DEPOSIT INSURANCE FOR COOOPERATIVE BANKS A CRITICAL

STUDY OF THE INDIAN SCENARIO

BY:
Harshdeep Singh (11A051)1

1 Batch 2011-2016, Gujarat National Law University, harshdeeps11@gnlu.ac.in

ABBREVIATIONS
% - percentage
DICGC Deposit Insurance and Credit Guarantee Corporation
DIF Deposit Insurance Fund
etc. et cetera
i.e. that is
RBI Reserve Bank of India

ABSTRACT
In this paper, an analysis of the current system of deposit insurance prevailing in our country has
been carried out. The current system of deposit insurance is based on the Deposit Insurance and
Credit Guarantee Act which was introduced in 1961 and the DICGC is a subsidiary of the
Reserve Bank of India. Thus, an analysis of the extent of the DICGC was done, how it applies to
commercial banks and cooperative banks, the requirement of such a system, the flaws of the
system and how the deposit insurance system could be altered and amended in our country in
order to make it more efficient, effective and all in all, more just, fair and equitable. After an
analysis of the prevailing deposit insurance system, certain recommendations are made in order
to make the system more sustainable and more economically viable for the commercial and
cooperative banks established in India.
Keywords: Deposit insurance, cooperative banks, DICGC
Key Audience: Students of Banking Law, professionals in the banking field

WHAT ARE COOPERATIVE BANKS?

A co-operative bank is a financial entity which belongs to its members, who are at the same time
the owners and the customers of their bank. Co-operative banks are often created by persons
belonging to the same local or professional community or sharing a common interest. Cooperative banks generally provide their members with a wide range of banking and financial
services (loans, deposits, banking accounts etc.).2 Cooperative banks differ from commercial
banks in many ways. They differ from commercial banks in the sense of their formation, in the
sense of their values i.e. to whom they primarily seek to provide their services. Commercial
banks are largely urban oriented while cooperative banks target the rural sector and thus are
classified more as rural oriented. Cooperative banks also function in a three tier approach
while commercial banks predominantly function in a unitary approach. The RBI, however, has
recently proposed a four tier banking structure in its recent discussion paper.3
The structure of commercial banking is of branch-banking type; while the co-operative banking
structure is a three tier federal one.

A State Co-operative Bank works at the apex level i.e. works at state level.
The Central Co-operative Bank works at the Intermediate Level i.e. District Co-operative

Banks ltd. works at district level

Primary co-operative credit societies at base level i.e. at village level
With the primary bank functioning at the most basic level, the hierarchical structure here
places the State Cooperative Banks at the foremost level in terms of cooperative banks.
There is only one State Cooperative Bank per state, Central Cooperative Banks are
formed district-wise and primary cooperative credit societies are formed in various
localities in villages with a minimum of ten people. Primary cooperative credit societies
are reliant on central cooperative banks and the latter is further dependent on State
Cooperative Banks for its functioning. State Cooperative Banks in fact lay out the whole
credit structure for cooperative banks in the respective state.

2 http://shodhganga.inflibnet.ac.in/bitstream/10603/2031/11/11_chapter%202.pdf
3 Banking Structure in India The Way Forward (Accessible at :
http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=29405)

The history of co-operative movement in India is about a century old. The movement was started
in India with a view to encourage and promote thrift and mutual help for the development of
persons of small means such as agriculturists, artisans and other segments of the society. It was
also aimed at concentrating the efforts in releasing the exploited classes out of the clutches of the
money lenders. Keeping this as one of the objectives, credit societies were formed under Cooperative Societies Act of 1904. It was eventually the Cooperative Societies Act, 1912 which
provided for the establishment of cooperative banks throughout the country. However, the
provisions of this Act were not sufficient to meet the requirements of some of the states where
the cooperative movement had made significant progress. Thus, some of the states, initiated by
Bombay, the pioneers of the cooperative movement, passed their very own Acts. Bombay was
followed by Madras, Bihar and Bengal in this regard.4

