India’s banking sector has witnessed significant transformations over the years, with policy changes aimed at strengthening the financial system and ensuring depositor protection. One such critical aspect is the bank deposit insurance limit, which guarantees depositors’ funds in case of a bank failure. Currently set at ₹5 lakh per depositor per bank, this limit has been in place since February 2020, when it was raised from ₹1 lakh. However, discussions are now emerging about the feasibility and necessity of further increasing this limit to enhance financial stability and boost depositor confidence.
As India experiences economic growth and increasing financial inclusion, raising the deposit insurance threshold becomes a pertinent subject. This article explores the rationale behind such a move, the potential benefits and challenges, and how it aligns with global banking trends.
Understanding Bank Deposit Insurance in India
Deposit insurance in India is managed by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve Bank of India (RBI). The DICGC Act, 1961, mandates that every commercial and cooperative bank must insure its depositors’ funds with the corporation. If a bank faces liquidation, the insured amount is paid to the depositors.
Key features of the current deposit insurance system:
- Coverage Limit: Up to ₹5 lakh per depositor per bank, including principal and interest.
- Banks Covered: All commercial banks, cooperative banks, regional rural banks (RRBs), local area banks (LABs), and small finance banks (SFBs) are insured.
- Premium Payment: Banks pay a premium of 12 paise per ₹100 of assessable deposits to the DICGC.
- Claim Settlement: If a bank fails, the DICGC compensates depositors within 90 days.
Why Consider Raising the Deposit Insurance Limit?
Several factors are driving the discussion about raising the bank deposit insurance limit beyond ₹5 lakh:
1. Economic Growth and Rising Deposits
Since the last increase in 2020, India’s GDP and per capita income have grown, and inflation has increased the cost of living. Many middle-class and affluent families now hold deposits significantly exceeding ₹5 lakh in a single bank. A higher insurance limit would provide better security to a larger segment of depositors.
2. Banking Sector Stability and Public Confidence
Recent banking crises, such as the collapse of Punjab and Maharashtra Cooperative (PMC) Bank, YES Bank’s crisis, and the insolvency of small cooperative banks, have underscored the vulnerability of depositors. Increasing deposit insurance coverage would enhance trust in the banking system and prevent panic withdrawals during financial distress.
3. Alignment with Global Standards
Many developed nations offer higher deposit insurance coverage. For instance:
- The United States (FDIC) covers deposits up to $250,000 (~₹207 lakh) per depositor.
- The United Kingdom (FSCS) provides protection up to £85,000 (~₹89 lakh).
- The European Union sets the limit at €100,000 (~₹89 lakh).
Compared to these, India’s limit remains relatively low. Raising the cap would bring it in line with international practices and reinforce depositors’ confidence.
4. Increasing Risks in the Banking Sector
While India has a strong banking system, non-performing assets (NPAs), fraud cases, and liquidity crises continue to pose challenges. Some cooperative banks and small financial institutions struggle with governance issues, making their depositors more vulnerable. A higher insurance limit would protect more depositors in case of bank failures.
5. Digital Banking and Financial Inclusion
With the rise of digital banking, fintech, and neo-banks, more Indians are engaging with the formal banking system. Many individuals, especially in rural areas, are depositing larger sums into banks. Enhanced deposit insurance would safeguard their savings and encourage continued financial participation.
Potential Challenges of Increasing the Limit
While raising the deposit insurance cap has multiple advantages, it also presents certain challenges that policymakers must address.
1. Higher Insurance Premiums for Banks
Increasing deposit insurance coverage would mean higher premiums for banks, potentially leading to increased costs for customers through higher service charges or lower interest rates on deposits.
2. Moral Hazard Risk
If banks know that deposits are fully insured up to a much higher amount, they might engage in riskier lending practices, assuming that depositors will remain confident regardless of the bank’s financial health. This could lead to reckless banking behavior and a rise in bad loans.
3. Impact on Smaller Banks and Cooperative Banks
Many cooperative banks and regional banks operate on limited capital. An increase in insurance coverage might strain their resources, especially if they are required to pay significantly higher premiums to the DICGC.
4. Fiscal Implications for the Government
In the event of multiple bank failures, the burden on the DICGC (and indirectly the government) could rise significantly. Policymakers would need to ensure that the DICGC remains well-funded to handle potential claims efficiently.
Possible Approaches to Raising the Limit
To mitigate these challenges while still increasing deposit insurance, India could consider a tiered approach rather than a uniform increase for all deposits.
1. Gradual Increase in Phases
Rather than a sudden jump, the government could incrementally raise the limit from ₹5 lakh to ₹10 lakh and review its impact before considering further increases.
2. Different Limits for Different Bank Categories
- Higher insurance coverage for systemically important banks (such as SBI, HDFC Bank, ICICI Bank).
- Lower coverage for smaller cooperative banks, where risks are higher.
3. Optional Higher Insurance for Depositors
Banks could offer voluntary additional deposit insurance, where depositors can opt to pay an extra premium for coverage beyond ₹5 lakh.
4. Strengthening Risk-Based Premiums
DICGC could adopt a risk-based premium structure, where banks with stronger balance sheets and better governance pay lower premiums, while riskier banks pay higher premiums.
Conclusion
The discussion around increasing India’s bank deposit insurance limit beyond ₹5 lakh is timely and essential. With growing economic prosperity, increasing banking risks, and the need to align with global standards, a higher insurance limit could enhance public confidence and financial stability. However, it must be implemented thoughtfully, balancing depositor security with economic feasibility.
A well-structured policy—perhaps a phased increase, differentiated coverage, and risk-based premiums—could help India transition smoothly into a higher deposit insurance regime while maintaining banking sector resilience. Ultimately, protecting depositors’ savings while ensuring a robust and responsible banking system should be the priority for policymakers in this evolving financial landscape.