Insuring public deposits

THE Central Bank last week announced a scheme to insure public deposits held in licensed banks and finance companies. The move is mandatory and is effective from 1 October. Deposit insurance systems are one component of a financial system safety net that promotes financial stability. In that context the scheme is long overdue and hence it is welcome.

The Central Bank assured it a long time ago; but given the complexities as well as its importance perhaps it took a longer time.

Named Sri Lanka Deposit Insurance Scheme (SLDIS), it is made legal under the provisions of the Monetary Law Act. The Initial capital of the SLDIS is Rs. 1.1 billion which funds would be provided by the Central Bank.

All deposits excluding deposits of member banks and finance companies, the Government of Sri Lanka, shareholders, directors, key management personnel, other related parties, deposits held as collateral against any accommodation granted, deposits falling within the meaning of ‘abandoned property’ in terms of the Banking Act and dormant accounts in terms of the Finance Companies Act, will be considered as eligible deposits under the scheme

According to the SLDIS, in the event the licence or registration of a member institution is suspended or cancelled by the Monetary Board, depositors will be compensated up to a maximum of Rs. 200,000 per depositor.  While member banks and finance companies will participate in this scheme on a mandatory basis from 1 October 2010, depositors will be entitled to benefits after 1 January 2012.

The premium to be levied on eligible deposits will range between 0.10% and 0.15% per annum and will be required to be paid by member institutions on a monthly/quarterly basis. Such premia will be credited to a Deposit Insurance Fund which will be operated and managed by the Monetary Board of the Central Bank. However, such Deposit Insurance Fund will be distinctly separate from the Central Bank, and its liability will be limited to the extent of the Fund balance.

Insurance schemes for deposits are prevalent in most countries and it is unfortunate that Sri Lanka did not have one for some time. Even after the collapse of Mercantile Credit and HPT about two decades ago, and the lessons learnt subsequently successive governments and the monetary authorities were slow to act. Collective failure by all concerned to efficiently carve out an effective scheme until last week had cost innocent depositors dearly later on, as several other financial services organisations also collapsed or defaulted.

A part of the blame for this could be attributed to the reluctance on the part of financial institutions to contribute to the scheme. There had also been differences of opinion between the more sound banks versus the weaker and the larger versus smaller.

Successive governments despite their so called welfarist slogans, also failed to walk the talk by setting aside seed capital for a fund or absorbing the cost of a small insurance premium. However these governments were quick to tax withdrawals made by a customer from his/her account. At the same time, some banks themselves made hefty profits though they were stingy to contribute to a deposit insurance scheme. There were also arguments to the effect that it was the responsibility of the regulatory authorities to ensure the soundness of financial institutions that accept deposits from the public, rather than banks themselves being asked to contribute.

In its statement announcing the deposit insurance scheme, the Central Bank was quick to stress that with the implementation of the Scheme, public confidence will be enhanced; interests of small depositors with low financial literacy will be safeguarded; savings among small scale depositors will be encouraged; unauthorised deposit taking activities will be discouraged; and the commitment of the Government in the case of failure of a financial institution will be reduced.

Whilst the scheme is ‘a better late than never’ strategy, the regulator cannot go back to hibernation on the foolish notion that public deposits are now insured and hence all is fine. Globally detractors of deposit insurance have claimed that the scheme introduces a moral hazard issue, encouraging both depositors and banks to take on excessive risks.  Experts have also emphasised that the deposit insurance scheme should not be viewed as a substitute for adequate regulation and supervision, or as a panacea for problems in the banking sector which may emerge from time to time. Whilst strengthening the stability of the financial system must be persisted upon with much vigour and finesse, the Central Bank also needs to remain ever vigilant as well as effective in ensuring soundness and viability of deposit taking institutions by requiring them to adhere to best practices in corporate governance and risk management.