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Deposits
31st July 2021
Reading time ~ 3 minutes
Hi there,
The folks over in the Union Cabinet approved the Deposit Insurance and Credit Guarantee (Amendment) Bill on 28th July. The bill pertains to your deposits with banks (such as fixed deposits, recurring deposits, savings a/c) and the protections you get, in case the banks go under. This is a great move by our Finance Ministry, especially considering recent issues with Yes Bank, PMC bank, etc. and we'll do a quick explainer on it.
So, here's what happened:
"The Union Cabinet on Wednesday cleared changes to the deposit insurance laws to provide funds up to Rs 5 lakh to an account holder within 90 days in the event of a bank coming under the moratorium imposed by the RBI."
Let's break this down:
Say you want to open a savings a/c or start a fixed deposit with a bank. You go over to the friendly folks at your neighborhood branch, open an account and deposit some amount. Depending on whether it's savings a/c or fixed deposit, you'll earn interest on this deposit. Right?
Now, of course, banks don't just keep this money as deposits - they lend it to folks - individuals, small businesses, corporates, etc. for various uses. The borrower will pay back the loan, along with an interest through the period of the loan. The structure is simple:
The difference between what Luna pays and what the bank owes you counts as the bank's earnings.
In reality, banks can't lend the entirety of the deposits - there is a minimum amount that it's required to keep aside, which is set by the RBI. This helps ensure that whenever you'd like to withdraw funds from the bank, it's able to service the withdrawal.
And this is how the entire system works and everything usually functions pretty smoothly. Now, consider a scenario when Luna is not able to pay back the loan in full. Not a big deal - the bank can handle one or more of such cases, it has enough reserves to figure this out.
Then, add more and bigger corporate loans to the mix that are not going to get paid back - that's a problem and the bank will have to take steps to fix this before it gives out more loans. The RBI is also now breathing down its shoulders to get its act together and will start putting some restrictions.
Finally, add a couple more bad loans to the mix and it's suddenly looking quite bleak. Think of this situation like a company going bankrupt - the bank now owes more to the depositors (you) than what it will receive from the borrowers, and won't have the money to pay you back.
Unfortunately, in such (although one-off) cases where things are just not salvageable, the bank is placed under a moratorium (i.e. the bank doesn't have to service withdrawal requests more than a certain amount, for a period of time, along with many other operational restrictions as well). This is to ensure that any rushed withdrawals don't put more pressure on an already distressed bank. Obviously, not a good scenario for the bank or the depositors.
In any case, RBI doesn't like to shut down banks, so they'll try to restructure the bank instead - merge them with some other entity, or the bank will get acquired. The idea is to save the bank and keep your deposits safe. In fact, this is what happened recently with Yes Bank and Lakshmi Vilas Bank.
Now the issue is that while RBI will do everything it can, moratoriums can last for quite some time. Take the case of PMC bank - depositors have been waiting for 20+ months to get their money bank. And obviously, this is not a great look for the bank or for the RBI, especially when they should be protecting depositors.
So what now?
Enter: DICGC
Think of the Deposit Insurance and Credit Guarantee Corporation as an insurance company. It functions under the RBI. Its mission is to "contribute to financial stability, by securing public confidence in the banking system through the provision of deposit insurance, particularly for the benefit of small depositors." Basically, DICGC extends insurance on your deposits to banks. So, if you've deposited some amount in the bank, the amount may be insured by DICGC and in the event that the bank goes under, you'll be able to claim the amount.
Now, DICGC has been insuring deposits for a long time, but earlier - you'd have to wait until the entire restructuring process is completed to get the insured sum back. And this is what the amendment is about. Basically, you don't have to wait years and years to get this sum - DICGC will process the amount in 90 days from which the bank is placed under a moratorium by the RBI.
The bill was cleared by the Union Cabinet on 28th July and will be introduced in parliament soon.
Pretty good news!
So, what all should I know?
The DICGC insures 98.1% of the accounts in India - you can check out the list of insured banks here. They insure deposits such as recurring, fixed, savings, current - you can find more information here.
Note that the insured amount is 5L, so if you have deposited 6L, only 5L will be insured. Further, if you have two accounts in the same bank, only 5L will be insured, but if you have accounts in different banks, then each account will be insured separately.
Hopefully, the new bill helps provide some respite in an already tough time.
Thoughts or questions? Reach out to me at rujgupta@laana.club
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