Last week, the Union cabinet decided to extend the benefits of deposit insurance to banks under moratorium, which would bring some relief to customers whose funds are stuck with banks that are financially stressed. This has wide-ranging implications for the banking ecosystem as well as the common man. Let’s take a deeper dive into the announcement.

What changed?

Following Wednesday’s announcement by finance minister Nirmala Sitharaman, changes have been recommended to the Deposit Insurance and Credit Guarantee Corporation (DICGC) Act, 1961. Under this act, bank savings — savings and current accounts, fixed and recurring deposits — are insured up to Rs 5 lakh per depositor per bank, subject to terms and conditions.

A deposit insurance claim is made when a stressed bank, which is unable to repay its depositors, has its licence cancelled by the Reserve Bank and is liquidated.

Deposit insurance secures a vast majority of low-value accounts held in the bank during such an event, thus ensuring that depositors aren’t at a total loss.

With the latest announcements, insurance claims may also be made after a moratorium is imposed on a bank during which its business operations are restricted and its depositors’ access to funds is cut off.

Why this happened

There’s a long journey between the first signs of financial trouble and the process of liquidation. We’ve seen recently that a few banks were put under moratorium during which depositors could not withdraw their hard-earned money.

The RBI imposes these restrictions to protect the bank from collapse and by extension, also protect depositors who will be harmed by the bank’s collapse. While some banks come out of these restrictions, some don’t. Their depositors are, therefore, cut off indefinitely from their funds, sometimes for years.

To address depositors stuck in this limbo, the finance minister had announced earlier this year in the Union budget that the DICGC provisions will be extended to banks under moratorium as well. Now, the announcement will be operationalised.

What is DICGC?

The DICGC is an RBI subsidiary. Banks are required by the DICGC Act to pay a premium on their deposits to the DICGC. All commercial, cooperative and rural banks, as well as foreign banks with Indian branches, must comply with this requirement.

According to the DICGC, 2053 banks are insured by it, including 89 government, private, foreign, and small finance banks, which constitute some of the largest commercial banks in the country.

Among the banks are over 1,900 cooperative banks. The chances of large banks failing are remote. The RBI will see to their stability. However, cooperatives are more vulnerable. According to the DICGC, in 2021 alone so far, main claims against as many as six cooperatives were settled. In 2020, there were seven. Therefore, cooperative banks going under is routine.

Who benefits?

The finance minister said the latest decision will also apply to banks under moratorium. The problems at the PMC Bank —another cooperative — are now well-documented. Its moratorium may have triggered these policy updates. The bank’s small depositors can hope to finally get some relief. However, the coverage limit will be strictly imposed. Payouts only up to Rs 5 lakh can be expected towards the principal and interest owed to depositors of such banks.

The FM suggested that the claims settlement process will be time-bound and must be wound up in 90 days. If much more than Rs 5 lakh is owed to the depositor, the wait for redemption may continue indefinitely.

Are banks safer?

The depositor insurance limit, which was just Rs 1 lakh, was increased five-fold last year. According to statistics provided by the finance minister, 98.3 per cent of all deposit accounts fall within this new limit.

Hence, depositors can be assured that their funds are safe to this limit should their bank fail.

The latest announcement would also increase customer interest in cooperatives and small finance banks which often pay higher rates of interest to depositors, who nevertheless haven’t gone rushing to them because of doubts over the banks’ track record, NPAs, corporate governance, stability and customer service.

With the latest announcements, depositors will be empowered to try those banks. We are in a low interest period. Higher interest returns will help depositors, especially pensioners. However, the DICGC safety net is only for depositors.

Banks that have high NPAs and poor corporate governance will still have their struggles. Hence, like with investments, one must not just diversify their savings but also keep an eye on the goings-on at their banks.

Deposits will be safer with the DICGC Act updates, but only to a limit. Therefore, while chasing higher returns, one most never lose sight of the risks.

The writer is CEO, BankBazaar.com