Why RBI Needs to Protect Depositors Instead of Enabling Corporates

RBI’s recommendation to enable corporate houses to acquire and operate banking licences has been widely criticised.

There’s much to be said for the perseverance of the RBI. Full marks for consistently trying to develop solutions to deal with the spate of problems that have beset our economy and financial system – many not of its making – in the last few years.

But a lower score may need to be awarded for impact and practicability. The recommendation of its Internal Working Group (IWG) to enable corporate houses to acquire and operate banking licences is another instance of this problem.

Working on the assumption of Murphy’s law that “if something can go wrong, it will”, economists and other pundits have all decried the move for reasons related to the inevitable urge to fund related or associated parties, the concentration of economic power and the ensuing conflict of interest. In this, their concerns are genuine.

Depositors As Collateral Damage

However, despite the fact that in all these debates, the risks that could accrue to depositors, whose capital is at risk, has been duly noted, one gets the sense that the acknowledgement is cursory.

Akin to admitting that a poorly built bridge – over a river – would severely restrict commercial traffic, dislocate a waterway, and jeopardise the lives of those who are on it, if it collapses. In a nutshell, depositors are collateral damage.

This is strange, because elsewhere depositors are considered the first and most important stakeholder of a bank.

The US Federal Deposit Insurance Corporation (FDIC) and European Forum of Deposit Insurers (EFDI) ensure that every accountholder’s deposits in every bank is insured to up to $250,000 and € 100,000 respectively, in the event of bank failure. By comparison, India’s Deposit Insurance and Credit Guarantee Corporation (DICGC) only guarantees up to INR 5 lakhs per bank.

In fact, this number was increased from a limit of Rs1 lakh as recently as February 2020, during a budget speech that went on to mirror other speeches by the finance ministry during the pandemic. Because though promising in size, even this number may not be nearly enough.

Any argument that seeks to compare this assured limit of Rs 5 lakh with the average size of a bank deposit is specious. By its own admission, the government successfully grew the banked population in India from 54% of the adult population in 2014 to 81% in 2018.

Raise the Bar on Bank Deposit Insurance Limit

It is no secret that most of these accounts were forcibly created, often with the intention of using them as vessels into which benefits and subsidies could be deposited. By comparison, for the nearly 250 million salary and wage earners in India who keep up to 66% of all their household savings in bank deposits, this number represents a risk – given the rate of failing banks in India – that even a banker might avoid.

In America, 95% of the population rely for their retirement on the sale of their home as they downsize, social security pensions and life savings, which tend to be a healthy mix of stocks, mutual funds, fixed deposits, money market accounts and company-sponsored retirement lumpsums (401Ks).

In India, where there is no social security blanket and disposable income precludes a diversified investment portfolio, banks become the repositories of hope for the future.

Instead of enabling corporate houses, it may be more pertinent to raise the bar on the bank deposit insurance limit – up to INR 25 lacs per depository account. At a premium of about INR 0.05 per INR 100, this is not a huge cost for the system to bear.

It reinforces the right behaviour by aligning it with incentives and penalties. There’s a good reason why Amazon suppresses fake reviews, enforces stricter truth in advertising norms and verifies sellers. If it does not, trust will be eroded and sales will suffer.

Facebook is not similarly incentivised and the results are obvious. So too with banks. A higher depository insurance premium, coupled with stringent safeguards and penalties, will automatically put pressure on a bank to contain risks and desist from activities that will unduly constrain liquidity in the event that loans turn sour.

Impetus for RBI to Overhaul Monitoring Infrastructure

Secondly, and more importantly, it provides the impetus for RBI to augment its monitoring and enforcement infrastructure – which must be overhauled – without which oversight has neither the bark to correct careless lenders nor the bite to penalise errant ones.

Banks, who are the bulwarks of the financial system, are not meant to, and are seldom allowed to fail. But depositors need proof of this beyond manic moves to rescue and recapitalise institutions after an inevitable collapse. Guaranteeing a higher depository insurance limit may both assure consumers and justify their confidence in the system.

(The writer is currently an IOT services professional and was the erstwhile Head of Citi Merchant Services, North America. The Quint neither endorses nor is responsible for them.)