Deposit Insurance in India
Author: Mr. M.R. Das
Pages: 107 Price: Rs.125 Publishers: Himalaya Publishing House
Reviewed by: Mrs. Kiran Sharma, MOF, CAB
Anomalies and deficiencies in the banking and payment systems, if not handled timely and properly, could lead to financial crises which may bear a substantial cost to the economy. A run or a run-like situation in one bank may cause similar problem in other banks because of the inter-dependence of the banking and financial system. Further, in view of the emergence of cross-border banking, stability of banking system has gained critical importance. To limit the effects of failure of bank(s), countries across the world have evolved safety nets to meet the exigencies of the banks singly or as a whole.
Such safety nets are broadly of two types of namely, lender of the last resort and deposit insurance. In the form of lender of the last resort, banks can rely upon the Central Bank of a country to meet any liquidity mismatch arising due to internal/external factors and thus avoiding insolvency like situation. The existing system of the lender of the last resort, although useful for stabilizing the banking system, may not be a preferred mode of solving the problem as it may lead to the reputation of the bank being damaged. As a result, along with the lender of the last resort, almost all countries have evolved deposit insurance schemes providing guarantee to their depositors, especially small depositors, so that in case of a run or failure of banks their (depositors’) interest could be safeguarded.
Thus, the principal objective of deposit insurance is to contribute to the financial stability and to protect small depositors when banks fail. Evolving appropriate deposit insurance, of course, involves complexities having domestic and cross border orientation. There is also a concern that excessive reliance on deposit insurance may lead to the problem of moral hazard which may negate the benefits of deposit insurance. In the context of other deposit insurance organizations, the nature and structure of deposit insurance in India is also of key interest to those involved in finance. The book by Mr. Das is a ready reckoner for all these and many other issues which are presented in a very precise manner.
The book, in brief, encompasses various issues, focusing on both the policy and operational aspects. It begins by setting out the specific objective of deposit insurance.
The author illustrates that though general insurance and deposit insurance appears to be

akin to each other, there is a fundamental distinction between the two. The major distinction between insurance and deposit insurance is that the probability of bank’s failure is not identical to actuarial category as in the case of contingencies like death, illness, fire, theft etc. or car accident. Perhaps the assessment of the bank’s failure is beyond any fit of probability distribution. Evaluation of the norms of deposit insurance necessitates more detailed knowledge of the banking sector and their relationship with other markets. In this background, author discusses the relevance of the lender of the last resort with respect to deposit insurance.
The next section discusses the global scenario covering vision, mission and objectives of the International Association of Deposit Insurance (IADI) in terms of its origin, objective, etc. It is interesting to note that in the wake of large scale failure in 1933, Federal Deposit
Insurance Corporation (FDIC) of the USA was created and since then no depositors has lost any amount of insured funds as a result of banks’ failure. Further, the author reveals that the FDIC uses a risk-based premium system that assess higher rates on those institutions those poses greater risk to the Deposit Insurance Fund.
The author then goes on to provide an overview of the Deposit Insurance architecture in
India. The birth of deposit insurance in India was a result of the crash of Palai Central
Bank. While initially the scheme of deposit insurance was restricted to commercial banks, by 1968 the facility was extended to the cooperative banks . As of 2008-09, there are 166 commercial banks, including 86 RRBs, 2137 Cooperative banks and 4 Local
Area Banks (LABs), registered with Deposits Insurance. Author also provides rich information on the feature and coverage of deposit under deposit insurance scheme, covering recent policy initiatives up to 2008-09.
The next section covers the recommendations of various Groups set up for examining the reforms necessary for the deposit insurance system in India.The author outlines that the deposit Insurance has increased public confidence in the banking system, promoted savings in bank deposits and enabled banks to perform intermediation function more effectively. Further, the author explains that the deposit insurance may in turn lead to the issue of moral hazard which may defeat the objective of deposit insurance. In order to alleviate the problem of moral hazard, one possible way out could be that there is a need to shift to risk-based premiums rather than flat premium as is being followed now.
Author also raises the issue of whether deposit insurance should be restricted to the banking sector only, or it should be extended to the non-bank financial organizations involved in mobilizing deposits from the small depositors.
Recalling the Basel Committee’s Core Principles for Effective Banking supervision which recommends that carefully designed system of deposit insurance can contribute to

public confidence in the financial system and thus limit contagion from banks in distress, the author summarizes core principles for effective deposit insurance and India’s position thereof. As per the author’s submission, the success of deposit insurance depends upon the enabling environment of the economy especially relating to the banking sector. For the success of deposit insurance regulatory mechanism, a well designed financial system, and matching safety net is essential.
The author has made a commendable effort in putting the role of deposit insurance mechanism in real perspective, showing clearly how rich and involved the canvass is for deposit insurance, which provides stability in the banking system, particularly in respect of upholding small depositor’s interest thereby going a long way to create trustworthiness and credibility for the savers in the economy. The book will prove very useful for all the students of finance especially of banking and insurance.