Is Our Dodgy Insurance Protection History to Blame For the Woeful Promise Made in the PMC Bank Case?

The small amount of the promise has been one of the most controversial aspects of the news of the bank's fall.

Earlier this week, the RBI placed the Punjab and Maharashtra Co-operative Bank (PMC), a ‘multi-state scheduled urban co-operative bank’ operating in multiple states including Maharashtra, Delhi, Karnataka, Goa, Gujarat, Andhra Pradesh and Madhya Pradesh, under direction.

The bank has been curbed from granting or renewing loans or advances, accepting deposits or disbursing payments without due approval, even though the RBI’s direction itself did not specify the exact reasons why the bank was in crisis. The worst hit are perhaps depositors, who had been allowed to withdraw a maximum sum of Rs 1,000 of the total balance every bank, which has now been increased to Rs 10,000.

Perhaps the most controversial news around the ‘demise’ of PMC has been over the scant deposit insurance money that has been promised to people.

To understand this completely, it is crucial to dip into the history of co-operative banks, a species somewhat different from general commercial banks. In fact, the history of the governance of co-operative banks (which are regulated by the RBI in case of multi-state co-operatives and by state governments in case of single state co-operatives respectively) is rooted in the start of the Deposit Insurance and Credit Guarantee Corporation (DICGC) in the 1960s.

In this context, there are two very important policy issues to be addressed: one on the adequacy of the deposit insurance protection being offered, and the second on the governance of co-operative banks, inextricably linked to the history of deposit insurance in India.

The origins of deposit insurance

On the first issue of deposit insurance, it is important to remember that the concept was a rather late admission in the scope of banking regulations. It was preceded by a banking crisis in India, most notably the banking crisis in Bengal. The controversy was precipitated by a bank run through four entities in 1950 – the Bengal Central Bank, the Comilla Union Bank, the Comilla Banking Corporation, and the Hooghly Bank and more generally thanks to the liquidation of at least 50 banking concerns between 1947 and 1950.

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The crisis was compounded significantly by the inability of these banks to pay depositors. Of the 82 banks that suspended payments in Bengal, only 13 banks made ‘small payments’ to their depositors, fuelling public resentment and provoking people to write letters to Nehru, famously stating that the central bank was ‘only meant for the big pandas who … only know how to squeeze’ the poor. People also wrote that a loss of public faith in the government and its institutions would force those in the region to court their ‘worst fate’ and ‘join…hands’ with the communists.

After a number of committee deliberations, in 1956, K.N.R. Ramanujan, who was the director of banking research drew up a tentative scheme of deposit insurance covering upto Rs 500 per account, which would extend full protection to an estimated 61% of all accounts of all banks and partial protection to the rest.

Police personnel stand guard outside Punjab and Maharashtra Cooperative Bank (PMC) at GTB Nagar, in Mumbai on September 26, 2019. Photo: PTI

This was followed by the crash of the Palai Central Bank, the largest bank to fail in independent India and the second major bank to suffer that fate in the Travancore-Cochin region within a quarter of a century.

The idea of deposit insurance again saw a resurgence and a Working Group proposed in its report a maximum cover of Rs 1,000 per depositor which would fully protect nearly 80% of account holders and secure 15% of deposits.

In 1962, when the DICGC Act was passed, India as it happened, was only the second country in the world after the US, to provide insurance cover to bank deposits. Thanks to the introduction of deposit insurance in 1962, by 1967 the phenomenon of large-scale bank failures and of the public losing the larger part of its deposits was largely relegated to the past.

The insurance amount was increased to Rs 1,500 or the total amount deposited, whichever was lower. In 1968, this amount was further raised to Rs 5,000, fully insuring over 91% of all deposit accounts.

In 1993, the amount was set at Rs 1 lakh. In this historical context, offering Rs 1,000 to depositors now at the failure of PMC seems woefully inadequate. More importantly, it is to be remembered that deposit insurance was never meant to be an end in itself, precisely because it came about as a direct response to multiple banking crises in India. The success of deposit insurance as was noted in 1951, depended ultimately on the soundness of individual banks, and therefore, deposit insurance would have to be accompanied, as in the US, by ‘rigorous control and comprehensive supervision’ of banks’ affairs.

Also read: PMC Bank Restrictions Leave Customers, Employees Feeling Worried

As such, a conversation just about the adequacy of deposit insurance without talking about the governance of co-operative banks would be antithetical to its original purpose and intent.

