Duvvuri Subbarao: Funding of deposit insurance systems
Inaugural address by Dr Duvvuri Subbarao, Governor of the Reserve Bank of India, at the
International Conference "Funding of Deposit Insurance Systems" hosted by the Deposit
Insurance and Credit Guarantee Corporation (DICGC), Mumbai, 18 January 2010.
* * *
At the outset, on behalf of the Reserve Bank of India, I welcome you all to India and to this
wonderful state of Goa. My thanks also to the Asia Regional Committee (ARC) of the
International Association of Deposit Insurers (IADI) for giving an opportunity to the Deposit
Insurance and Credit Guarantee Corporation (DICGC) to host this Conference. This event is
particularly important for us because it is being hosted as a part of the Platinum Jubilee
celebrations of the Reserve Bank of India (RBI).
Evolution of deposit insurance
2. Deposit insurance has historically been a reassuringly stabilizing force in a financial
system notoriously susceptible to instability. In fact panics were a regular feature of American
economic life even as banking was taking roots - most spectacularly during the Great
Depression. It was the introduction of deposit insurance in 1933 that substantially reduced
the vulnerability of American banks to runs.
3. Over the years deposit insurance has taken root all around the world. Collectively, we
traversed a steep learning curve and learnt a number of lessons about the systems and
processes of deposit insurance. The recent crisis has, however, thrown up a number of fresh
questions about the financial sector, including about deposit insurance. Finding answers to
these questions and addressing the consequent challenges is going to be the priority task for
all of us in the financial sector. I want to talk about some of the issues, but first let me say a
few words about deposit insurance in India.
Historical perspective on deposit insurance in India
4. DICGC, a wholly owned subsidiary of RBI, is the second oldest deposit insurance
system in the world. It was established in January 1962 initially only as a deposit insurance
institution. However, in 1978 the Corporation was also entrusted with the responsibility of
credit guarantee and was rechristened as the Deposit Insurance and Credit Guarantee
Corporation (DICGC). The objective of extending guarantee cover to credit was to encourage
commercial banks to extend credit to small borrowers belonging to weaker sections of
society. But over time, it was felt that the credit guarantee schemes operated by the
Corporation had outlived their utility and the schemes were discontinued. The Corporation
has now reverted to being an exclusive deposit insurance system.
5. Over nearly 50 years, the DICGC has evolved and moved up the value chain - learning
by doing as it were - and met many challenges along the way. By far the biggest challenge
came in 2001 when a large co-operative bank in the state of Gujarat was in trouble. Since
several banks, particularly many small co-operative banks, had exposure to this bank, its
failure had the potential to precipitate a crisis in the banking industry. The Government and
the Reserve Bank put in place resolution of this bank through a restructuring programme.
The key element of this programme was proactive action by the DICGC towards prompt
payment of claims to the depositors of the bank. This action by DICGC ensured that panic
did not spread.
Global crisis and deposit insurance
6. Let me now turn to the recent financial crisis. Though the crisis impacted the entire
world, it affected different countries in different ways. After the collapse of Lehman Brothers
in mid-September 2008, there was an abrupt breakdown of trust, which spread rapidly from
the United States to other advanced economies, causing financial markets in all advanced
economies go into seizure. Suddenly, there was a great deal of uncertainty about the extent
of losses, the ability of banks to withstand those losses, the extent of risk in the system,
where it lay and how it might explode. This uncertainty triggered unprecedented panic and
almost totally paralyzed the entire chain of financial intermediation. Banks hoarded liquidity.
Credit, bond and equity markets nearly froze. Several venerable financial institutions came to
the brink of collapse. Massive deleveraging drove down asset prices setting off a vicious
cycle. In such a situation, governments and regulators had to take extraordinary measures in
a big way.
7. Not surprisingly, deposit insurance emerged as the most visible part of the financial
safety-net in arresting a panic reaction. Several deposit insurance systems increased their
insurance coverage limits; in some cases the governments extended blanket deposit
guarantee. These measures went a long way in restoring public confidence in the banking
system in economies where it came under serious threat.
