K C Chakrabarty: Empowering deposit insurance entities to face
challenges posed by an emerging financial landscape - global and
Indian experience
Valedictory address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India,
at the International Conference on "Role of deposit insurance in bank resolution framework -
lessons from the financial crisis", Jodhpur, 15 November 2011.
* * *
Assistance provided by Dr A Raravikar in preparation of this address is gratefully acknowledged.
1. Mr. Hiroyuki Obata, Deputy Governor, DICJ, Japan, Mr. Carlos Isoard, Secretary
General, IADI, Switzerland, Mr. Jerzy Pruski, President, BGF, Poland, Mr. Fred S. Carns,
Director, FDIC, USA, Mr. G. Gopalakrishna, Executive Director, RBI, distinguished
delegates, ladies and gentlemen. At the outset, on behalf of RBI, I extend a hearty welcome
to all of you to India and especially to this fascinating state of Rajasthan. We thank IADI for
agreeing to hold this conference jointly with DICGC. As you are aware, DICGC entered its
Golden Jubilee year on January 1, 2011. This event is being hosted as a part of the Golden
Jubilee celebrations of DICGC and, hence, holds a special significance for us.
Global financial crisis and deposit insurance
2. Recent global financial crisis has revealed that financial systems around the world
rely on safety nets to reduce the adverse impact of financial crisis as also to prevent the
re-occurrence of the crisis. During the global crisis, uncertainty triggered panic reactions and
collapse of banks. Under these circumstances, deposit insurance emerged as an important
part of financial safety net in arresting panic reaction. Governments across the globe took
measures such as raising the deposit insurance coverage limits, providing blanket
guarantees, etc. These measures restored the public confidence in banking systems. Thus,
the importance of deposit insurance as a tool for preventing and mitigating the impact of
financial crises as also for the smooth running of financial systems and maintaining financial
stability has been fully appreciated.
3. The global financial crisis, thus, evoked rethinking on the role of deposit insurance
systems and broader safety net issues. It is now widely felt that the important safety nets
such as deposit insurance systems should play a more pro-active role in regulatory
frameworks for early identification of bank failures and their effective resolution. In order to
enable the deposit insurance systems to play their roles more effectively, a need has been
felt for redesigning the deposit insurance systems with, inter-alia, an increased role in bank
resolutions. When individual institutions fail, rather than let depositors be rescued solely by
insurance cover, which is anyway not comprehensive for larger depositors, it is more
effective to involve the insurer in the process right from the beginning. This will give
depositors, as a stakeholder group, a voice in the process, allowing them to better protect
their interests, while simultaneously increasing the capacity of the insurance scheme.
4. In the light of the above, I am happy to note that this Conference has been held on
the theme "Role of Deposit Insurance in Bank Resolution Framework - Lessons from the
Crisis" which is very relevant, appropriate and timely. The experts from a number of countries
have made presentations on significant sub-themes viz., critical elements in bank resolution
framework, country experiences, regulators' responses and international best practices.
Various aspects have been covered in this Conference such as elements of insolvency
framework, cross-border insolvency framework, role of deposit insurance in bank resolution,
country experiences, crisis framework, regulatory reform (Basel III), deposit insurers'
response to financial crisis, review of global practices with respect to resolution framework,
key attributes for bank resolution and core principles for effective deposit insurance systems
and challenges to assessment of safety net framework. Several thoughts, views and
experiences have been shared and discussed in this conference by the experts and
delegates, along with prescriptions for policy makers. I would like to summarise these.
Key deliberations at the conference
5. In this conference, global regulatory reforms were overviewed and their impact on
Asia, especially on Asian banks, was analysed. There is a need to create a buffer of capital,
improve liquidity risk management of banks, reduce their reliance on short-term wholesale
funding, promote resilience through incentives for banks to fund activities with more stable
sources of funding, perform the micro and macro stress testing, and create stronger capital
base. The relationship between macro-prudential policy framework and deposit insurance
was discussed. The issues covered a macro-prudential perspective by deposit insurers, their
specific role in financial stability, funding arrangements, deposit insurance premium,
coverage, and cross-border coordination of deposit insurance. USA (FDIC)'s experience
revealed the need to restore discipline in the marketplace, allowing the failure of large
financial entities if they become nonviable, necessity of cross-border cooperation for their
orderly liquidation, strong capital base by banks and enforcing objective capital standards by
supervisors. Other country experiences showed the need for strengthening the legal and
operative tools of deposit insurers, making banking resolution simulation exercises, and
regular monitoring of systemic institutions.
