By Jayesh and Veena Sivaramakrishnan
World over, deposit insurance has become a popular tool used by governments in an effort to ensure the stability of the banking system and protect bank depositors from incurring large losses in case of bank failures. Most countries have financial safety nets in place that include explicit and/or implicit deposit insurance, bank regulation and supervision, central bank lender of last resort facilities and bank insolvency resolution procedures. Apart from the explicit deposit insurance scheme established by most countries, many countries also have an implicit deposit insurance scheme in place since governments would inevitably intervene and impose a moratorium and/or provide other relief measures rather than allow a bank to fail and expose the financial system to a systemic risk.
The Great Depression of the 1920s compelled the need to instill confidence in the public at large by providing better protection against bank failures. This prompted the United States of America to introduce a deposit insurance scheme in 1934, which was the first of its kind in the world. Under this scheme, the Federal Deposit Insurance Corporation reimburses the depositors of failed banks, thereby reducing the impact of such bank failures. Such schemes gained popularity in the 1960s, with nine other countries, including India, following this move.
Growth of Deposit Insurance in India
India was the second country in the world to introduce deposit insurance. As in the rest of the world, the need for deposit insurance in India was also on account of bank failures in the late 19th and early 20th centuries. The failure of the Travancore National and Quilon Bank (the largest bank in the Travancore region) in 1938 led to various interim measures relating to banking legislation and reforms. The banking crisis in Bengal between 1946 and 1948, coupled with the failure of Laxmi Bank and the subsequent failure of the Palai Central Bank in 1960 led to the introduction of deposit insurance in India.
The Deposit Insurance Corporation Act was enacted in 1961, leading to the formation of the Deposit Insurance Corporation (DIC), which regulated and supervised deposit insurance in India. DIC, a wholly owned subsidiary of the Reserve Bank of India (RBI), commenced operations on January 1, 1962 with 287 banks registered with it as insured banks. However, this number dwindled on account of RBI’s policy of reconstruction and amalgamation of small and financially weak banks so as to make the banking sector more viable.
The 1960s and 1970s, which were a period of institution building, also witnessed the establishment of the Credit Guarantee Corporation of India Ltd. (CGCI). While deposit insurance had been introduced in India out of concerns to protect depositors, ensuring financial stability, instilling confidence in the banking system and helping mobilization of deposits; the establishment of the CGCI was essentially in the realm of affirmative action to ensure that the credit needs of the hitherto neglected sectors and weaker sections were met. The essential concern was to persuade banks to make available credit to the not so creditworthy clients i.e. small borrowers belonging to weaker sections of society.
With a view to integrating the functions of deposit insurance and credit guarantee, the DIC and the CGCI were merged and the Deposit Insurance and Credit Guarantee Corporation (“Deposit Corporation”) came into existence on July 15, 1978. The Deposit Insurance Act, 1961 was thoroughly amended and renamed as the Deposit Insurance and Credit Guarantee Corporation Act, 1961 (“Deposit Corporation Act”). After the merger that integrated the functions of deposit insurance and credit guarantee, the focus of the Deposit Corporation shifted to credit guarantees. Following the financial sector reforms of the 1990s, credit guarantees gradually were phased out and the focus of Deposit Corporation is now back to deposit insurance with the objective of averting panics, reducing systemic risk, and ensuring financial stability.
The coverage limit in India has been sensitive to the growth of the economy and has been revised from time to time. It has been revised from INR 1,500 initially to INR 5,000 in 1968; INR 10,000 in 1970; INR 20,000 in 1976; INR 30,000 in 1980, and finally to INR 100,000 in 1993, which has not been revised to date.
All commercial banks (including branches of foreign banks operating in India), local area banks and regional rural banks, and all co-operative banks regulated by the RBI (other than those from the States of Meghalaya, and the Union Territories of Chandigarh, Lakshadweep and Dadra and Nagar Haveli) (“Insured Entities”) are covered by the bank guarantee deposit scheme (“Scheme”).
All deposits in the nature of savings, fixed, current, recurring, etc. that are placed by natural persons, sole proprietorships and partnership entities (but not limited liability partnerships) in an Insured Entity are covered under the Scheme.
The salient features of the Scheme are as follows:
(a) Guaranteed Amount: The deposits are insured up to a maximum amount of INR 100,000 (Indian Rupees One Hundred Thousand Only) cumulative of principal and interest, held by a depositor in the same capacity in the same bank. Effectively, the deposits kept in different branches of the same bank in the same capacity are aggregated, but the deposits held in different capacities are not.
(b) Premiums: The Scheme is ‘ex-ante,’ i.e., Insured Entities pay advance premiums to the Deposit Corporation on the basis of their assessable deposits semi-annually, within two months from the beginning of each financial half year based on its deposits as at the end of previous half year. The premium paid by the Insured Entities to the Deposit Corporation is required to be borne by the Insured Entities themselves.
(c) Triggering Payment Under the Scheme:
(i) Liquidation: The Deposit Corporation is liable to pay to each depositor through the liquidator.