Global crisis and India's response
8. That India was hit by the crisis dismayed many people. In the years before the crisis,
the decoupling theory gained intellectual ascendancy. This theory held that even if advanced
economies went into a downturn, emerging market economies would not be affected
because of their improved policy framework, robust foreign exchange reserves, and sound
banking systems. The crisis ruptured the credibility of the decoupling theory by engulfing
almost every part of the world. India was no exception. The crisis spread to India through
finance and real channels.
9. Importantly, the crisis also spread through the confidence channel. However, in sharp
contrast to global financial markets which got paralyzed on account of a crisis of confidence,
Indian financial markets continued to function in an orderly manner, even as the risk aversion
of the financial system increased and banks became cautious about lending. The point to
note is that, the global financial crisis did not pose any major threat to the banking system in
India at any point of time. As such, the need for any special measures pertaining to deposit
insurance did not arise. However, in line with the global trend, there was also some demand
here to increase the deposit insurance cover. If one looks even at broad data, it becomes
quite clear that this demand had no persuasive force. Under the existing insurance cover,
number-wise almost 90 per cent of the deposit accounts are fully covered. Amount-wise,
over 60 per cent of total insurable deposits are covered. We determined, therefore, that the
cost-benefit calculus was not in favour of enhancing the deposit cover.
10. In India, the contagion of the crisis was effectively contained by coordinated fiscal and
monetary measures taken by the Government of India and the Reserve Bank respectively.
The results are evident from the marked improvement in the performance of the industrial
sector in recent months - upturn in domestic and external financing conditions, revival of
capital inflows, increased activity in the primary and secondary capital markets, softening of
interest rates and substantial easing of liquidity conditions. GDP growth of 7.9 per cent
during the second quarter of this fiscal (2009-10) was robust - up from 6.1 per cent in the
previous quarter. There are, however, several challenges on the way forward including the
timing and sequencing of exit from the expansionary fiscal and monetary policies. These
issues are being debated all over the world and occupy the central place in our policy matrix
too. The challenge for the Reserve Bank is to support the recovery process without
compromising on price stability.
Financial stability
11. The global financial crisis has also underlined the critical role of central banks in
systemic oversight of the financial sector and in preserving financial stability. This calls for a
paradigm shift not sector. Financial stability needs to be understood and addressed both
from the micro and macro perspectives. At the micro level, we need to ensure that individual
institutions are healthy, safe and sound. But an important lesson of the crisis has been a
reiteration of the fallacy of composition - that a collection of safe and sound financial
institutions does not necessarily deliver a safe and sound financial sector. We need to take
care of systemic stability as a separate and distinct obligation. This calls for safeguarding
financial stability at the macro level through what has now come to be called
macroprudential regulation of the system as a whole.
12. Today, RBI is an active participant in several important international institutions that
seek to promote more effective regulatory structures, and financial and systemic stability. We
have, for some time now, been shareholders of the Bank for International Settlements (BIS)
and member of the Committee on Global Financial System the Committee on Payment and
Settlement Systems and the Markets Committee. Post-crisis, we have also become
members of the Financial Stability Board and the Basel Committee on Banking Supervision
(BCBS). And of course, we have been an active participant in the G-20 deliberations.
DICGC - challenges for the future
13. Let me now comment briefly on the challenges for DICGC on the way forward. One key
challenge is reducing the time taken to settle claims. Though the Corporation has been able
to settle all claims within the statutory time limit, its goal is to go beyond the statutory
prescription, and ensure settlement of claims within a few days of liquidation of a bank as
against a few months taken now. Towards this end, effort is required in two directions. First,
DICGC must have a computerised depositors' data base in respect of over 85,000 branches
spread across the country. Second, the entire process of filing claims by the liquidator and
their processing by the Corporation should be computerized with appropriate connectivity.
