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Amendment to deposit insurance and credit guarantee: Paving path towards risk-free real return?


The risk-free fixed deposits route of investment does not seem too attractive considering the minuscule interest rates offered by large banks and the uncertain nature of higher returns found in cooperative and small finance banking segment. However, the recent amendment raises hope to find a worriless and frictionless path towards risk-free real return.

Saving for rainy day

Saving a fraction of one’s earnings has always been a part of human wisdom, be it in the form of food grains by the earlier civilizations or money by the contemporary ones. As the world bank data suggests, gross domestic savings in India evolved from a mere ~6% of GDP in 1960 to peak of over 34% in 2007 and remained within sub- 30% range in the recent years1. Further, though it was sufficient to only nutritionally safeguard the commodity-based savings, the money-based saving demands more as it could be usurped by not so clearly visible force of inflation, leaving lesser than necessary to get by the rain.

Inflation and reduction in purchasing power 

Money based saving preserves currency denomination and not the purchasing power, which is eroded by inflation. Consider a sum of Rs 100 at the beginning of year 2011 and its worth at the end of the decade.

Inflation and reduction in purchasing power – Rs 100 during last decade

A significant erosion of the purchasing power is apparent in the form of a loss of about half the value, with a saving of Rs 100 in 2011 could buy goods and services worth only Rs 54 in 2020.

Investment Return and Preservation of Purchasing Power

Surplus earnings engaged in unproductive avenues is always threatened by inflation, an issue tackled by the antidote of investment and return. Based on the inflation observed in India over the last decade, an annual return of 7 per cent could have ensured preservation of purchasing power and a certain real return too.

Countering Inflation with investment return: Rs 100 during last decade with inflation as well as investment return

As apparent, an annual return of 7% could have ensured purchasing power was retained with even a risk-proportionate real gain of ~7%.

Where is the Coveted 7% Risk-Free Return?

One could always head towards equity and fixed income – including peer to peer, chit funds and shady finance companies – and other riskier markets to attempt 7 per cent return on a consistent basis. However, given their uncertainty, fixed deposits have traditionally and reasonably been an avenue for risk-free investment. As of present, the interest rates offered on fixed deposits by larger Indian banks fail to reach the coveted 7 per cent to assure preservation of purchasing power and real gain.

 Fixed Deposit interest rates by largest banks in India

Bank Rate Decadal Real Return*
HDFC 5.50% -7.33
ICICI 5.50% -7.33
Punjab National Bank 5.25% 6.72
SBI 5.25% -9.50
Bank of Baroda 5.25% -9.50
Average 5.35% 6.72

*Assuming similar average decadal inflation as observed during the years 2011-2020.

#Highest Rates offered to general public subject to duration and amount limits. Interest rates for senior citizens are higher by average 0.25% – 0.8%. Even the highest interest rate of 6.3% offered to senior citizens would have barely managed to retain the purchasing power.

What about the Cooperative and Small Finance Banking Segment?

The interest rates offered on similar deposits by Cooperative and Small Finance banks appear to be materially higher, with a potential to preserve purchasing power over a decade, ceteris paribus.

 Interest Rates Offered by Cooperative and Small Finance Banks

Bank ROI for General Public ROI for Senior Citizens
The Janlaxmi Cooperative Bank Limited 7.50% 8.00%
Jain Cooperative Bank Limited 7.00% 7.25%
Nagar Urban Co-operative Bank Limited 7.00% 7.50%
Utkarsha Small Finance Bank 6.75% 7.25%
Jana Small Finance Bank 6.75% 7.25%
Average 7.00% 7.45%

Risky past of cooperative and small finance banking segment

The turmoil at the Punjab and Maharashtra Cooperative Bank raised significant concerns about the efficiency and solvency of cooperative and small finance banks. Though the issue is not just solvency, but also the concern that even the insured and guaranteed sums are non-accessible for unreasonably long period of time, creating unnecessary hassles, concerns and even disruptions in sustenance.

 Amendment to deposit insurance and credit guarantee

In response to the realization that such delays render the entire concept of insurance and guarantee meaningless, the Deposit Insurance and Credit Guarantee Corporation (Amendment) Act 2021 came into force on 1st September 2021. It is an attempt to ensure that depositors should be able to withdraw up to Rs 5 lakh within 90 days from the date of the central bank’s intervention in the forms of liquidation, license cancellation or restructuring announcement. For PMC Bank it means that depositors will be compensated – to the extent of lower of their actual deposits per separate account or Rs 5 lakhs – by 30th November 2021.

Risk elimination through tactful deposits

The deposit insurance and credit guarantee limit stands revised at INR 5 lakhs since February 2020, but a deeper analysis of the ‘letter and the spirit’ of the law indicates that the limit stands for principal and interest amount held in an account, and not by a depositor. In other words, by distributing deposits across different banks and/or account types a depositor could safeguard larger sums, as permitted by the regulations themselves.

Tactful deposits to preserve INR 25 lakh across the banking system

Bank  Account Beneficiary Account Type Fixed Deposit Amount Is Total Deposit Risk-free?
ABC Bank Mr. Investor Savings Account INR 5,00,000 Yes
ABC Bank Mr. Investor Joint Account with Mrs.

Investor (Mr. Investor Primary Account

Holder, Mrs. Investor Secondary)

INR 5,00,000 Yes, as this account at the same bank is separate from the

savings account in individual

capacity and the other joint

account

ABC Bank Mr. Investor Joint Account with Mrs.

Investor (Mrs. Investor

Primary Account

Holder, Mr. Investor Secondary)

INR 5,00,000 Yes, as this account at the same bank is separate from the

savings account in individual

capacity and the other joint

account

XYZ Bank Mr. Investor Savings Account INR 5,00,000 Yes
KBC Bank

 

Mr. Investor

 

Savings Account INR 5,00,000 Yes
    Total Amount INR 25,00,000 YES, each separate individual/joint account is

insured upto INR 5 lakhs,

assuring complete insurance of

INR 25 lakh deposited accordingly

 So, save for a rainy day! Ensure it is not washed away!

A higher as well as a certain avenue of return is an elusive aspiration, a reasonable expectation rather is to earn a proportionate return, which could even be done without significant default and liquidity risk too.

Visualization of State of INR100 invested at 7% annual return towards the end of decade 2021-30 (Real Purchasing Power)

Thus, within the cognizance of this basis risk-return framework, Deposit Insurance and Credit Guarantee Amendment Act does promise to pave a worriless and frictionless path toward risk-free real return, while being a ray of hope for distressed investors too.

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Disclaimer

Views expressed above are the author’s own.



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