Syllabus: GS3/ Economy
Context
- The Central Board of Directors of the Reserve Bank of India (RBI) approved a risk-based deposit insurance framework for banks at its 620th meeting, held in Hyderabad.
What is the Deposit Insurance Framework?
- Deposit insurance is a mechanism to protect bank depositors against the risk of bank failure.
- In India, deposit insurance is administered by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the RBI.
- Currently, deposits up to ₹5 lakh per depositor per bank are insured.
- Banks pay an insurance premium to DICGC, which funds payouts to depositors if a bank fails.
- Existing System: DICGC has been operating the flat rate premium-based deposit insurance scheme since 1962.
- Under the scheme, the banks are now charged a premium of 12 paise per ₹100 of assessable deposits.
Risk-based Premium Structure
- Under the risk-based framework, premiums are expected to vary based on parameters such as asset quality, capital adequacy, and overall risk exposure.
- Such models are used in several banking systems globally to align insurance costs with underlying risk and reduce cross-subsidisation between banks.
Significance of the New Framework
- Promotes Financial Discipline: Banks are incentivised to improve asset quality and capital buffers to reduce premium burden. It encourages prudent lending and better risk management practices.
- Reduces Cross-Subsidisation: Under the flat-rate system, well-managed banks indirectly subsidise weaker banks. Risk-based pricing ensures that each bank bears the cost of its own risk.
- Aligns with Global Best Practices: Several countries, including the US and EU members, already follow risk-based deposit insurance models.
- More Efficient System: Sound banks benefit from lower insurance costs, improving profitability and competitiveness.
Implementing Challenges
- Impact on Weak Banks: Higher premiums may strain already stressed banks, particularly smaller or regional banks, reducing their lending capacity and worsening financial stress.
- Complexity in Assessment: Risk evaluation requires robust data, transparent methodology, and continuous monitoring. Misclassification or opacity may raise concerns among banks.
- Procyclicality Risk: During economic downturns, banks’ risk profiles may deteriorate, leading to higher premiums when they can least afford them.
- Possibility of Regulatory Arbitrage: Banks may attempt to temporarily improve metrics to reduce premiums without addressing structural weaknesses.
Way Ahead
- A gradual and calibrated rollout of the risk-based framework is essential.
- RBI and DICGC must ensure transparent criteria, periodic review, and safeguards against procyclicality.
- Special consideration may be required for small banks and cooperative banks during the transition.
- Combined with strong supervision, the framework can enhance depositor protection and systemic stability.
Source: AIR
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