MUMBAI: It seems changes are on the anvil on the deposit insurance front with a second deputy governor calling for periodic revision in the premia based on the risk profiles of the deposit-taking institution just a day after his peer did the same, over the weekend.
Calling for periodic revision, the deputy governor of RBI M Rajeshwar Rao, has said a targeted insurance approach with full coverage for certain sections of customers like small depositors and senior citizens can be also explored.
This also means that banks introducing more innovative products and new risks potentially impact deposit growth, a risk-based premium would be a more effective option for the deposit insurer to ensure the robustness of its finances and enhance its ability to adapt to changing financial conditions.
Addressing the International Association of Deposit Insurers (IADI) Asia-Pacific regional committee meeting hosted by the Deposit Insurance and Credit Guarantee Corporation (DICGC) in Jaipur over the weekend, said “a periodic upward revision in the uniform deposit insurance coverage of Rs 5 lakh is necessary, as the country’s growth and formalisation is likely to lead to a significant rise in both primary and secondary deposits, which may create a gap between the ideal insurance reserve requirement and the available reserves.”
Normally, central bankers test the market/the reaction of the entities regulated by it by suggesting mostly through speeches or articles how the central bank is looking at certain things. This was something the Reserve Bank began doing in the times of former governors Bimal Jalan and YV Reddy.
Addressing the same conference a day before, another deputy governor Swaminathan J mooted risk-based premia for deposit insurance, saying risk-based premium increases for deposit insurers can ensure that those institutions with higher risk profiles contribute more to the insurance fund.
"By tying insurance premiums to the level of risks posed by individual financial institutions, deposit insurers can incentivise banks to adopt stronger risk management practices. This approach not only enhances the overall stability of the financial system but also ensures that institutions with higher risk profiles contribute more to the insurance fund," Swaminathan said.
Currently, in the country, there is a uniform deposit insurance coverage of Rs 5 lakh per depositor of each insured bank.
“Considering multiple factors like growth in the value of bank deposits, economic growth rate, inflation, increase in income levels etc, a periodic upward revision of this limit may be warranted. This means that the deposit insurer has to be mindful of the additional funding and needs to work out suitable options to meet the same,” Rao told the conference.
Though suggesting that having full insurance cover for deposits appears to be ideal for depositors and also helps to avoid bank runs, he however admitted that “this is likely to be a suboptimal solution given the associated moral hazards and financial non-viability.”
According to an IADI survey, the median deposit insurer covers 43.1 per cent of the value of eligible deposits in the country. Additionally, the number of fully protected accounts constitutes 97.8 per cent as of March 2024, of the total number of bank accounts, as against the global benchmark of 80 per cent. While the scope and coverage appear satisfactory at this juncture, there are challenges likely going forward, Rao said.
Emphasising the need for considering whether the coverage of digital deposit-like products should also be an option for the deposit insurer, he said recently, a committee formed by RBI for the review of customer service standards in lenders recommended extending deposit insurance cover to money kept in wallets of prepaid card issuers.
Rao also said that challenges like the Finternet (the Internet for the financial world alone), tokenisation of deposits, CBDC/ digitalisation etc highlight the need for the financial ecosystem to have an enhanced technological backbone to support the financial sector activities.
But this does not in any way deflect the deposit insurers from their core mandate of providing a backstop for the depositors to generate confidence in the financial sector entities who support the real sector and also promote financial stability.
This calls for exploring the need to examine whether deposit insurance should expand vertically (increase the cover offered) or horizontally (increase the nature of entities to be covered through insured products) and also explore its role along a third dimension reflecting fintech innovations which change the way the depositors’ liabilities reside within the financial services sector.
“This then brings up the issue of funding the deposit insurance system and whether the premium paid by the financial institutions should be based on their respective risk profile. Globally, more than 96 per cent of the deposit insurance systems, including the one followed by DICGC, are ex-ante funding systems wherein the deposit insurer maintains a deposit insurance fund, primarily financed by premiums collected from the insured institutions and the fund is used to pay the depositors in the event of a bank failure,” he said.
The deposit insurers collect premiums from member financial institutions either at a flat rate or a differentiated rate based on an individual bank’s risk profile. Although the flat rate premium structure has the advantage of being relatively easy to understand and administer, it does not consider the level of risk that a bank poses to the deposit insurance system and can be perceived as antithetical to the concept of insurance.
The primary objective of differential premium systems is to provide incentives for banks to avoid excessive risk-taking, minimise moral hazard and introduce greater equity into the premium assessment process, he said.
As per IADI, around 55 per cent of deposit insurers use a differential premium system globally.
“There is also a dilemma that the introduction of a risk-based premium can render the riskier institutions more vulnerable to deposit flights and shorten the distance to failure. However, we also need to recognise that with greater innovations in product offerings by banks newer risks that can impact deposit growth, the demand for higher coverage for deposits, risk-based premiums would be a better option for the deposit insurer to ensure the robustness of its finances and also enhance its capability to operate in changed financial milieu. It is therefore important for us to carefully examine the option of adopting risk-based deposit insurance cover,” Rao concluded.