6. According to some other presentations, deposit insurance should be the responsible
resolution agency with financial accountability and core competencies. There should be
contingency planning, collaboration of authorities, ex-post funding scheme, consumer
awareness, recovery and resolution plans, faster payouts, and regulatory reforms. Deposit
insurer needs to have independence, quick responding ability, access to financial data,
adequate funding, and legal protection. Key attributes of resolution regime were identified
that would help the deposit insurers to meet their objectives. Concern was expressed on
weakening of deposit insurance systems due to supervisory and regulatory lacunae, slow
implementation of new measures, and apprehensions about increased moral hazards by
governments.
7. FSB's work on resolution stressed the need for deposit insurers to be well
connected to all aspects of the resolution framework including Information, tools, contingency
planning etc. In the context of cross-border insolvency, there should be a multi-prong policy
approach comprising increasing loss absorbency, strengthening the resolution regimes,
market infrastructures and supervision. Discussions also hovered around addressing
systemic risks, changing role and future directions for deposit insurers, their design features
and organizational issues with implications for expanded resolution role. Finally, role of core
principals was elaborated, along with assessment challenges.
8. The deliberations and discussions in this conference have been fruitful and have
certainly provided food for thought for the policymakers. I will now give you a snapshot of
India's deposit insurance system, flag the issues in the context of the required further reforms
and look at the way forward for the global deposit insurance systems.
India's deposit insurance system
9. In a country like India where there is a significant extent of financial exclusion and
small depositors are worried about safety of their funds, deposit insurance is critical for
financial inclusion and plays a role of a catalyst therein. Deposit insurance also protects
small depositors from strategic errors by management and wider systemic shocks. At the
same time, other elements of financial safety net framework including financial regulation/
supervision also work towards promoting financial inclusion. It is surprising that in India, there
is inadequate awareness of the facility of deposit insurance. One reason for this could be that
in India banks are perceived to be either too-big-to-fail or impossible to fail on account of the
Government or RBI backing. While this may be true for the public sector banks, it certainly
does not hold good in the case of private sector banks, foreign banks operating in India and
the large number of cooperative banks.
10. Let me give you a broad overview of the deposit insurance system in India. India's
Deposit Insurance and Credit Guarantee Corporation (DICGC) was set up way back in 1962
as per the provisions of an Act of Parliament, i.e., DICGC Act, 1961. It is the second oldest
ongoing deposit insurance agency in the world. DICGC is a wholly-owned subsidiary of
India's central bank, viz., Reserve Bank of India. It is virtually a Pay-Box System as its role is
limited to settlement of claims as per extant rules and regulations. Table 1 below would give
you an idea of the magnitude of claim settlement operations of DICGC. DICGC's Mission is
"To contribute to financial stability by securing public confidence in the banking system
through provision of deposit insurance, particularly for the benefit of the small depositors". Its
Vision is "To be recognized as one of the most efficient and effective deposit insurance
providers, responsive to the needs of its stakeholders". All commercial banks and eligible
co-operative banks are covered under deposit insurance. The number of banks registered
with DICGC as on March 31, 2011 stood at 2,217. The insurance coverage is INR 0.1 million
per depositor (about US$ 2,240). About 93 per cent of deposit accounts by number and
35 per cent of deposits by value are covered under insurance (Table 2). This coverage
stands at 1.6 times India's per capita GDP as on March 31, 2011. The insurance premium is
charged at a flat rate. It may be mentioned that the banking sector in India remained largely
buffered from the recent global financial crisis and as such, post-global financial crisis, there
is no change in the insurance coverage and the rate of premium.
11. I would like to inform you that an Assessment Team comprising representatives of
IADI and IMF visited DICGC in end-September 2010 to undertake a field test of the Draft
Assessment Methodology for the Core Principles for Effective Deposit Insurance Systems.
According to the Report of the team, DICGC is compliant or largely compliant with about half
of the eighteen Core Principles for Effective Deposit Insurance Systems. In its "paybox"
function, the DICGC is fully or largely compliant on all core principles. However, weaknesses
in the overall insolvency framework that are outside the control of the DICGC makes overall
compliance with many core principles limited.
12. On the eve of the Golden Jubilee, DICGC has initiated measures to enhance public
awareness on deposit insurance through printing of brochures and posters and
communication to the insured banks to spread awareness by displaying information about
DICGC in all bank branches. The Corporation is also trying to roll out depositor-centric tools
such as Integrated Claims Management System (ICMS) for capturing more accurate and
up-to-date information on deposits that would aid in faster settlement of claims.
