The banking system of any country is built on an edifice of trust that depositors have in their banks. The confidence that money is safe, keeps depositors away from withdrawing their funds unless they really need it. Meanwhile, it allows banks to lend out the money to borrowers which generates interest income for the depositor, profit for the bank and larger economic growth
Bail-in clause creates confusion
The ‘bail-in’ clause in the government’s Financial Resolution and Deposit Insurance (FRDI) Bill has created confusion
Section 52: allows to cancel the liability owed by a failed bank
- Section 52 of the Bill allows the proposed Resolution Corporation to cancel the liability owed by a failed bank
- Since the main liability of a bank is the ordinary depositor’s money, it naturally causes concern whether depositors stand to lose their money beyond what is insured in the event of a bank failure
Unless nipped in the bud, a panic reaction could destabilise the banking system.
Why should depositor liability be cancelled at all? When a failed bank does not have any assets left to pay its creditors, it is natural that depositors will not get back all or part of their money.
‘Guard against signals’
Government can’t cover all the risk
The government can never commit to pay out all depositors in such an event.
Such a commitment would signal to banks that it is acceptable to take more risks because, in case they go belly-up, the government will pay out depositors
The level of risk in the banking system would simply explode
So, depositors have to take the hit?
Hence, depositors have to take some hit if a bank fails.
This is formalised in the Bill’s bail-in clause.
“The intentions are good,” said Dr. K. Cherian Varghese, former CMD of Union Bank of India and Corporation Bank.
Deal with NPAs currently
“The new provision of ‘bail-in’ is welcome. However, when the banking system is struggling with the larger issue of non-performing assets, it is better to concentrate on recovery and also encourage bankers grant fresh loans for that the economy grows at faster pace.
Proposed law can be discussed later
The proposed law may be taken up later when there are no apprehensions in the minds of depositors,” he said.
Depositor’s trust: need for a bail-in will never arise
Yet, it is important for the depositor to believe that the need for a bail-in will never arise
Here lies the role of trust in the banking system.
Convincing depositors about safety of their money. How?
How can banks convince depositors that their money is safe?
- One way is through prudential regulations such as capital requirements and supervision.
- The other way is to guarantee through an insurance scheme that the insured part of deposits will be paid out to depositors by an insurance company.
Comparison with income
In India, up to ₹1 lakh of a depositor’s money is protected by insurance provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve Bank of India.
Insurance limit not revised
However, this insurance limit has not been changed since 1993 even while income and deposit levels have grown substantially.
Globally it has been revised after 2008
- Many countries revised their deposit insurance limits after the global financial crisis of 2008 but India did not do so
- Deposits up to $250,000 are protected by insurance in the U.S. while the figure is $1,15,000 in the U.K
Taking into account average income in a country
But the accurate comparison should take into account the average income in a country
- In US and UK:Deposit insurance limit is 3-4 times the average income levels in the U.K. and the U.S.
- In Brazil and China:In the case of emerging countries like Brazil and China, the insurance limit is 9 times the per capita income.
- In India:Compare that with India where the insurance limit is actually a little less than its per capita income.
Need to increase the insurance limit
The government should increase the deposit insurance limit under the Bill, considering that at about $1,600, it is at a much lower level than some of the other developing or larger economies.
Provision for periodic review
Further, there should be provision for a periodic review to raise the quantum of deposits covered by insurance.
- The current elevated level of non-performing assets and mounting losses of banks indicate that the RBI could have been more proactive in its supervision
- More frequent audits with public disclosure of audit findings would improve transparency… Further, depositors should also evaluate performance of banks at least on a yearly basis and take informed decisions.
Taken by surprise
People were taken by surprise at the explicit recognition of a bail-in process which was thus far implicitly present
Problems with the clarifications of the government
The government tried to soothe nerves by talking about implicit guarantees for deposits in PSU banks. There are two problems with this clarification
- First, the implicit guarantee cannot be emphasised beyond a point lest it creates a moral hazard in the form of risky behaviour by banks and lazy monitoring of banks by depositors
- Second, what about private banks who hold 25% share of total deposits in the country? Are their customers not deserving of the same protection from the government?
One optionwas to make riskier banks pay a higher insurance premium
But the aim must be to ensure that the relatively less affluent have 100% insurance coverage and the affluent investors diversify across asset classes
Disagreement with the above option
However, Mr. Gupta disagree with this suggestion. “It’s not [the point] about affluent or less affluent which needs to drive the deposit protection; rather it’s the faith which needs to be built in the system about the safety of the deposits. Else, the financialisation of our savings will be impacted and the savings will get channelised to less productive assets like gold, real estate etc and as a country we will remain starved of capital for investment.”
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