{"id":32236,"date":"2018-10-29T13:11:25","date_gmt":"2018-10-29T07:41:25","guid":{"rendered":"https:\/\/blog.forumias.com\/?p=32236"},"modified":"2018-10-29T13:11:25","modified_gmt":"2018-10-29T07:41:25","slug":"frdi-depositer-trust-is-the-key-to-banking","status":"publish","type":"post","link":"https:\/\/forumias.com\/blog\/frdi-depositer-trust-is-the-key-to-banking\/","title":{"rendered":"FRDI: depositer trust is the key to banking"},"content":{"rendered":"<p><a href=\"http:\/\/www.thehindu.com\/business\/Industry\/frdi-depositor-trust-is-key-to-banking\/article22392036.ece\"><strong>FRDI: depositer trust is the key to banking<\/strong><\/a><\/p>\n<p><strong>Context<\/strong><\/p>\n<p>The banking system of any country is built on an edifice of trust that depositors have in their banks. The confidence that money is safe, keeps depositors away from withdrawing their funds unless they really need it. Meanwhile, it allows banks to lend out the money to borrowers which generates interest income for the depositor, profit for the bank and larger economic growth<\/p>\n<p><strong>Bail-in clause creates confusion<\/strong><\/p>\n<p>The \u2018bail-in\u2019 clause in the government\u2019s Financial Resolution and Deposit Insurance (FRDI) Bill has created confusion<\/p>\n<p><strong>Section 52: allows to cancel the liability owed by a failed bank<\/strong><\/p>\n<ul>\n<li>Section 52 of the Bill allows the proposed Resolution Corporation to cancel the liability owed by a failed bank<\/li>\n<li>Since the main liability of a bank is the ordinary depositor\u2019s money, it naturally causes concern whether depositors stand to lose their money beyond what is insured in the event of a bank failure<\/li>\n<\/ul>\n<p><strong>Panic Reaction<\/strong><\/p>\n<p>Unless nipped in the bud, a panic reaction could destabilise the banking system.<\/p>\n<p>Why should depositor liability be cancelled at all? When a failed bank does not have any assets left to pay its creditors, it is natural that depositors will not get back all or part of their money.<\/p>\n<p><strong>\u2018Guard against signals\u2019<\/strong><\/p>\n<p><strong>Government can\u2019t cover all the risk<\/strong><\/p>\n<p>The government can never commit to pay out all depositors in such an event.<\/p>\n<p><strong>Why?<\/strong><\/p>\n<p>Such a commitment would signal to banks that it is acceptable to take more risks because, in case they go belly-up, the government will pay out depositors<\/p>\n<p>The level of risk in the banking system would simply explode<\/p>\n<p><strong>So, depositors have to take the hit?<\/strong><\/p>\n<p>Hence, depositors have to take some hit if a bank fails.<\/p>\n<p>This is formalised in the Bill\u2019s bail-in clause.<\/p>\n<p><strong>Good Intentions<\/strong><\/p>\n<p>\u201cThe intentions are good,\u201d said Dr. K. Cherian Varghese, former CMD of Union Bank of India and Corporation Bank.<\/p>\n<p><strong>Deal with NPAs currently<\/strong><\/p>\n<p>\u201cThe new provision of \u2018bail-in\u2019 is welcome. However, when the banking system is struggling with the larger issue of non-performing assets, it is better to concentrate on recovery and also encourage bankers grant fresh loans for that the economy grows at faster pace.<\/p>\n<p><strong>Proposed law can be discussed later<\/strong><\/p>\n<p>The proposed law may be taken up later when there are no apprehensions in the minds of depositors,\u201d he said.<\/p>\n<p><strong>Depositor\u2019s trust: need for a bail-in will never arise<\/strong><\/p>\n<p>Yet, it is important for the depositor to believe that the need for a bail-in will never arise<\/p>\n<p>Here lies the role of trust in the banking system.<\/p>\n<p><strong>Convincing depositors about safety of their money. How?<\/strong><\/p>\n<p>How can banks convince depositors that their money is safe?<\/p>\n<ul>\n<li>One way is through prudential regulations such as capital requirements and supervision.<\/li>\n<li>The other way is to guarantee through an insurance scheme that the insured part of deposits will be paid out to depositors by an insurance company.<\/li>\n<\/ul>\n<p><strong>Comparison with income<\/strong><\/p>\n<p>In India, up to \u20b91 lakh of a depositor\u2019s money is protected by insurance provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve Bank of India.<\/p>\n<p><strong>Insurance limit not revised<\/strong><\/p>\n<p>However, this insurance limit has not been changed since 1993 even while income and deposit levels have grown substantially.<\/p>\n<p><strong>Globally it has been revised after 2008<\/strong><\/p>\n<ul>\n<li>Many countries revised their deposit insurance limits after the global financial crisis of 2008 but India did not do so<\/li>\n<li>Deposits up to $250,000 are protected by insurance in the U.S. while the figure is $1,15,000 in the U.K<\/li>\n<\/ul>\n<p><strong>Taking into account average income in a country<\/strong><\/p>\n<p>But the accurate comparison should take into account the average income in a country<\/p>\n<ul>\n<li><strong>In US and UK:<\/strong>Deposit insurance limit is 3-4 times the average income levels in the U.K. and the U.S.