Deposit insurance plays a crucial role in maintaining the stability of the financial system by protecting depositors in the event of a bank collapse. Traditionally, the Deposit Insurance and Credit Guarantee Corporation (DICGC) in India has charged banks a uniform insurance premium—12 paise per ₹100 of assessable deposit. This approach, however, may not adequately reflect the varying risk profiles of individual banks.
The case for risk-based premiums
Swaminathan J, Deputy Governor of the RBI, advocates for a shift towards risk-based premiums for deposit insurance. This system would link the cost of insurance to the level of risk posed by each bank. The rationale is straightforward: banks with higher risk profiles should contribute more to the insurance fund. This approach would not only enhance the overall stability of the financial system but also incentivise banks to adopt stronger risk management practices.
“The implementation of risk-based premiums merits consideration… This approach ensures that institutions with higher risk profiles contribute more to the insurance fund,” Swaminathan stated at the International Association of Deposit Insurers-Asia Pacific Regional Committee (IADI-APRC) conference in Jaipur.
Benefits of risk-based premiums
Enhanced stability: By aligning premiums with risk levels, deposit insurers can better stabilize the insurance fund, ensuring that banks posing a higher risk contribute more.
Incentive for risk management: Banks with riskier profiles will be incentivized to improve their risk management practices to lower their insurance premiums.
Comprehensive risk assessment: This approach allows for a more nuanced evaluation of risks, including technological and operational resilience. By integrating cybersecurity risk assessments and monitoring digital payment systems, deposit insurers can set more accurate premiums.
Addressing technological risks: Swaminathan also emphasized the importance of incorporating technology risk assessments into insurance premiums. As financial institutions increasingly rely on digital platforms, the risk of technology-induced issues rises. Evaluating an institution’s technological resilience and operational stability can provide a more accurate picture of its risk profile.
The need for regular updates: As the financial sector evolves, so too must the regulatory frameworks governing deposit insurance. Regular updates are necessary to address emerging risks associated with digital payments and fintech innovations. By adopting a proactive stance, deposit insurers can ensure that financial institutions are prepared to manage these risks effectively.
Current coverage and future prospects: As of September 2023, only 44% of bank deposits were covered by insurance, a decline from previous years. The DICGC currently provides coverage up to ₹5 lakh per depositor per bank, a limit increased from ₹1 lakh in February 2020. Analysts suggest that this coverage amount should be revised periodically to keep pace with inflation and the growing value of deposits.
India’s deposit insurance fund ratio of 2.02% is comparable to the global median. The DICGC aims to achieve a ratio of 2.5% by March 2028, reflecting a commitment to strengthening the financial safety net.