4 http://shodhganga.inflibnet.ac.in/bitstream/10603/1106/9/09_chapter%203.pdf

DEPOSIT INSURANCE AND CREDIT GUARANTEE CORPORATION

The Deposit Insurance and Credit Guarantee Corporation (DICGC), a subsidiary of the Reserve
Bank of India (RBI), was established in 1961 under the Deposit Insurance and Credit Guarantee
Corporation Act, 1961. With the establishment of the DICGC, India became the second country
in the world to have a Deposit Insurance System. The preamble of the Deposit Insurance and
Credit Guarantee Corporation Act, 1961 states that it is an Act to provide for the establishment of
a Corporation for the purpose of insurance of deposits and guaranteeing of credit facilities and
for other matters connected therewith or incidental thereto. The banks covered by the deposit
insurance under the DICGC Act are all commercial banks within the territory of India (including
branches of foreign banks within the territory of India) and eligible cooperative banks as defined
under Section 2(gg) of the DICGC Act, 1961.
Initially, under the provisions of Section 16(1) of the DICGC Act, the insurance cover was
limited to 1,500/- only per depositor(s) for deposits held by him (them) in the "same right and
in the same capacity" in all the branches of the bank taken together. However, the Act also
empowers the Corporation to raise this limit with the prior approval of the Central Government.
Accordingly, the insurance limit was enhanced from time to time as follows:
5,000/- with effect from 1st January 1968
10,000/- with effect from 1st April 1970
20,000/- with effect from 1st January 1976
30,000/- with effect from 1st July 1980
1,00,000/- with effect from 1st May 1993 onwards.
DICGC insures all bank deposits, such as saving, fixed, current, recurring, etc. except the
following types of deposits.
(i)

Deposits of foreign Governments;

(ii) Deposits of Central/State Governments;
(iii) Inter-bank deposits;
(iv) Deposits of the State Land Development Banks with the State co-operative
banks;
(v) Any amount due on account of and deposit received outside India;

(vi) Any amount which has been specifically exempted by the corporation with the
previous approval of the RBI.

The rate of insurance premium was initially fixed at .0.05 or 1/20th of 1 per cent per annum.
It was reduced to .0.04 or 1/25th of 1 per cent per annum with effect from 1st October 1971.
However, it was again raised to .0.05 or 1/20th of 1 per cent per annum with effect from 1st
July 1993.Since 2001, the Corporation has had to settle claims for large amounts due to the
failure of banks, particularly in the Co-operative Sector causing a drain on the Deposit
Insurance Fund (DIF). While there is sufficient corpus in Deposit Insurance Fund for the
present, it is necessary to build up a sound DIF in the long term to protect the interests of the
banking system. With this objective the Corporation decided to enhance the deposit insurance
premium from 5 paise per 100 of assessable deposits per annum to 10 paise per 100 of
assessable deposits per annum in a phased manner over a period of two years. In the first
phase, the premium was raised to 8 paise per 100 of assessable deposits from the financial
year 2004-05 and later to 10 paise per

100 assessable deposits from the fiancial year 2005-

06. The Corporation will continuously review the DIF and will consider revising the
premium further from time to time with the objective of maintaining a strong DIF. 5

5 http://www.dicgc.org.in/English/AU_Profile.html

IS DICGC EFFECTIVE?
Deposit insurance schemes are a very important facet of a healthy economy. Banks often find
themselves in situations where they borrow short term and lend long term, thus suffering from a
maturity mismatch. Banks, for their sustenance, often rely upon inter-bank deposits and thus are
very well connected. Because banks rely on each other in the inter-bank market for crucial
funding, any signal that a bank in the market is less creditworthy and faces a greater risk of a
liquidity crisis will cause other banks to try to limit their exposure to that bank by removing
their deposits from that bank and declining to make new deposits with that bank or charging a
higher interest rate for making new deposits with that bank. This would indeed have contagion
consequences wherein the failure of one bank would lead to failure of similar connected banks
and in turn the entire banking system in turn may collapse, thus affecting greatly the financial
integrity and stability of the economy.
Having understood the importance of the deposit insurance scheme and having seen how the
DICGC operates in our country, a comparative analysis of its application to commercial and
cooperative banks is required in order to truly gauge and measure the effectiveness of this
scheme. Being mandatory for both commercial banks and cooperative banks to become members
of the DICGC in India, both these banks have the same rights and are treated equally under the
deposit insurance scheme. In India, failures of commercial banks have been rare, and the
beneficiaries of the deposit insurance system have mainly been the urban co-operative banks.6
In order to be able to make a clear analysis of the deposit insurance schemes for commercial
banks and cooperative banks, a complete understanding of the deposit insurance system is
essential. As has already been stated, the DICGC runs on premium received from the banks who
are members. Insured deposits of both cooperative and commercial banks are treated in same
rights and capacity by DICGC and both set of banks pay the same flat rate of premium on their
assessable deposit base. As per the above system, banks which are more susceptible to risks pay
the same premium that is paid by banks with less risk. The RBI has already found that
cooperative banks are more susceptible to risk and they have been the major benefactors of the
6 Banking Structure in India The Way Forward (Accessible at :
http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=29405)

