Deposit Insurance Hikes – Stop The Panic-Driven Cycle

Every bank crisis in India seems to trigger the same predictable response — a clamour for raising deposit insurance limits. It’s an understandable reflex, especially when small depositors fear for their life savings. But like most reactionary measures, it’s neither optimal nor sustainable.

The Reserve Bank of India’s recent intervention at the New India Cooperative Bank has once again revived calls for a higher deposit insurance ceiling. The Finance Ministry is reportedly considering raising the current ₹500,000 limit. At the same time, the All India Reserve Bank Employees Association has floated the idea that the government should cover the additional deposit insurance premiums if the limit is raised.

That would effectively shift the cost of insuring private deposits onto the taxpayer — a distortion that chips away at the basic risk-reward balance between depositors, banks, and regulators.

India’s last deposit insurance hike — from ₹100,000 to ₹500,000 — came after the Punjab and Maharashtra Cooperative Bank collapse. At the time, it was hard to argue against it. After all, the limit had been frozen since 1993, even as the economy and average savings multiplied many times over. But increasing the limit again, just five years later, following another cooperative bank failure, raises a bigger question — why does India lack a precise, rule-based mechanism for adjusting deposit insurance limits in the first place?

It’s also important to recognise that both the Punjab and Maharashtra Cooperative Bank collapse and the current crisis at the New India Cooperative Bank stem from alleged frauds committed by the banks’ own management. When bank failures are driven by outright misconduct rather than poor business decisions or external shocks, the optics of reactively raising deposit insurance limits become far more problematic.

At the heart of this issue is the tension between depositor protection and moral hazard. Data from the Deposit Insurance and Credit Guarantee Corporation shows that at ₹500,000, about 97.8% of all deposit accounts are fully insured. In value terms, 43.1% of all deposits sit within the insured limit.

That tells us most small savers — the people deposit insurance is meant to protect — are already covered. Raising the limit further mainly benefits wealthier depositors and businesses that deliberately chose to park large sums in banks chasing slightly higher returns.

The New India Cooperative Bank case makes this clear. More than 90% of its 130,000 depositors already fall within the existing ₹500,000 cover. Raising the limit would mostly protect a thin layer of larger depositors — many of whom knowingly placed their money in a cooperative bank for better rates, fully aware that these banks come with weaker governance and higher risk.

 

That brings us to the larger, and more uncomfortable, question — should the government and RBI really guarantee every rupee, regardless of the risks depositors willingly took? If all deposits are implicitly guaranteed, what’s left to nudge savers to choose safer, better-run banks over those offering higher rates?

The moral hazard extends to the banks themselves. Knowing that deposits are fully protected, smaller banks — particularly cooperative ones — face weaker market discipline. Lending standards slip when banks no longer fear a depositor flight. The flat-rate premium system India uses only worsens this — cooperative banks pay the same premium rate as systemically important lenders. Effectively, stronger banks end up cross-subsidising weaker ones.

India needs to break this cycle. Raising deposit insurance isn’t the problem — the absence of a framework is. Linking deposit insurance limits to inflation, median deposit size, or per capita income would make coverage predictable and credible, rather than being driven by each new crisis.

There’s also a strong case for tiered premiums, where riskier banks with weaker governance pay more for coverage. That would encourage better risk management and put a price on mismanagement — instead of relying on stronger banks to prop up the weakest.

Could India also explore supplemental deposit insurance, like the US? There, banks can offer excess insurance options to large depositors, paid for by the depositor, not the state. As of now, Indian depositors have no direct access to the Deposit Insurance and Credit Guarantee Corporation — it’s the banks that interact with the insurer.

As India’s economy matures, there will likely be appetite for more sophisticated financial products. Offering high-value depositors the option to purchase additional coverage could spur innovation in financial engineering, giving wealthier depositors the flexibility to protect their money while keeping it within the banking system.

Deposit insurance was never meant to be a blanket guarantee. If India wants a healthier, more responsible banking system, it’s time to rethink deposit insurance as a safety net — not a political tool to calm the public every time a bank falters.