share of PvSBs in the total deposits eligible for insurance cover is bound to go up significantly, which increase the risk of the insurer that needs to be compensated adequately.

III. DICGC has no control over how the funds are deployed (RBI also has limited control by way of CRR/SLR prescriptions only)

PvSBs are shareholder centric and they deploy in loans and advances, which offer the maximum return. While this approach is rewarding during boom in the economy, it hurts when the environment is under stress. The increased concentration of commercial banks on unsecured advances, credit cards, micro finance (the segments that offer a rate of return in the range of 18% to 30%) in the recent past, where PvSBs outpace PSBs in growth, is an example of where things can go wrong .

IV. Need for risked based premium: 

In the above circumstances, unless Deposit Insurance Fund of DICGC grows in proportion to the increase in insured deposits, uncertainty to settle all claims by the insurer from its own funds, in case of a failure of a bank having significant deposits, remain. 

DICGC has no other revenue to improve the surplus fund, other than through premium and investing the surplus fund in rated securities. As the assessable deposits did not increase significantly in relation to the increase in insured deposits on account of increased coverage per depositor, the increase in premium rate on a flat scale across all the eligible banks may not help DICGC to improve its insurance surplus fund at an acceptable level in the near future*. 

(*The revenue from premium has gone up from Rs.13234 cr. in FY 2019-20 to Rs.17517 cr.* in FY 2020-21, . The increase works out to just 32%, even after the premium was raised by 20%, in relation to the huge jump in insured deposits by 106%)

Hence the need of the hour is to introduce risk based premium (RBP) on insured deposits for different banks. The RBP should take into account

 

(a) Sovereign/ non-Sovereign character 

(b) Credit ratings (to be introduced for canvassing retail deposits as is done for certificate of deposits now)

(c) Higher risk of deployment of funds in toxic assets beyond certain ceilings that can be defined. 

V.Viswanathan

25th December 2021.

(Recirculated on 20th August 2024 as the topic becomes live again)

Sources: DICGC Annual Report 2020-21, RBI Monthly Bulletin