(ii) Reconstruction/Amalgamation/Merger: A scheme of compromise or arrangement or of reconstruction or amalgamation of an Insured Entity may be sanctioned providing for payment of an amount that is less than the original amount (total amount due by the Insured Entity) and also the specified amount (currently INR 100,000) to the depositor. of the Insured Entity, In such an event, the Deposit Corporation shall be liable to pay to every such depositor the lesser of an amount equivalent to
(a) the difference between the amount so paid or credited and the original amount, or
(b) the difference between the amount so paid or credited and the specified amount (currently INR 100,000).
(d) Time Frame: The time frame for payment of the insured amount is 2 months from the date of receiving the list of depositors from the liquidator in case of winding up of the bank. In case of a reconstruction, arrangement or amalgamation, the Deposit Corporation shall be furnished with a list of depositors within 3 months from the date on which the scheme of amalgamation / reconstruction comes into effect and thereafter, the Deposit Corporation shall make payments under the Scheme within 2 months, either directly to the depositor or to the transferee bank or insured bank for credit to the account of such depositors.
(e) Source of Payment: The Deposit Corporation can pay the amount from its general funds and out of returns of investments made by it, with a right of repayment from the liquidator or the transferee or the insured bank. In addition, the depositors can claim the amount as per the manner set out in the Banking Regulation Act, 1949, subject to priority of certain other creditors such as workmen dues, dues from the state government, etc. Since its establishment, the Deposit Corporation has always been able to fulfill its obligations.
(f) Recovery by the Deposit Corporation: The liquidator (in case of liquidation) or the insured bank or the transferee bank (in case of an amalgamation or merger, etc.), as the case may be, is required to repay the Deposit Corporation out of the amounts realised from the assets of the failed bank and other amounts in hand after making provision for the expenses incurred. Such claims of the Deposit Corporation are not privileged to claims of third parties.
As per the latest available data, Deposit Corporation boasts of having fully protected 89.3 percent of the deposit accounts as of March 31, 2009 as compared to the international benchmark of 80 percent. Amount-wise, 56.2 percent of the assessable deposits were protected by the deposit insurance cover, as against the international benchmark of 20 percent (Source: Annual Report of Deposit Corporation for the year ending 2008-2009).
The goal of Deposit Corporation, as explained by Subir Gokarn, the Deputy Governor of RBI and Chairperson, Deposit Corporation is “to go beyond the statutory prescription, and ensure settlement of claims within a few days of liquidation of a bank as against a few months taken now.” To achieve this, Deposit Corporation would be required to have a computerised depositors’ database for over 85,000 branches spread across the country. Secondly, the entire process of filing claims by the liquidator and their processing by the Deposit Corporation would have to be computerized with appropriate connectivity. The Deposit Corporation is believed to have already initiated steps to move in this direction by formulating an ambitious project of Integrated Claims Management System.
There have been frequent demands to raise the limit of deposit insurance cover in India. As the economy of India has grown substantially since 1993, there is a proposal to enhance the deposit cover to INR 250,000 as against the current maximum amount of INR 100,000. In our view, while this would be a welcome move, it may be some more time before this sees the light of the day given that the statistics mentioned above reflect a wide coverage. .
With regard to the issue of the extension of deposit insurance cover to deposits mobilised by Non Banking Finance Companies (“NBFCs”) and Financial Institutions (“FIs”), a working group set up in 1999 recommended against the extension of deposit insurance cover to NBFCs, and suggested that the matter be re-examined later when the supervisory mechanism concerning the NBFCs is fully stabilised. Extension of the deposit insurance cover to FIs was not considered favourably for a range of reasons, including but not limited to the fact that they do not enjoy the regulatory protection which banks do. In our view, given the present set up of NBFCs and their stringent regulatory regime (especially for deposit taking NBFCs), the time is ripe to consider extending deposit insurance to such NBFCs.
An important step going forward will be to reduce the inordinate delays in payments. Given that these delays have been attributed to the delay on the part of the liquidators, it is hoped that a computerised depositors’ database and the Integrated Claims Management System become a reality sooner than later, as the Indian banking system may not remain unaffected by the next global financial crisis.
Jayesh is the Founder Partner of Juris Corp. Mr. Jayesh is an expert in the field of Financial Services and is the pre-eminent practitioner in India for Derivatives, Structured Finance and Structured Products. He has been consistently recognized as one of Asia’s Leading Lawyers. Mr. Jayesh is an Advocate, Solicitor, Diploma holder in Business Finance and a Chartered Financial Analyst. He is a member of Mensa International and of GARP (Global Association of Risk Professionals). He can be reached at firstname.lastname@example.org.
Veena Sivaramakrishnan is a partner at Juris Corp. Veena started her career at Juris Corp in 2004 and then worked with ICICI Bank Limited and Davis Polk and Wardwell (as a Foreign Temporary Associate) at New York. Veena returned to Juris Corp in 2009 and became a partner in 2010. Her practice focuses on regulatory and documentation issues relating to the entire spectrum of derivatives, structured products, banking and money market related issues. She can be reached at email@example.com.