To protect the rights of individual depositors, widen the base of deposit insurance kitty and to take the concept of deposit insurance forward, the Reserve Bank of India (RBI) has called for setting up a Deposit Insurance Corporation (DIC). DIC is expected to provide bank deposits coverage to the tune of Rs 0.1 mn. The central bank has also decided to increase the annual premium paid by banks to Rs 23.5 bn, up from Rs 2.7bn in 1998-99.
For small time depositors it is a welcome move, as it will provide them with a cushion to fall back on - in case of closure of a bank. However to begin with, DIC is not expected to cover non-banking finance companies and institutions at this point in time.
The increase in premium is required to enable the Deposit Insurance and Credit Guarantee Corporation build up a deposit insurance fund of 2% of insured deposits over the next four years.
The RBI report on Reforms in Deposit Insurance in India has recommended that the deposit insurance fund should be equal to at least 2% of insured deposits as against 0.7% currently. It is felt that raising the limit to 2% will provide liquidity support to small time depositors, in the event of operational failure of a bank.
As per the central bank's recommendation, a bank with deposits of around Rs 200 bn will end up paying a premium of Rs 0.5 bn instead of the Rs 0.1 bn at present. This means that the bank will have to take a knock of nearly Rs 0.4 bn on its profits. The assumption of a premium of Rs 0.5 bn is based on the fact that weak bank will be charged higher premium compared to strong banks.
For the deposit insurance fund to account for 2% of insured bank deposits, the total size of the fund would need to be Rs 94 bn. At the same time to ensure that there is no moral hazard arising out of the security of deposit insurance, RBI has proposed to introduce a risk-based pricing of the premium.
The report on Reforms in Deposit Insurance India has stated that the DIC would have the right to reject insuring a bank's deposit if the bank’s rating is below investment grade for three consecutive years.
As per the central bank's recommendation, the liquidity in the event of a bank failure will have to be provided by the corporation. Thus there is a need for DIC to have a larger deposit insurance fund to inspire depositors confidence in the system.
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