deposit insurance system in India. It has also been found that between 1993-94 and 1998-99, the
total amount of claims paid and provisions made by DICGC were solely on account of
cooperative banks. The premium payment made by cooperative banks to DICGC between 199091 and 2001-02, net of claims paid and provision made by DICGC on account of such banks,
was small and sometimes negative.7 Also, on account of the total payment made by the DICGC
since its inception, about 52.1% of the claims were paid to cooperative banks. Thus, due to the
bloated risk of failure that cooperative banks are exposed to added to the fact that the premium
paid by these banks is the same as commercial banks which pose less systemic risk to the
DICGC, it has often been suggested in the past and is particularly relevant in the Indian context
that a risk-based premium structure would be more appropriate for the Indian context. 8 It has also
been considered that by eroding a crucial component of safety net for the commercial banks, the
most dominant segment of the Indian financial system, a unified deposit insurance system for
cooperative and commercial banks is likely to expose the whole financial system to serious
systemic risk.9 Aside from the systemic risk caused by the volatility of cooperative banks in our
economy, often the acceptability of the process of recapitalization of cooperative banks with
public money has been questioned. Thus, it has been suggested by experts that, due to the
financial stress on our economy and on the DICGC by keeping commercial banks and
cooperative banks under the same umbrella, a separate deposit insurance system should be
created for cooperative banks and commercial banks.

7 Deposit Insurance for Cooperative Banks : Is There A Road Ahead?, Sujan Hajra, Economic
and Political Weekly, November 30, 2002
8 Deposit Insurance:A Survey of Actual and Best Practices Garcia, G G H (1999): , IMF
Working Paper, No WP/99/54.
9 Deposit Insurance for Cooperative Banks : Is There A Road Ahead?, Sujan Hajra, Economic
and Political Weekly, November 30, 2002

A NEW DEPOSIT INSURANCE SYSTEM?

In order to keep the cooperative banks out of the scope of the DICGC and to bring about a
separate deposit insurance scheme for these banks, a few preconditions need to be met and
addressed in this context. Firstly, it is important to answer whether creation of a separate deposit
insurance scheme for cooperatives is in line with objectives of public policy. Secondly, in order
for certain type of financial companies to be brought under the system of deposit insurance,
certain preconditions need to be fulfilled and it is important to note whether these preconditions
are satisfactorily met by the cooperative banking sector.
Protection of small depositors is a well established objective of public policy 10 and cooperative
banks through primary agricultural credit societies, district central cooperative banks and state
cooperative banks more than fulfil the aforementioned objective. The above has also been
accepted as a common public policy objective for the establishment of deposit insurance systems
in most countries. 11
There are several preconditions for the establishment of a separate deposit insurance system for
cooperative banks. First, for making cooperative banks eligible for membership to a deposit
insurance system, it is essential that they be brought under effective prudential regulation and
supervision. Secondly, without strong norms and practices relating to transparency, deterrency
and accountability, introduction of deposit insurance system may in fact enhance rather than
reduce systemic instability of the underlying banking system. 12 It is crucial to initiate adequate
measures to meet the preconditions for deposit insurance system before extending such facilities
to cooperative banks.
10 The Reserve Bank of India 1951-1967, Balachandran, G (1998), Oxford University Press,
Delhi
11Guidance for Developing Effective Deposit Insurance Systems, Financial Stability Forum
(FSF) (2001),Basel

In order for an effective deposit insurance system to exist in India, there are certain prerequisites
which should be adhered to. Firstly, membership of the deposit insurance system should be made
compulsory for all cooperative banks under this scheme. However, if certain cooperative banks
do not meet certain conditions required for membership in terms of asset classification,
accounting and provisioning norms, there should be an option for them to be rejected
membership of the new deposit insurance system. Also, an upper limit should be placed on the
amount of premium payable by banks seeking membership. Furthermore, as one of the primary
reasons for the establishment of a new deposit insurance system was the inequality between
payment of premium and the actual level of risk per bank. Thus, a system of risk-based premium
structure for this new deposit insurance system is another prerequisite. Lastly, a specific target
for the deposit insurance fund should be fixed, which should be built from the proceeds of
premium payments within a specified time period. The quantum of this fund should be linked to
deposit base, which is insured by the deposit insurance system. It is also important that in order
to establish a new deposit insurance specifically targeting cooperative banks depositors need to
be educated about the difference between good and bad banks. Depositors in cooperative
banks being mainly farmers and other small depositors, this education is an essential requirement
as depositors need to be protected at all levels i.e. not only after their deposits have been made in
cooperative banks, but also prior to this stage. Vigilance by the depositors about the business
conduct of banks is an important aspect of market discipline, which banks are subject to. Setting
up of a deposit insurance system for cooperative banks without educating depositors is likely to
enhance negative externalities associated with deposit insurance system. It is important to realise
that no deposit insurance system can effectively protect the interests of small depositors if the
underlying banks are not strong and they do not conduct their business within the regulatory
norms.
Arguments against the introduction of a new deposit insurance system for cooperatives focussed
on the fact that tentative calculations showed that a risk-based premium structure would entail
significantly higher payments by cooperative banks.13 A solution to the above could involve
reduction of the amount of insurance coverage provided to cooperative banks. The current limit
12 Deposit Insurance around the Globe: Where Does it Work?Demirguc-Kunt, A and E J Kane
(2001): , World Bank, mimeo.

