That yet another Urban Co-operative Bank (UCB) — the New India Co-operative Bank, based in Maharashtra, has failed is not a ‘new’ occurrence, since the history of UCBs is replete with such failures due to several factors. Incidentally, Maharashtra is home to almost a third of the UCBs in the country.
Poor governance, lack of transparency and vigil in operations (especially, loan operations), absence of proper risk management systems, external meddling, uneconomic sizes, poor quality manpower and high concentration risk are some of the factors responsible for fragility of several UCBs.
This is evidenced from the fact that during the five-year period 2019-20 to 2023-24, the RBI had cancelled licences of 50 UCBs. It had also imposed ₹495 million as penalties for 588 instances of regulatory violations predominantly by the UCBs.
Basically, the UCBs are repositories of savings from low- and middle-income households. The extra one per cent rate of interest offered by the UCBs (over and above the rate that commercial banks offer) attracts most of these households to them. Ethnic connections and persuasion also matters in deposit mobilisation by the UCBs.
Insured UCBs
The Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly-owned subsidiary of the RBI, is the official deposit insurance agency for all banks operating in India. At March-end 2024:
* 1,472 UCBs were registered with the DICGC.
* The insured deposits of the registered UCBs stood at ₹3,718.6 billion and the insured deposits/assessable deposits ratio (i.e., extent of protection) was 66.8 per cent.
* The share of insured deposits of the registered UCBs in the system-wide insured deposits stood at four per cent.
* The co-operative banks contributed 5.6 per cent to the total premium received by the DICGC (during 2023-24).
* The DICGC had settled claims of 431 UCBs involving an amount of ₹160.3 billion.
Paradoxically, the current Deposit Insurance System (DIS) in India, which aims at protecting depositors and ensuring financial stability, has certain features in it that adds to the banks’ stress or failure.
Although Section 15 (1) of the DICGC Act, 1961 provides for a variable premium system, the DICGC follows a flat-rate system, i.e., the premium rate is same for all banks — strong (say, commercial banks) or weak (say, co-operative banks). The flat-rate system continues despite several committees starting from the 1998 Narasimham Committee-II Report to those constituted thereafter by the RBI/DICGC recommending introduction of a risk-based premium system.
The flat-rate system has led to under-pricing of risks (to the deposit insurance fund or DIF) in respect of the vulnerable co-operative banking sector. This encourages overly aggressive behaviour by the co-operative banks.
Further, fungibility of the DIF balance between the commercial and co-operative banks potentially incentivises the DICGC to meet losses, if any, arising out of co-operative bank failures in future, out of the funding (of the DIF) by the commercial banks.
Combined, both make the co-operative banks lackadaisical about the safety of their depositors’ money. Lack of ‘depositor discipline’ exacerbates the situation further.
At times, it is argued that some cross-subsidisation is ‘inherent’ in any kind of insurance, but as far as the co-operative banks and commercial banks interface in this regard is concerned, it has been going on for too long. Therefore, it would make eminent sense if the cross-subsidisation of risks are eliminated.
Policy proposals
* The DICGC should quickly act on implementing a risk-based premium system. For some co-operative banks, if a risk-based system cannot be implemented fast, the flat-rate system may continue, but with a time-bound plan for phasing in a risk-based system. However, under both flat-rate and risk-based systems, the premium rates for the co-operative banks need to be higher than those for the commercial banks. This will likely cause some churning in the co-operative banking system, but would jettison the unprofitable and inefficient ones, thereby improving systemic efficiency.
* The RBI Report on Reforms in Deposit Insurance in India (1999) had recommended instituting two DIFs, one for the commercial banks and the other for the co-operative banks and this should be implemented.
* Increasing the deposit insurance limit as and when a problem strikes typifies panic reaction, which pacifies the bank’s depositors temporarily. It neither prevents future crises nor solves the psychological and financial trauma that small depositors undergo until they get their full deposits back.
The large depositors, who are privileged to monitor their bank’s activities continuously and have enough contacts in their banks, run at the first sign of trouble, and hence, they remain safe.
The limit revisions need to be rule-based and carried out at fixed time intervals.
* The coverage of DIS in terms of types of (a) institutions, (b) deposit accounts and (c) deposit owners needs to be reassessed.
* The DICGC should adapt the globally-practised and time-tested resolution strategies which would result in speedier deposit reimbursement.
* The RBI/DICGC should be more aggressive about their depositor awareness programmes.
Some of the above-mentioned recommendations were favoured by three RBI deputy governors in the International Conference of the International Association of Deposit Insurers-Asia Pacific Regional Committee hosted by the DICGC on August 14, 2024. Therefore, one may expect some changes in the Indian DIS in near future that would bolster safety of deposits in the entire banking sector and enhance banking sector stability – goal of the DISs.
Das, a former senior economist of SBI, has worked on deputation with DICGC; Rath is a former central banker. Views expressed are personal