Reforms in deposit insurance system
13. I now turn to the reforms required to be made in India's deposit insurance system
and flag the issues therein. First, the recent crisis has shown that deposit insurers should
play a proactive role in regulatory frameworks for early identification of bank failures and their
effective resolution with the aim of protecting their funds and maintaining public confidence.
Therefore, it is necessary to broaden the mandate of DICGC from pay-box (to pay the claims
of depositors to the extent and in the manner stipulated in the law) to attending all aspects of
bank resolution, not only as part of the liquidation process, but in monitoring of banks, prompt
corrective action and finding and implementing the least cost method of resolution of troubled
banks. This would lead to faster settlement to depositors, lower costs and higher speed of
resolution with associated benefits for the stability of the financial system. The ultimate way
out is to put in place a clearly defined bank solvency regime and a properly designed
resolution process. Second, RBI should have powers to resolve a bank before insolvency. A
special bank resolution legislation is needed to expand resolution powers. Also, a legislation
is needed for appointment of temporary administrator. Third, for depositors of failed banks to
maintain confidence in banking system, it is essential to provide depositors quick access to
their funds. Therefore, DICGC needs to look into ways to expedite reimbursement to
depositors. This requires technology upgradation, including the adoption of CBS by all urban
co-operative banks (UCBs) and an effective interface between the DICGC and banks' Core
Banking Solutions (CBS) to access depositor databases. Moreover, deposit insurers should
be informed sufficiently in advance of the conditions under which a reimbursement may be
required and be provided with access to depositor information in advance. Fourth, it is
necessary to increase the coverage limit that has remained unchanged at INR 0.1 million
since 1993. The increase in deposit insurance coverage has also been alluded to in the
recent Damodaran Committee report on Customer Service. Fourth, due to the dual nature of
control over co-operative banks and low level of technology deployed in these banks, there
are delays in receiving information regarding depositors. Also, there are delays in
appointment of liquidators. DICGC, currently, has little powers over liquidators to expedite
the collection of information. The process can be expedited if liquidators provide the
information within a shorter time-frame. Therefore, it will be beneficial to grant DICGC the
power to appoint and monitor liquidators. Fifth, for maintaining depositor confidence, the
deposit insurer should have sufficient funds available to fulfill its mandate. The financial
position of DICGC needs to be strengthened with appropriate arrangements for back-up
funding. About half of the premium income of DICGC, which is its main source of funds, is
paid as income tax to Government. Since DICGC is a non-profit organisation serving social
obligations of protection of small depositors, it should be exempted from payment of tax, as
is done globally. The tax exemption would enable DICGC to build up its fund base and
thereby provide higher coverage to depositors and even pass on the benefits to insured
banks by reducing the rate of premium, after the desired reserve ratio is attained. Sixth,
global crisis has shown that deposit insurer does need assistance from Government/Central
Bank in case of any systemic crisis and the required amount is unpredictable. The back-up
funding to DICGC from RBI is a small amount (INR 50 million). Therefore, it would be ideal if
availability of back-up support can be made unlimited and with a quick approval process.
Seventh, DICGC has been having a flat rate premium system. This could be replaced by a
risk-based differential premium system. The latter would reduce moral hazard and bring
greater fairness in the premium assessment process.
14. For redesigning India's deposit insurance system by making many of the requisite
reforms as discussed above, it would be necessary to make thorough changes in the DICGC
Act. A Working Group on Reforms in Deposit Insurance, including Amendments to DICGC
Act has been set up by us which would be looking into these aspects.
Global deposit insurance systems: policy issues and the road ahead
15. The session on "Critical Elements in Bank Resolution Framework" presented, apart
from elements on insolvency framework, the cross border insolvency framework and role of
deposit insurance in bank resolution. For prevention/insulation of an economy from financial
crisis, deposit insurance systems across the globe need to be a more integral part of the
overall safety net framework. In this context, there is a need to broaden the mandate of
deposit insurers for effective resolution of banks of all sizes, as also to initiate preventive
action and risk minimization. It is also necessary to give powers to deposit insurers to fulfill
their mandates. An effective bank resolution process with participation of deposit insurers
would facilitate the ability of deposit insurers to meet their obligations, minimize resolution
costs as well as disruption in markets, maximize recoveries on assets, reinforce discipline
through legal actions and set up flexible mechanisms such as those facilitating bank
acquisitions.
