Do Indians need insurance for bank deposits?

What is the issue?

India needs to move to a risk-adjusted premium model so investors are more aware of the risks

The revamped deposit insurance scheme was upgraded through the Deposit Insurance and Credit Guarantee Corporation (DICGC) Amendment Bill, 2021,
It guarantees to compensate depositors up to a limit of Rs. 5 lakh within a period of 90 days from when a bank fails.
So far Rs. 1,300 crore has been paid to depositors in troubled cooperative banks.

Rs. 1 lakh limit was set in 1990s.
Considering the inflation rate this has become extremely inadequate.
Compared to international standards our insurance limit is much lower ( 6 to 10 times) than several comparable economies like South Korea and Brazil.
We are also way below U.K. and U.S.A.
Though we cannot compare figures across countries in isolation due to differences in purchasing power we still have a lower amount of deposit insurance than other countries.
So, by raising the limit to Rs. 5 lakh, we are going in the right direction.

History - Discussion on deposit insurance began in India after a number of bank failures. Attempts were made to stabilise the banking system.
In the 1930s, the U.S. set up deposit insurance. India set it up in the 1960s to deal with bank failures.
So each time your banks fail in large numbers, the central bank does something about deposit insurance.
Confidence Building Measures - We want to give confidence to depositors that if a bank does go down, they don’t need to run to the bank.
Instead they can keep their money in the bank, and the bank can continue operating without any financial trouble. It is a combination of these things.
Cost of Delayed Payment – Investors are not able to figure out good banks and bad banks. They generally invest in banks where returns are high.
But no one has lost money in any scheduled commercial bank in India.
There may be a liquidity risk but no credit risk because the government always comes in and rescues banks. It means there is 100% insurance.
However there may be a delay in case of bad banks and that can be pretty costly. The sooner we get there, the better it is.
So we need risk-based deposit insurance premiums, which is simply absent in India.

It comes into play when panic sets in, like in 2008.
Everybody was panicking about the financial sector and wanted their money back, fueling a self-fulfilling crisis.
In that scenario, private insurance might not work because people might think that the private insurer will become bankrupt.
This is where the might of the government comes in because the government has the ability to be the lender of last resort.
We saw in the 2008 crisis that the U.S., which is generally seen as a more market-driven financial system, had to be eventually bailed out by the government.

The DICGC is basically owned by the RBI.
But when it comes to bank failures, it is the RBI and not the DICGC that is playing a major role
In U.S.A the Federal Deposit Insurance Corporation also plays a role in the resolution of troubled banks
The Federal Reserve doesn’t play an active role in the resolution process other than lending to the troubled institution.
When these bank failures happen there are a lot of signs of the failure that build up leading to the crisis.
Regulators are always a few steps behind the banks. They are still playing the catch-up game in figuring out the true level of risk that banks have.
RBI should disclose risk information and take quick action before a bank fails. For this you need to have a good model to figure out which bank is under stress.
Depositors discipline has to go hand in hand with improvement in risk management system across the board.

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