Management of Deposit Insurance Fund : Indian Experience.

Management of Deposit Insurance Fund : Indian Experience

IADI ARC Meeting and International Conference, Goa , India : 18-20 January, 2010

Presentation Outline

1. About DICGC Funds

2. Adequacy

3. Management

4. Governance

5. Taxation

6.Conclusion

Indian Experience


The Oldest Pay Box in the World

Snapshot - As on 30 September 2009

Fund (Actuarial Liability) 18.17 0.39

Surplus 157.48 3.35

Total 175.65 3.74

Insurable Deposits 40,182.40 854.94

Insured Deposits 22,570.45 480.22

Fund / Reserve Ratio 0.78 % 0.78 %

INR Billion U$D Billion

No. of Insured Banks No. of Deposit A/Cs A/Cs fully Protected

2,287(Commercial 169 + Coops 2118

1.35 billion 1.20 billion

U$D 1= INR 47

About


DI Fund Features

A Single DI Fund – Advance funded @ Flat Rate

Covers liquidation, amalgamations, reconstructions, compromise schemes

Explicit back-stop for DIF is insignificant

Actuarially determined liability sequestered as a part of DIF

No dividend pay-out / operating expenditure charges

In case of liquidation of DICGC – DIF Assets: To insured banks in proportion of premium paid

Other Assets: To Reserve Bank of India

DICGC

Deposit Insurance Fund

Credit Guarantee Fund

General Fund

Three Balance Sheets

About


DIF - Source and Application

Source Application1. By Premium

(including interest / penalty for delayed remittance)1. To Settlement of Insured Deposit Claims

2. By Investment Earnings

3. By Share in Recovery by Liquidators

4. By Transfer from Credit Guarantee Fund 2. To Transfer to Credit Guarantee Fund*

5. By Advance from CGF / GF* 3. To Repayment of Advance from CGF / GF*

6. By Advance from RBI* 4. To Repayment of Advance from RBI*

* Scarcely used 5. To Staff and other expenses*

Fund Back up from RBI (India’s Central Bank) pegged at originally fixed INR 50 Million as against currently achieved DIF of INR 175.65 Billion.

About


1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

0.00

10.00

20.00

30.00

40.00

50.00OthersRecoveryInvestment ReturnsHalf Yearly Premium

INR Billion

DIF – Contributors to Gross RevenueAbout


DIF – Disposal of Gross Revenue

Consolidated for 10 years period 1999-00 to 2008-09 (in INR Billions)

39.24

81.59

5.67

103.9

To Net D I ClaimsTo Accumulated Surplus (DI Fund)

17 %

35 %

3 %

45 %

INR Billion

To Net Income Tax

To Investment Depreciations

About


Pay Box Trident on Fund

DI Fund

Assessment Deposits understated ?

Claims submitted by liquidators not overstated ?

Is recovery and its sharing with DICGC just ?

Dir

ect a

nd In

dire

ct T

ools

About

Tackled

Tackled

Being Tackled

2.96

26.88 29.84

1.21 2.143.35

Claims PaidRecovered

Since 1962

INR Billion

41 % 8 % 11 %

Comm. Coop All


Relevance of Reserve RatioFund Adequacy

No Hard / Soft Target Reserve Ratio Prescribed

Numerator Bias

Denominator Bias

Free Surpluses are the major component

The capital not counted – available in case of need.

Actuarial Liability counted as part of Reserve

Year Capital (INR)

1961: 10 Million

1972: 15 Million

1973: 100 Million

1981: 150 Million

1984: 500 Million

Estimation Error – Depositor-wise Aggregation

Reporting Error –Coverage & quality of reporting

Time Lag –Insurable Deposit Vs. Insured Deposit

‘Going Concern’ prejudice – Back Testing Results

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

60657075808590

Reported IDR Observed IDR

Insured Deposit Ratio : Back Testing for Coop Banks

%

Standard Deviation of 12.41


Actuarial Liability - DIF

Actuarial Liability = PV of Claim Outflows - PV of Earnings Inflows

Broad Assumptions Claims restricted to the current insured deposits till projected maturity.

Year-end deposits go down by 20% each year cumulatively on reducing balance basis.

The ratio of Insured deposits to insurable deposits is basis for projections fund flows.

Premium, Interest and Tax rates are the current rates.

Claim Rates based on historical bank mortality married with forward looking supervisory indicators.

Margin of adverse variation in rates and margin for adverse claim ratio are factored in.

