Why deposit insurance of five lakhs is not enough to protect investors

Last Updated on April 27, 2025 at 9:09 am

The finance minister announced a long-awaited increase in the insurance coverage of bank deposits from Rs. one lakh to five lakhs in budget 2020. While this is a welcome move, we argue that it is not enough to protect investor interests.

This budget announcement was formalised by an RBI circular on 4th Feb 2020. The Deposit Insurance and Credit Guarantee Corporation (DICGC) has now increased the insurance to Rs. five lakhs per depositor. To understand more about the term and conditions of this insurance, please consult our earlier article: What happens if my bank fails? All about Deposit insurance (DICGC) As a result, the DGIC has increase deposit insurance premium from 10 paise per Rs. 100 per year to 12 paise per Rs. 100 per year.

The finance minister said, “I wish to inform this august House that robust mechanism is in place to monitor the health of all Scheduled Commercial Banks and that
depositors’ money is safe”.

While this may seem to assuage/reassure, we must take stock of the grim reality. Banking failures are a lot more common than we think! According to livemint (written after the PNB Nirav Modi scam), “Between 1935 and 1947, nearly 900 banks failed followed by 665 banks in the period from 1947 to nationalisation in 1969″. As always, regulation follows a scam.

Between July 26th 2019 and Feb 5 2020, one can find as many as 17 RBI press releases related to “Directions under Section 35 A of the Banking Regulation Act”. That is a restriction and/or ceiling on withdrawal/acceptance of deposits.

This means the bank is trouble (typically due to a scam or fraud) but has technically not yet failed! This means the deposit insurance does not come into play as yet! Even if the bank does actually fail, it would be foolish to expect or assume that the Rs. 5 lakh would be paid out immediately.

You can check the DICGC Claim Submission Pending page to understand different circumstances under which payment could be delayed. A simple appeal by the bank can drag on for months to years.

As it turns out, investors are too easy to please. They do not care if their EPF interest is delayed (and therefore returns lowered). “As long as it comes, I am okay” is the popular attitude. When a debt fund portfolio gets segregated, they tell themselves, “this means if the money is paid, I will get it back”. And in the case of deposits, many assume, “I will at least get back Rs. five lakh at some point”.

Deposit insurance is only symptomatic treatment. It does not address the cause. It is not a cure. The union cabinet has yesterday increased RBI’s role in the administration of cooperative banks. The Banking Regulation Act has been amended to allow audits as per RBI guidelines while Registrar of Cooperative Societies will still handle day-to-day administration.

While this is no doubt another step in the right direction, it should be kept in mind RBI inspection reports on even state-owned Indian Bank and SBI showed a disparity in reporting bad loans (aka “divergence”).

Thus allowing RBI to audit cooperative banks may not immediately avert a crisis such as this: PMC Bank Fraud: Lessons from Sanjay Gulati’s story. While lending is the lynchpin of the economy, can it ever be done responsibly with shareholders breathing down the necks of the bank management and while it remains so easy to cook the books, misrepresent financial health or even commit fraud? Mis-selling by a relationship manager pales in comparison: How & why bank relationship managers destroy your wealth by mis-selling! Stay away from them!

Investors would do well not to consider bank deposits as “safe” and diversify risks. Even if it is hard to transact with a post office, it is good to remind ourselves from time to time that they come with a 100% sovereign guarantee.