Deposit insurance, co-operative banks and state autonomy

In this regard, it is also important to consider the particular legislative history of deposit insurance in the context of cooperative banks. It must be remembered that when the DICGC Act was originally passed in parliament, cooperative banks were excluded from its ambit, a fact that did not go unnoticed. In fact, certain state governments including the Madras government, a pioneer in this respect, decided in December 1961 to guarantee, up to some limit, three-year and longer fixed deposits of state and central cooperative banks.

A number of states including Orissa, Mysore and Bihar wanted to follow suit. Finally in 1968, the DICGC Act was amended to give RBI limited powers of reconstruction, amalgamation and winding up, and extend deposit insurance to cooperative banks. Even now, most co-operative banks are rarely governed with the same rigour as most commercial banks. These are either governed by the lesser-known Multi State Cooperative Societies Act, 2002, or individual state Acts which bestow the central or state registrar with most powers of administration and operational management, keeping limited powers vested with the Reserve Bank.

Customers stand outside the Punjab and Maharashtra Cooperative Bank at GTB Nagar in Mumbai. Photo: PTI

This issue of duality of control is a continuation of a post-Independence legacy of co-operative fiscal federalism, meant to give state governments more autonomy. Of course state co-operative banks in India today are riddled with corruption and concentration of local political power, and fail on a consistent basis. An important question to be asked is whether this is the best way to further fiscal state autonomy.

Consider this, DICGC notes in its latest annual report, that it settled aggregate claims of Rs 434.7 million during 2017-18 alone, in lieu of 18 co-operative banks, the highest claims coming out of Maharashtra and West Bengal. This is deeply symptomatic of the governance rot that has crept up in the co-operative banking system.

The governor of the RBI at the time of passing the DICGC Act in 1962, P.C. Bhattacharya, when the issue of state government power vis-à-vis the power of the central bank played out for many years, had attempted to break the impasse by placing the issue of cooperative banking regulation itself in a wider context, and commenting on the ‘important bearing’ operations of cooperative banks had on the ‘currency and credit situation’, because they played a prominent role in financing certain sensitive sectors of the economy.

However, in the current context, whether co-operative banks with dual management and regulatory systems are desirable to be continued in their present form, and if they indeed continue to have an important bearing on credit, currency and financial inclusion are tough questions that need to be asked. Further, if indeed the regulatory structure is to be streamlined and brought under a single regulator, an important issue to consider would be RBI’s ability to regulate and resolve the thousands of co-operative banks that lie scattered across rural and urban India.

Questions we need to ask 

The fall of the PMC Bank should trigger alarming governance questions, and with good reason.

Also read: The Seeds of FRDI Bill’s Failure Lay in Our Flawed Public Discourse on Banking

Questions should be asked of the RBI and its regulatory forbearance in acknowledging its failure, and on the efficacy of continuing to separate co-operative banks from regular commercial banks even though modern wisdom tells us to regulate function over form.

Politicisation of banks, failing governance mechanisms and depositor concerns in cooperative banks were raised almost a decade ago in the Rangarajan Committee. It remains to be seen if the recommendations were completely followed.

Further, deposit insurance itself needs to re-hauled. As recommended in 2016, risk-based premia need to replace the flat rate of premium that is currently deployed to reduce cross subsidisation of bank failures. This is perhaps the only way to build up a healthy corpus of deposit insurance fund.

The DICGC Act and all attendant state and Union laws need to be harmonised, at least for bank resolution and deposit insurance – timely, and higher payouts.

In this context it is important to acknowledge that the now withdrawn Financial Resolution and Deposit Insurance Bill (FRDI) attempted to bring all insured banks – commercial and co-operative banks under a uniform resolution regime, with resolution powers shifting from the RBI to the ‘Resolution Corporation’.

The Bill also called for a revamp of the deposit insurance framework, specifically asking for a reconsideration of the Rs 1 lakh deposit insurance amount, a strict payout timeline, higher protection levels for depositors, and a shift to a risk based insurance premia.

Most importantly, the Bill anticipated regulatory forbearance and asked for widespread banking regulation reform, with higher supervisory focus on riskier, bigger and more interconnected financial institutions, irrespective of whether they were commercial or co-operative or state owned banks. Special amendments were also demanded of state co-operative banks with the specific promise of deposit insurance protection to bring them into the resolution framework.

With the withdrawal of the Bill in 2018, India’s conversation on harmonised banking regulation and resolution abruptly stopped.

The discourse around the demise of PMC Bank should trigger some of these older and larger questions on the way co-operative banks are governed, and the way we handle their failure, because the history of banking in India shows that the deposit insurance emerged as a direct consequence of banking crisis. It is perhaps time to examine our current crisis and reimagine how to protect depositors again, particularly in the macro context of bank regulation, and resolution. 

Shohini Sengupta is a policy lawyer based in Delhi. She tweets @shohinisengupta.