on deposit insurance coverage is almost equal to five times of the per capita gross domestic
product of India. As compared with many countries, even among the emerging market
economies, this is on the higher side. Furthermore, since one of the major public policy
objectives for installing deposit insurance system is to safeguard the interests of small depositors
this reduction is unlikely to hamper their interest.14

13 Deposit Insurance for Cooperative Banks : Is There A Road Ahead?, Sujan Hajra, Economic
and Political Weekly, November 30, 2002
14 Deposit Insurance for Cooperative Banks : Is There A Road Ahead?, Sujan Hajra, Economic
and Political Weekly, November 30, 2002

CONCLUSION
We have analysed over the course of this project how the deposit insurance scheme in India, the
Deposit Insurance and Credit Guarantee Corporation, has applied to a variety of banks across the
country. Predominantly, the focus was on commercial banks and cooperative banks. We noticed
the stark differences between how these banks are established, run and to what class of society
they cater. A deep rooted analysis of the application of the DICGC to commercial and
cooperative banks was done and it was understood how the application of the prevailing deposit
insurance system in India may not be ideal. By looking at statistical figures presented over time,
it was noticed as to how the existing system of a standard premium rate for all banks registered
under the DICGC Act may not be a fair and justifiable measure as all banks would not garner the
same return from the premium paid by them. It was suggested that a risk-based premium be
introduced in order to integrate the deposit insurance system in our economy in a more justifiable
manner. Apart from clear subsidisation of premium payments of cooperative banks by
commercial banks, the present arrangement is threatening the viability of the deposit insurance
system in India. Deposit insurance system is an important component of the safety net for the
banking sector. Given the high systemic risk posed by the clubbing of cooperative and
commercial banks within a unified deposit insurance system, there is an impending need to take
out the cooperative banks from the scope of deposit insurance system for commercial banks.
Thus, after establishing that the current system wherein both commercial banks and cooperative
banks are placed under the same deposit insurance system is not viable, the feasibility of a
separate deposit insurance system for cooperative banks was considered and analysed. A new
deposit insurance system for cooperative banks would require adherence to certain objectives of
public policy while on the other hand it would also have to satisfy certain prerequisites to entail
the introduction of a new deposit insurance system. While also analysing arguments against the
establishment of a new deposit insurance system for cooperatives, it is concluded here that the

overall benefit for the setting up of a new deposit insurance system for cooperatives would be, on
the whole, more than the negatives arising out of such a system. Thus, there should be reforms
introduced under the DICGC Act prevailing in India.

BIBLIOGRAPHY
Articles Referred:

Banking Structure in India The Way Forward, Discussion Paper, August 2013
Deposit Insurance around the Globe: Where Does it Work?Demirguc-Kunt, A and E J

Kane (2001): , World Bank, mimeo

Deposit Insurance for Cooperative Banks : Is There A Road Ahead?, Sujan Hajra,

Economic and Political Weekly, November 30, 2002

Deposit Insurance:A Survey of Actual and Best Practices Garcia, G G H (1999): , IMF

Working Paper, No WP/99/54.

Guidance for Developing Effective Deposit Insurance Systems, Financial Stability
Forum (FSF) (2001),Basel

Websites Referred:

http://shodhganga.inflibnet.ac.in/bitstream/10603/1106/9/09_chapter%203.pdf

(last

accessed : 1 September 2013)

http://shodhganga.inflibnet.ac.in/bitstream/10603/2031/11/11_chapter%202.pdf

(last

accessed : 1 September 2013)

http://www.dicgc.org.in/English/AU_Profile.html (last accessed : 1 September 2013)
http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=29405 (last accessed : 1
September 2013)