How does deposit protection work in banks?

Knowledge:

MAS Team | 10 July 2020

Did you know that your bank deposits are guaranteed for safety against risk events for an amount up to Rs.5 lakh? If a bank undergoes severe stress and is likely to fold, in such situations an account holders deposits up to Rs.5 lakh are insured by the Deposit Insurance and Credit Guarantee cover.

The DICG cover is applicable to all commercial banks, including branches of foreign banks functioning in India, local area banks and regional rural banks.

The insurance cover is also extended to all the state, central and primary co-operative banks which have the amendments to allow RBI to intervene, wind up or supersede its management. This includes all co-operative banks. Primary co-operative societies are not covered.

But it is worth knowing how the insurance cover works, so that you can accordingly plan your bank accounts.

Part 1: Determining Ownership of Accounts

A bank will first try to aggregate accounts with the same type of ownership across all its branches before deposit insurance is determined. If the funds are in different types of ownership or are deposited into separate banks they would then be separately insured.

Ownership here means bank accounts opened as individual, as a partner of a firm, as guardian for someone, as director of a company, jointly etc. Each of these is a distinct type of ownership even though the beneficial owner is the same person.

Even in the case of joint accounts, the bank will insure accounts based on the order of the names in the joint account. So a joint account in the order of A, B and C and another joint account of B, A and C will be considered separately for the insurance cover.

Exceptions are there as well. An account opened in the name of proprietary concern where the individual is the sole proprietor, such accounts will be clubbed with the individual’s own account in his/her own capacity for insurance cover.

Accounts under same ownership at different branches of the same bank will be aggregated for the insurance cover.

Pro tip: If you want to transact with only one bank, then consider opening accounts in different types of ownership, as individual, jointly with spouse or as guardian for minor son. If not possible, then open account with two or more different banks.

Part 2 – Aggregating all accounts under owner

Once the ownership is determined, all the current, savings, fixed deposits belonging to the owner are aggregated to determine the insurance cover for the account. This should alarm account holders who may have thought that their fixed deposits are separately insured from their savings account.

While having an equal amount of money in separate banks may not be efficient, as individuals tend to use bank accounts for various purposes, a solution here is to go with safer and larger banks for your major needs. And for small needs such as investments or anything else, then you may try the services of the smaller banks.

The purpose of DICG cover is not to take extra risks with your money. Although the bank guarantees the amount, it does take a while for that money to be paid to its liable depositors. The DICG cover is only paid two months after the troubled bank goes into liquidation, and the liquidator has calculated the claims liable to every bank account.

Liquidation is not the immediate resort in the event of a bank failure. There are other steps taken before, as liquidation is a strenuous process and usually loss making. The RBI has still not taken the troubled PMC bank to liquidation even after 10 months since its issues were known.

Thus, it is a good idea to assume that the bank may fail, and accordingly take steps. Also, you do not need to panic and open bank account with several banks. Having an account with two different banks, one being large and established, is adequate in terms of risk management.

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