<\/li>\n<li><strong>In Brazil and China:<\/strong>In the case of emerging countries like Brazil and China, the insurance limit is 9 times the per capita income.<\/li>\n<li><strong>In India:<\/strong>Compare that with India where the insurance limit is actually a little less than its per capita income.<\/li>\n<\/ul>\n<p><strong>Need to increase the insurance limit<\/strong><\/p>\n<p>The government should increase the deposit insurance limit under the Bill, considering that at about $1,600, it is at a much lower level than some of the other developing or larger economies.<\/p>\n<p><strong>Provision for periodic review<\/strong><\/p>\n<p>Further, there should be provision for a periodic review to raise the quantum of deposits covered by insurance.<\/p>\n<p><strong>Banking supervision<\/strong><\/p>\n<ul>\n<li>The current elevated level of non-performing assets and mounting losses of banks indicate that the RBI could have been more proactive in its supervision<\/li>\n<li>More frequent audits with public disclosure of audit findings would improve transparency&#8230; Further, depositors should also evaluate performance of banks at least on a yearly basis and take informed decisions.<\/li>\n<\/ul>\n<p><strong>Taken by surprise<\/strong><\/p>\n<p>People were taken by surprise at the explicit recognition of a bail-in process which was thus far implicitly present<\/p>\n<p><strong>Problems with the clarifications of the government<\/strong><\/p>\n<p>The government tried to soothe nerves by talking about implicit guarantees for deposits in PSU banks. There are two problems with this clarification<\/p>\n<ul>\n<li>First, the implicit guarantee cannot be emphasised beyond a point lest it creates a moral hazard in the form of risky behaviour by banks and lazy monitoring of banks by depositors<\/li>\n<li>Second, what about private banks who hold 25% share of total deposits in the country? Are their customers not deserving of the same protection from the government?<\/li>\n<\/ul>\n<p><strong>Going forward<\/strong><\/p>\n<p>One optionwas to make riskier banks pay a higher insurance premium<\/p>\n<p>But the aim must be to ensure that the relatively less affluent have 100% insurance coverage and the affluent investors diversify across asset classes<\/p>\n<p><strong>Disagreement with the above option<\/strong><\/p>\n<p>However, Mr. Gupta disagree with this suggestion. \u201cIt\u2019s not [the point] about affluent or less affluent which needs to drive the deposit protection; rather it\u2019s the faith which needs to be built in the system about the safety of the deposits. Else, the financialisation of our savings will be impacted and the savings will get channelised to less productive assets like gold, real estate etc and as a country we will remain starved of capital for investment.\u201d<\/p>\n<p><strong>Word Power: <\/strong><\/p>\n<ol>\n<li><strong>Browbeat:<\/strong> (intimidate (someone), typically into doing something, with stern or abusive words<\/li>\n<li><strong>Lassitude:<\/strong>a state of physical or mental weariness; lack of energy<\/li>\n<li><strong>Edifice:<\/strong><\/li>\n<\/ol>\n","protected":false},"excerpt":{"rendered":"<p>FRDI: depositer trust is the key to banking Context The banking system of any country is built on an edifice of trust that depositors have in their banks. The confidence that money is safe, keeps depositors away from withdrawing their funds unless they really need it. Meanwhile, it allows banks to lend out the money&hellip; <a class=\"more-link\" href=\"https:\/\/forumias.com\/blog\/frdi-depositer-trust-is-the-key-to-banking\/\">Continue reading <span class=\"screen-reader-text\">FRDI: depositer trust is the key to banking<\/span><\/a><\/p>\n","protected":false},"author":61,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"footnotes":""},"categories":[555],"tags":[],"class_list":["post-32236","post","type-post","status-publish","format-standard","hentry","category-test-1","entry"],"jetpack_featured_media_url":"","views":{"total":0,"cached_at":"","cached_date":1704588916},"jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/32236","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/users\/61"}],"replies":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/comments?post=32236"}],"version-history":[{"count":0,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/32236\/revisions"}],"wp:attachment":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/media?parent=32236"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/categories?post=32236"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/tags?post=32236"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}