Raise the limit for deposit insurance

Raise the limit for deposit insurance

Also undertake systemic reform of banking.

India should double the limit for bank deposits that are insured, to at least ₹2 lakh. That would still be short of a rule of thumb, of the ceiling being double the per-capita GDP. The other rule of thumb, as former SBI economist M R Das explained on this page on Tuesday, is that the limit should cover 80% of depositors and at least 20% of the deposits. This is less relevant for India. The ₹1 lakh limit, estimates Das, cover 92% of depositors, thanks to the huge increase in the number of small account holders, following financial inclusion drives.

A static coverage limit of ₹1lakh since 1993 has resulted in the level of insured deposits as a percentage of assessable deposits falling, underscoring the need to raise the limit. The Raghuram Rajan Committee on Financial Sector Reforms 2009 recommended strengthening the capacity of the Deposit Insurance and Credit Guarantee Corporation, a more explicit system of prompt, corrective action, and making deposit insurance premia more riskbased. India needs a law to put banks and the rest of the financial sector on a more secure footing and make people feel safe about their money, apart from reform of the practice of banking. The government had proposed the Financial Resolution and Deposit Insurance Bill to provide a mechanism for resolution of distressed financial firms, but withdrew it over mass opposition to a provision of bailing in deposits in the case of extreme stress.

It is not politically feasible to legally prescribe bailing in the deposits of ordinary savers, even if only above a high threshold. At the same time, to continue with a system of implicit government bailout of banks is to encourage banks to undertake unwarranted risky lending. Institutionalised resolution mechanisms must be put in place for banks that fail. Asking them to maintain a loss-absorbing capital buffer over and above the Tier 1and Tier 2 capital they are required to hold would be one way to do it. These could be in the form of bail-in bonds that offer a higher return in exchange for the explicit risk of being bailed in, in case of bank failure.