Placed A Bank Deposit! Super Safe, Right? Wrong!!

A few days back, read these headlines in a newspaper.

The Deposit Insurance and Credit Guarantee Corporation (DICGC) said on August 1 that it will refund eligible depositors of 17 cooperative banks.

Hmmm.. Got me thinking, aren’t bank deposits safe? Why should anyone refund money to bank depositors? Banks in India never fail or are not allowed to fail, right?

You may remember the Rana Kapoor promoted infamous YES Bank which got into trouble. RBI got the State Bank of India to bail it out. The fixed deposit holders, current & savings a/c depositors got their money back but the perpetual bondholders were not so lucky. They lost 100% of their investments.

So how do these banks fail?      

Banking is a business like any other. A bank accepts deposits from the public and uses them to extend loans to individuals, corporates, or whoever they think fit. They charge higher interest to the borrowers and lower to the depositors and after accounting for the expenses the difference is their profit.

If a bank extends loans to unworthy borrowers who cannot pay them back, it will go bankrupt and will not be able to pay the depositors. (Nowadays banks engage in many other businesses, trading in financial markets, extending credit cards, selling financial products, etc, but the primary business of the bank is to accept deposits and extend loans)

A bank depositor can’t know what the bank is doing with her money, so how does she keep her faith in the bank? To the rescue, is a big daddy, the Central Bank, which is the Reserve Bank of India. RBI lays down rules on what the bank can and cannot do to safeguard the interest of the depositors. They ask the banks to set aside a part of the money from the deposits in the form of SLR & CRR (Statutory liquidity ratio & Cash reserve ratio). They put limits and rules on whom and how much the bank can lend to and have supervisory powers.

Did you know, that 27 commercial banks & 357 Cooperative banks have failed in the last 40 years?

Despite the supervision by the RBI, if a  bank is suspected to be in a weak financial condition the Reserve Bank of India places it under a moratorium. Typically they put an immediate restriction on withdrawals by the depositors which creates immense agony for them. If the depositor cannot access their own legitimately earned savings, it is natural to create stress, pain, and a sense of helplessness.

Why does the RBI put these restrictions on withdrawals?

The Reserve Bank has to restrict the withdrawal to stop a run on the bank. Banks accept deposits in small sums from retail for short periods and they extend loans in larger sums for longer periods. So if everyone who has deposited comes back to withdraw their deposits at a particular point in time, no bank will be able to pay them just then.

Banks run on trust and faith, a run on the bank is the worst nightmare for any banker. A few years back, some ATMS of a private bank ran out of money, rumours of the bank failing spread like wildfire and there were long lines in front of the bank to withdraw their deposits.  In this case, they moved armored trucks with cash and paid back every depositor who had lined up, to calm nerves & quickly squash the rumours.

All this is fine but what if the bank where I have an account fails?

Reserve Bank is wary and does not issue licenses to carry the banking business lightly. So the first thing to do is check whether your bank is licensed by the Reserve Bank. You can find the list here.

RBI then puts the bank into a moratorium, stops them from doing any business, and appoints a liquidator to check on its workings.They await their report and then try and merge the failed bank with a healthy bank to protect the interest of the depositors. For eg, Global Trust Bank was merged with the Oriental Bank of Commerce, PMC bank with Small Finance Bank, and Yes with State Bank.

All this while they put a limit on the withdrawals by the depositors. Initially, PMC bank a/c holders were allowed to withdraw Rs 1000, Global Trust Rs 10,000, and Yes Bank Rs 50,000.

Depending on the terms of liquidation, the depositors are paid back. Some accounts get defreezed quickly like in the case of Yes Bank which took weeks and some took years. Eventually depending on the rescue package worked out the depositors can get their money back.The wait for PMC Bank account holders that failed in 2019 is 10 years to get their full money back.

Why are you scare mongering? Isn’t there something called DICGC?

Certainly not trying to scare you, but definitely trying to create awareness. The Reserve Bank Promoted Deposit Insurance and Credit Guarantee Corporation insure deposits of banks registered with them.

Here is the list.

So what is the worry? If a bank goes under, DICGC will pay us back.

Unfortunately, there is an upper cap of 5 lacs... So any balance above 5 lacs is @the mercy of liquidators. Sometimes it takes years to get even the insured 5 lacs. The average number of days to settle a claim is 1.5 years and has also gone up to 5 years earlier.

Keep in mind that the limit of deposit insurance of 5 lacs applies to individual banks. So if you have 5 lacs deposits each in two different banks say bank A & bank B, the limit is not cumulative. If both banks go under, you will be eligible for 5 lacs from DICGC both of them.

Another interesting factoid is that deposits placed in different capacities are insured separately. If Priyanka & Rahul open an a/c and place a deposit as Priyanka/Rahul – 5 lacs & Rahul/ Priyanka – 5 lacs, both will be insured separately. But an individual deposit as well deposits as a sole proprietor will be merged.

Interesting.        

Click here for FAQs on the depositor’s guide from DICGC.

As Benjamin Franklin said “Nothing is certain except death & taxes”, it pays to be a bit careful, not paranoid but aware. Before placing a bank deposit check if they are regulated by the RBI and registered with the DICGC.If you want to be extra careful, spread your account balances & deposits above 5 lacs in different holdings. Ideally, in different banks.

Be wary of cooperative banks, just going by the sheer number of failures in them.