Larger banks being made to bear the burden of the failure of poorly regulated co-operative banks

The only beneficiaries of the deposit insurance premium collected by the Deposit Insurance and Credit Guarantee Corporation (DICGC) are badly-run and politically-influenced co-operative banks.

Since its inception, the Corporation has paid out about Rs4,051 crore in claims to depositors after bank failures. As much as a quarter of this-a whopping Rs1,025 crore-has been paid out in the past three years, from April 2008 to March 2011, which was given to 83 banks. And all of these 83 banks were co-operative banks.

This payment is to honour the guarantee of Rs100,000 per holding combination (individual/joint) provided by the Corporation on deposits of all commercial banks, including the branches of foreign banks functioning in India, local area banks and regional rural banks.

The payment is possible because DICGC collects the insurance payment from banks to guarantee deposits up to Rs1 lakh per account holder. The DICGC collects a premium from 2,249 banks, of which a whopping 2,080 are co-operative banks.

Here is the irony. Less than 200 commercial banks account for 88% of the insurance premium collected and co-operative banks account for under 8%. Yet, when it comes to payment on account of failures, 100% of the money is paid on account of co-operative banks.

What is worse, co-operative banks are poorly regulated under the dual regulation of the Reserve Bank of India (RBI) and the Registrar of Cooperatives. It is an open secret that RBI's supervision is completely ineffectual when it comes to co-operative banks, because of the enormous political influence wielded by their promoters.

Even recently, when the RBI finally acted against the Maharashtra State Co-operative Bank by appointing an administrator, after years of dithering, the Nationalist Congress Party (NCP) in Maharashtra accused it of bias. Poor supervision and low accountability has led to a series of failures among co-operative banks and huge losses to depositors. In fact, Moneylife Foundation our affiliate involved in financial literacy, cautions savers about keeping big chunks of their hard-earned income in these banks.

Here are some numbers on the DICGC website. Banks have to pay an insurance premium up to a maximum of Rs0.15 per Rs100 of insured deposits to DICGC every year to avail of the deposit insurance cover. As at the end of March 2010, DICGC had a deposit insurance fund of Rs20,152 crore made up from premiums received from banks and interest earned on the fund corpus. Commercial banks account for 88% of the total insured deposits for the period 2009-10 and co-operative banks account for just 8% of this. Hence it is clear that a majority of the premium amount comes from commercial banks.

According to DICGC's annual report for 2009-10, the value of insured deposits among 2,249 insured banks was Rs23,69,483 crore at the end of the financial year, covering 14,238 lakh depositor accounts. About 2,080 co-operative banks are presently covered by DICGC's insurance cover. The maximum deposit claims are paid out to liquidated co-operative banks.

Despite the numbers that are freely available on the DICGC website, the Damodaran Committee on banking customer services foolishly suggests that deposit insurance for banks should be raised from Rs1 lakh to Rs5 lakh and that the government must also consider insuring the entire deposit.

It says, "With the rise in general income levels resulting in increase in the size of individual bank deposits, this ceiling of Rs1,00,000 is considered insufficient. The Committee is of the view that this cover should be raised to at least Rs5,00,000 so as to encourage individuals to keep all their deposits in a bank convenient for them and in fact the Committee felt that, a way should be found out to insure 100% deposit by making necessary amendments in the relevant Acts."

However when Moneylife examined the data pertaining to the claims, it was clear that only the co-operative banks alone benefit through the insurance policy.This is like robbing the better-run nationalised, private and foreign banks to pay for the sins of the poorly regulated co-operative sector. It is interesting that the Damodaran Committee hasn't found it fit to recommend better regulation of co-operative banks, which, despite the guarantee of Rs1 lakh, end up causing huge losses to savers because of poor awareness and financial literacy in India.

Though there are numerous problems in extending deposit insurance cover to co-operative banks even under a separate scheme, still there may be compulsions to do so. For the viability and effectiveness of the deposit insurance system for co-operative banks, it is essential that the deposit insurance system be set up within a prudential framework.

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