“Although flat rate premium systems have the advantage of being relatively easy to understand and administer, they do not take into account the level of risk that a bank poses to the deposit insurance system and can be perceived as unfair in that the same premium rate is charged to all banks regardless of their risk profile,” the Reserve
(RBI) stated in its latest annual report.
Why this was needed
The deposit insurance cover for bank depositors was raised from Rs 1 lakh to Rs 5 lakh in case the bank fails and this became effective from February 4, 2020. However, this cover is not free for financial institutions like banks as they have to pay insurance premium to DICGC to enjoy this insurance cover.
Based on the risk profile of the financial institution DICGC collects premium either at a flat rate or a differentiated rate. The primary objective of a differential premium system is to provide incentives for banks to avoid excessive risk taking and introduce more fairness into premium assessment processes.
“The introduction of RBP in order to address the issue of moral hazard inherent in flat rate premium is a natural corollary. The Internal Committee on RBP (Chairman: Shri V. G. Venkata Chalapathy) undertook the risk assessment of banks, primarily based on CAMEL parameters and recommended the introduction of RBP,” says the RBI report.
The recent recommendations made by the Internal Committee under chairmanship of Shri V. G. Venkata Chalapathy are currently being considered by the RBI for their implementation.
Several committees in past had also recommended RBP, however, it could not be operationalised because the roll out of the process was linked with hike in deposit insurance cover. Though the insurance was raised to accommodate the rise in cover from Rs 1 lakh to Rs 5 lakh, however, the increase in the premium rate was marginal, as it was increased to 12 paise per Rs 100 of deposits from April 1, 2020, from 10 paise earlier.
What it means for deposit holders
To implement the RBP the premium may go up further. However, risky financial institutions will have to pay much higher premium for the cover while the strong ones will be rewarded for their prudence and pay a lower premium. As mentioned above, the banks with strong risk profile will offer much better risk adjusted return to their depositors compared to those with weaker risk profile once this is implemented. So even if you are getting a similar interest rate on your deposit in a strong bank and a weak bank, it would be much better to go with the former as the return will come at a lower risk.
