Post-SVB, Government Should Allow Depositors To Seek Better Insurance Coverage By Paying For It

The collapse of Silicon Valley Bank (SVB) and Signature Bank has not led to any panic among depositors largely because the US Federal Reserve and the Treasury Department effectively guaranteed the money of all depositors.

Legally, though, only $250,000 per account is insured.

While this decision to return everybody’s deposits may have stemmed an immediate crisis in the financial system, it has actually opened up a moral hazard: in future, all depositors and banks will presume that Uncle Sam will step in to save their deposits, no matter how badly the bank manages their money. 

In India, the Deposit Insurance and Credit Guarantee Corporation (DICGC) insures deposits upto Rs 5 lakh with any one bank (including deposits in all branches maintained by the same entities or individuals), but you can improve your deposit coverage if you maintain separate deposits with multiple banks.

You get Rs 5 lakh coverage for total deposits held with each bank separately. But branches of the same bank do not get separate insurance cover beyond Rs 5 lakh even if you hold multiple deposits.

For savers, it makes sense to distribute their deposits among three or four banks, with at least one of those banks being a state-owned bank where there is an implicit sovereign guarantee.

This may be cumbersome, but it is the least risky way to hold your retirement corpuses.

Clearly, there ought to be a better way to insure large deposits.

Two suggestions are worth making.

First, there is no reason why individual depositors should not pay additional premiums to the DICGC or a new private insurer of deposits to protect higher sums.

A new law to make this possible is worth attempting, not just in India, but the US too.

Even under current law, the DICGC is empowered to charge higher premiums from banks (especially cooperative banks) which may have a riskier profile.

While banks pay 12 paise for every Rs 100 insured, the corporation can charge up to 15 paise from some banks.

There is no reason why individual deposits cannot be insured for higher sums, if the depositor is willing to accept this charge.

Second, even where depositors are unwilling to pay this additional premium, they should have access to the underlying assets of the bank in case of liquidation, especially when those underlying assets are sovereign assets.

For example, most of Silicon Valley Bank’s losses stemmed from asset-liability mismatches, where the deposit money was invested in long-dated US Treasury stocks, which lost value when the Fed started raising interest rates.

In India too, banks have to compulsorily invest in cash reserve ratio (CRR) and statutory liquidity ratio (SLR), both of which add up to nearly 25 per cent of deposits for most banks.

Here’s the point: even for uninsured deposits, there is no reason why the underlying sovereign assets should not directly be assigned to the depositor in proportion to his deposits without the bank being liquidated first.

If depositors get their share of CRR/SLR funds in the form of government securities credited to their names, they may well not mind the lower market prices of their bonds since on maturity they will get the full face value from redemption proceeds.

Protecting depositors from bank failures is important for greater confidence in the system.

The two alternatives above may help prevent any bank or depositor from presuming that bank deposits carry no risk.