Deposit Insurance Risks: Lessons from Cooperative Bank Failures

Recent actions by the Reserve Bank of India (RBI) against cooperative banks, particularly the moratorium on New India Cooperative Bank, have underscored significant vulnerabilities within India’s deposit insurance system. Despite cooperative banks only contributing a small fraction of the total deposit insurance premium, they account for a disproportionate share of claims, raising concerns about governance, oversight, and the overall stability of this financial segment.

1. Disproportionate Claims from Cooperative Banks

Since its establishment, the DICGC has disbursed over Rs 16,326 crore to depositors, with a staggering Rs 10,670.4 crore attributed to claims from liquidated cooperative banks. This stark contrast to the mere Rs 295.9 crore paid for claims from commercial banks raises alarms about the stability of cooperative banks.

2. Governance Challenges

Cooperative banks operate under a fragmented regulatory framework, where the RBI and state authorities share oversight responsibilities. This dual control often leads to ineffective governance, as many board members lack banking expertise, resulting in an over-reliance on managers. Political appointments further complicate the issue, undermining the effectiveness of governance structures.

3. Market Share vs. Insured Deposits

Despite representing only 2.5% of the total deposit market share, cooperative banks hold nearly 8% of insured deposits. This discrepancy indicates a tendency among depositors to keep their funds within the DICGC’s insurance limit of Rs 5 lakh, reflecting a lack of confidence in the stability of these banks.

4. Rising Claims and Premiums

In the fiscal year 2023-24, DICGC collected Rs 23,879 crore in premiums, with commercial banks contributing 94.4% of this amount. The share of insured deposits to total deposits was highest for cooperative banks at 63.2%, showcasing a reliance on the insurance safety net. The claims settled by DICGC rose significantly, increasing from Rs 751.8 crore in 2022-23 to Rs 1,436.9 crore in 2023-24, all stemming from cooperative banks.

5. Historical Context of Failures

The recent moratorium on New India Cooperative Bank is part of a troubling trend, as seen in the notable failures of Punjab and Maharashtra Cooperative Bank and Sri Guru Raghavendra Sahakara Bank. These incidents illustrate the systemic risks associated with cooperative banks, particularly when they engage in risky lending practices without proper security.

At last we can say that, The situation surrounding cooperative banks in India reveals a pressing need for improved governance and regulatory oversight. As these institutions continue to pose risks within the deposit insurance framework, both depositors and regulators must remain vigilant. Strengthening the management and oversight of cooperative banks could help mitigate future risks, ensuring greater stability in the financial system. The ongoing challenges highlight the importance of addressing the governance issues that plague cooperative banks to protect depositors and maintain confidence in the banking sector.