16. It is imperative to create an enabling national legal architecture for effective and
timely functioning of the failure resolution framework, which would permit orderly liquidation
of banks and timely payout and transfer of insured deposits. Deposit insurer should have
effective resolution tools designed to help preserve critical bank functions, achieve transfer of
accounts or assets/businesses and/or maintain continuity of banking services. It would be
necessary to establish such resolution procedures which will allow flexibility for resolution at
a lesser cost than otherwise likely during depositor reimbursement due to liquidation. It is
essential to equip the deposit insurer with the powers to provide for transfer of insured
deposits to stronger banks. Resolution procedures should clearly ensure that banks'
shareholders take first losses. Deposit insurers should share in the proceeds of recoveries.
17. A framework needs to be in place for close co-ordination and information sharing
(on routine basis as also regarding banks in financial difficulty) among the deposit insurer
and other financial system safety-net participants. Such information should be accurate and
timely. Regarding cross border issues, while ensuring confidentiality, all relevant information
should be exchanged between deposit insurers in different jurisdictions and possibly
between deposit insurers and other foreign safety-net participants, when appropriate.
Depositors in the jurisdictions affected by cross border banking arrangements should be
provided with information on deposit insurance system legally responsible for reimbursement
and the limits and scope of coverage. Where a deposit insurer perceives a real risk that it
may be required to protect depositors in another jurisdiction, it should have contingency
planning that allows for cross-border arrangements or agreements.
18. With increasing global financial integration, consistency in the basic principles that
guide deposit insurance is essential to maintaining a level playing field internationally. In this
context, information exchange among deposit insurers gains importance. Today, there are a
large and growing number of cross border financial institutions functioning across multiple
deposit insurance jurisdictions. There is a need for clarity regarding the obligation of each
deposit insurer in respect of each cross-border institution. While the "Core Principles for
Effective Deposit Insurance Systems" state that the deposit insurance already provided by
the home country system should be recognised in the determination of levies or premium,
there is a need for a firm and shared understanding on this.
19. Sessions on country/regional experiences by US, Europe, Asia and Latin America
show that there is a large diversity in the deposit insurance systems, legal frameworks,
efficiency, mandates, economic and banking environments in these economies. My view is
that diversity does not mean adversity. The deposit insurance systems across the globe
should make earnest efforts to comply with IADI's Core Principles on Effective Deposit
Insurance Systems'. Core Principles outline the guiding framework for deposit insurance
systems and incorporate inherent flexibility. Compliance to them does not forbid countries
from making their own tailor-made systems. The presentations and discussions in this
conference on cross-country experiences would certainly help all of you to utilise this
knowledge in attaining your goals.
20. The Session on Regulators' Response covered the Crisis Framework, Basel III -
Global Perspective and Challenges to Implementation, and Deposit Insurers' Response to
Financial Crisis. The regulator's policies/actions should always be such that they facilitate the
deposit insurer's job, which will ultimately help in preventing/curing the crisis as also attain
financial stability and inclusion. Well-crafted regulatory reforms will always make the financial
systems immune, adaptable and complementary to deposit insurers' aims and operations.
Close and continuous co-ordination between the two is a sine qua non. As regards deposit
insurer's response to financial crisis, I would like to say that a deposit insurer, in collaboration
with the regulator, should develop an advanced sensory system for early detection of crisis
and excellent contingency planning with adequate funds on demand so as to nip the crisis in
the bud and safeguard depositors' interests. The adequacy of deposit insurance funds and
the financial strength of deposit insurers to meet their obligations during financial crises
requires specific attention in the light of the global events of the recent past.
21. The Session on Bank Resolution Framework - International best practices has
covered global practices with respect to bank resolution, key attributes for bank resolution
and Core Principles. These best international practices would act as good benchmarks for
you. You would know what is best and where do you stand and then accordingly how far you
have to march ahead and in which direction.
Conclusion
22. I conclude with an appeal to all of you to work upon your deposit insurance systems
to make them ideal by creating an environment comprising good bank regulation and
supervision, sound governance of safety net agencies, strong legal framework and strong
accounting and disclosure regimes. Avoid moral hazards, have a specified mandate and
necessary powers, build up sound governance, have appropriate interaction with other safety
net participants, make banks' membership compulsory, build up strong and quick funding
mechanisms, create public awareness and make the resolution process effective.
23. I am sure that this conference has given you valuable inputs and the knowledge
gained through the discussions on crucial aspects in this conference will be utilized by all the
delegates for attaining the best outcomes in their countries so as to make their safety nets
and deposit insurance systems ideal and insulating their economies from any financial and
systemic disturbances in future. My best wishes for all your endeavors.