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

Investor deposits are now protected up to Rs. five lakh person. This, however, does not mean your money is safe! Why a lot more has to be done to protect investor interests

Published: February 6, 2020 at 12:55 pm

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.

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps