Deposit Insurance hike –will it help replenish lost confidence?

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The Indian financial system has been rowing against the tide for quite some time now. It was first hit by the ILFS storm and then, followed by the DHFL crisis. While this expedition has taken its toll on the confidence of banks in lending to corporates, the erosion in customer confidence has been just as severe- and not without reason. The PMC bank crisis has been the latest punch in the gut for consumers, nudging people to think about parking their hard-earned money in risky banks, with cooperative banks topping the risk list. The deposit insurance available to the bank's customers which was fixed at 1 lakh some 27 years ago, remained unchanged, until now.

In today's post, we understand the major budget announcement of increasing the deposit insurance to Rs. 5 lakhs and look at its impact on both banks and customers.

Connecting the dots – why it is welcome for banks:

Deposits have always been the main source of funds for the Indian banking system, providing banks with a sticky and relatively cheap source of capital. For this, the banks compete with many players to attract the individual’s savings to be parked with them. In a largely risk-averse country with competitive rates, this was historically easy to accomplish.

In the recent past, however, competition has picked up pace, primarily due to the increasing awareness and availability of substitutes like mutual funds which typically offer higher returns over the medium to long term along with add-on features like tax benefits. Disintermediation by way of digitisation also supported this to some extent.

On the other hand, banks also compete with small saving schemes that include tax saving instruments like NSC, PPF, etc., in routing the savings to their kitties. An article published by RBI, earlier this fiscal year, statistically established the significant negative relationship of bank deposits with growing market substitutes, small saving schemes, and low-interest rates.

Adding more discomfort for banks in this competition, RBI has mandated to link all the new floating rate personal or retail loans and floating rate loans to MSMEs to an external benchmark. While this was welcome from the perspective of better rate transmission to the customers, it has become a double-edged sword for banks. As argued by them, lowering interest rates on the advances should have to be compensated by offering low-interest rates on deposits, which can endanger their competitiveness further to other alternatives.

In a situation like this, when all conditions are against banks, any further slippage in confidence of customers would have led to further bruising of banks’ competitive position. In this regard, the recent hike in deposit insurance to five times as earlier assumes more significance as it will at least turn one thing over to their side – confidence, which, is more important than many numbers for depositors.

Continued value migration or the rise of the weaklings?

While this is a positive sign for the banking system as a whole, it is to be noted that, big private banks and most of the PSU banks have been increasing their pie, during this time, aided by their brand and perceived inherent support from the government respectively. The private banks were able to attract significant premiums on the back of their stronger quality books and steadily increasing market share. While the trend of value migration should continue, this move certainly slows the process down.

The relative beneficiaries of this change would be those who had conceded some of their deposits to the big fish. However, the increase in the premia for insurance amount, which has to be borne by the banks from their pockets would put little weight on them depending upon the quantum of deposits they host. It should also be highlighted that few big banks are pushing for bank’s risk metric based premium payments, to avoid relatively safer banks paying premia for risky banks’ deposits. The acceptance of this, however, seems remote as of now.

What's in it for the customers?

On the other side, for a customer, with lower risk appetite this presents an opportunity to park their savings with more confidence, as anything below Rs. 5 lakh (including accrued interest) is a completely safe bet for them. Also, as the insurance remains independent for different bank accounts but not for different accounts within the same bank, an opportunity to diversify their savings into different banks is also at the disposal of the individual for any planned deposit over the insured amount.

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