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SBP working on deposit insurance scheme

February 29, 2004

KARACHI, Feb 28: With 80 per cent of banking taken over by the private sector, the State Bank is working on a scheme to provide risk insurance to depositors.

When all local banks were nationalized in the early 1970s, the state-run units had a market share of 80-85 per cent. Under the Banks Nationalization Act, security of depositors was guaranteed by the government. In major privatized banks that dominate the market, the safety net is now gone.

Normally, the banks also enjoy implicit support as governments intervene to prevent a banking system meltdown.

Not long ago, the State Bank intervened to bring about mergers of NDFC, a state-run DFI, and Merhran Bank, a private outfit, into the National Bank of Pakistan. It has encouraged development financial institutions to take over weak banks which may more appropriately be described as a bail out.

The banking system has also been strengthened by the central bank's policy to have "fewer but stronger banks" and to encourage universal banking.

Now, the regulators are trying to develop deposit insurance scheme. An official of the World Bank was here last week to update the central bank on product designs and the conceptual framework.

Deposit insurance is a complex and complicated issue with no professional consensus on related issues. The central bank is trying to evolve a scheme that would be home-grown. Once the proposals have been formulated, comments and suggestions of all the stakeholders will be invited before finalizing the scheme.

Incidentally, there is no consultative process to reach the depositors whose money is to be protected.

In a presentation before commercial bankers on global experience in deposit insurance, World Bank Advisor on Financial Sector Operations and Policy Ms Asli Demirguc-Kunt observed that not all countries have opted for deposit insurance schemes.

In all, 68 countries have deposit insurance of which 30 are in Europe, about a dozen in Asia and 10-12 in Africa with a wide range of product designs and experiences which can be shared. Since 1980s, more and more banks have adopted deposit insurance schemes. It has been the outcome of financial liberalization. Previously, the role of banks was restricted by regulatory authorities. So were the risks. Institutional arrangements differ from country to country. Deposit insurance schemes are run by the government, corporates or joint ventures with banks, which have normally more intricate knowledge of their business risks and bank fragility. What the world bank official emphasized is that the insurance body should be independent. It should not be subject to political abuse.

Even, the deposit insurance premium is not charged on a uniform basis. Initially, the premium was charged on flat rate but late comers in the business linked the premium to various levels of risks of individual banks. Compulsory membership of the deposit insurance is applied universally to both good and bad companies.

Ms Asli says in case of flat rates, small banks with greater risks benefit. The good banks pay for the bad banks.

A key issue is who pays for the insurance cover. Of course the depositors, say the bankers, unless there is a tough competition among bankers. A rare occurrence.

Currently, banks are awash with surplus money that has brought the interest rates to the lowest ever levels for the government and corporate borrowers and that gives a negative return to the depositors in the face of rising inflation.

In such a situation, would it be fair to ask depositors to pay for insurance premium ? Depositors are now subjected to wide-ranging penalty for keeping cash balances in their accounts below prescribed limits that are arbitrarily set.

Finally, consumer banking will mortgage future incomes/savings of depositors on which the banks will get much better returns compared with lending to the corporates and government.

Finance capital is fragile, the banking system is facing risks, instability and threat of moral hazards. The World Bank study on global experience of 40 crises shows that those countries which had strong institutions, good design products and strong regulatory body were able to give positive outcome. Blanket deposit insurance scheme accentuated the crises.