The Corporation has already initiated steps to move in this direction by formulating an
ambitious project of Integrated Claims Management System (ICMS).
14. The second challenge pertains to broadening the mandate of DICGC. DICGC is
presently working as a pay box system. Going forward, we are examining the possibility of
transforming it from a pay-box system to a system attending to all aspects of bank resolution.
This may, however, require sweeping reforms including a thorough change in the DICGC
Act, 1961. However, certain features of the financial sector supervision and regulation as
prevailing in India may have to be kept in view. For example, it may not be necessary to have
a separate supervisory machinery in DICGC independent of the Reserve Bank as is the
practice in some other jurisdictions, notably the United States.
Deposit insurance - post crisis
15. The global financial crisis has underscored the importance of a well designed explicit
deposit insurance system in maintaining financial stability. By assuring depositors that they
will get immediate payment to the extent of the insured amount, a deposit insurance scheme
can contain financial contagion. Indeed, there are a number of contrarian examples to show
that bank panics were exacerbated in situations where deposit guarantees were not explicit,
not incentive compatible and did not have the resources to back their guarantee obligations.
In order, therefore, to inspire the trust and confidence of stakeholders, a deposit insurance
scheme must satisfy two criteria - first, it must be adequately funded, and second, it must
have robust delivery systems in place to effect payments within, if not well within, the
assured time.
This important lesson from the recent financial crisis has been clearly brought out in the Fifth
Report (2007-08) of the Treasury Committee of the House of Commons, entitled "Run on the
1
Rock". After analyzing the reasons for the run on the Northern Rock, the report concluded:
"All banks and building societies should be covered by a deposit insurance
scheme, such that, in cases such as Northern Rock, or an even larger bank, the
Government would not be required to step in to protect depositors."
The Report further observed that
"There should be a requirement in law that all insured deposits should have to
be paid within a few days of a bank failing and calling on the deposit protection
scheme."
17. The above observations are clearly self-evident. But every crisis has demonstrated
how its root causes can be traced to the neglect of some basic tenets. An important
preventive going forward will be to review the effectiveness of our deposit insurance
schemes and repairing the deficiencies, if any, and strengthening the weak spots.
Deposit insurance - global coordination
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 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 need for a firm and shared understanding on this.
Relevance and value of the conference
19. I am glad to note that "Funding of Deposit Insurance Systems" is the theme of the
Conference. This is extremely relevant in the context of the present emphasis on promoting
financial stability. I note from the schedule of the Conference that you will be addressing
several aspects of funding of deposit insurance systems, including funding mechanisms and
the management of funds.
20. I also note that there is an exclusive session for "Core Principles for Effective Deposit
Insurance Systems" with special reference to guidance on funding. It is indeed a rare
privilege that we have, at this conference, distinguished speakers on the subject, not only
from Asia, but from other parts of the world as well.
21. I would like to take this opportunity to flag for your consideration a few issues, which
might be of importance to DICGC and many other deposit insurance systems around the
world:
•
In light of the recent experience which has challenged the concept of "too big to fail",
is there a need to review the manner of defining "risk" for the purpose of determining
risk-based premium? How do we go about it?
•
How do we factor-in the risk associated with all the non-banking business of a
financial conglomerate on its banking business? How should risk based premium
factor in this risk?
•
Should the entire income or the surplus of a deposit insurance system or any part of
it be subject to taxes?
•
Is it possible to define an international benchmark or at least a standard
methodology for determining a bench-mark for the Reserve Ratio (Ratio of Deposit
Insurance Fund to Insured Deposit), signifying the adequacy of Deposit Insurance
Fund?
•
What countercyclical measures should a deposit insurance system take to build up
its funds for the rainy day?
22. Needless to say, this conference has come in at a very appropriate time. I do hope that
your deliberations over the next two days will result in enhancing our collective
understanding of deposit insurance and provide pointers for action.
23. I wish the Conference all success.