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

1

3

5

7

9

11

13

15Actuarial Fund Net Claims

(INR Billions)

Actuarial Fund Back Testing

Fund Adequacy


Fund / Reserve Ratio

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

30

50

70

90

110

130

150

170

0.50%

0.55%

0.60%

0.65%

0.70%

0.75%

0.80%

0.85%

0.90%

Fund Size

RR (Actuarially Ad-justed)

Reserve Ratio (RR)

Fund Size(INR billion)

Fund Ratio(Percent)

Fund Adequacy


Category-wise Loss Distribution

State Bank Group

Public Sector Banks

Regional Rural Banks

Foreign Banks

Local Area Banks

Private Banks

Coop Banks Total0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%DIF > Insured Deposits (Of each bank)Insured Deposit Ratio

93 % of Insurable De-posit

7 % of Insurable Deposits

Historical Mortality Risk

Too Big To Save ?

Fund Adequacy

Residual ‘tail’ risk well-covered


Deposits Demography

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-095000

100001500020000250003000035000

Insurable DepositInsured Deposit

INR Bil-lionINR Bil-lion

CAGR 16.09 %

CAGR 19.11 %

Deposits Growth

Fund Viability

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-090%

10%20%30%40%50%60%70%80%90%

100%

Insured Deposits RatioFully Protected Accounts Ratio

Fund Adequacy


Multi-factor Stress Testing

A Member of Financial Stability Unit (FSU) set up by RBI

Deposit Insurance Fund

Increased Bank Failures

Increased Cover

Premium Hike

Tax Exemption

Recapitalization by RBI

Fund Adequacy


Recent Topical Initiatives Fund Adequacy

Move to Risk Sensitive Premium (2008)

Making Actuarial Evaluation more forward looking (2009)

RBI panel recommendation for Emergency Fund Facility for Urban Coops under Industry Support Agreement (ISA) for short & medium term (2009) - contributing interest-bearing 0.05 % of assets to a Fund (not DICGC)

Increase in Premium

DICGC assisted merger policy for legacy weak coop banks (2009)

2005 0.10 %

2004 0.08 %

1993 0.05 %

1971 0.04 %

1962 0.05 %


Risk Management Framework

Liability and Assets Perspective of DICGC

Risk Identification and Measurement

Current Risk and Investment Policy

Risk Management Framework - Review

Interest Rate Risk Management

Choice of Planning Period

Cash Flow Matching & Investment Categorization

Surplus maximization & Return Management

Policy of Rebalancing

Fund Management

Liability Driven Investments (LDI)


Investment Policy Structure

Purpose / Scope of Policy

Investment Objectives

Investment Processes

Investment Accounting / Valuation

Reporting and Reviewing

Authorized InvestmentsInvestment CommitteeDelegation of AuthorityStandard of PrudencePortfolio StrategiesCounterpartiesDealing through Brokers

Fund Management

ONLY CENTRAL GOVT SECURITIES


Investment Approach

C. Maximization of Returns

A. Man

agin

g Dep

osit

Insu

ranc

e Fun

d B. Maintenance of orderly cash flow

Principal Protection ?

Viability of Fund established ?

Within Acceptable level of Risk

No Target Returns

Meeting liabilities within defined planning period.

An ALM / Structural Liquidity Approach Strategies

Tool Kits

Benchmarks

Reviews

Fund Management


Tools & Benchmarking Fund Management

Portfolio approach - tracking of an ‘All Sovereign Bond Index’

Duration ± Leeway Targeting

‘Tracking Error’ monitored

Virtual tranching of portfolio in to ‘core’ & ‘current’ dynamically.

‘Market Risk’ - Higher of ‘Standardized Duration Method’ and ‘VaR Method’

Time Weighted Return (TWR)

Close watch on portfolio Duration and corresponding re-balancingMain Constraints

Single asset class held on fully-invested

basis

Few money market instrument permissible

Both cash flow liquidity and market liquidity

Well-nigh absence of back –up funding

facility


Total Returns Route

2004-05 2005-06 2006-07 2007-08 2008-09

-5

-3

-1

1

3

5

7

9

11

13

3.493.98 3.91

5.04 5.34

-4.55

3.97

5.17 5.27

13.09

-2.96

2.452.77

6.60

10.10

-2.68

4.57

6.01

9.00

12.55T-Bills IndexLiquid Bond IndexAll Sovereign Bond IndexDICGC (DIF) Portfolio

Fund Management

All Index of Clearing Corporation of India (CCIL)

%


Transparency & DisclosuresFund Governance

Expressly precluded from taking speculative position Day-to-day audit of treasury transactions and procedures by external concurrent auditors

Daily Performance Dash Board before the CEO

Monthly Review by Investment Committee

Quarterly structured review by Audit Committee and Board

Annual Statutory Audit by independent auditors and certification

Face / Book / Market Value of investments disclosed on-balance sheet

Significant Accounting Policy disclosure as per Indian GAAP

Disclosures about Repo / Reverse Repo transactions

Trades on Order Matching System and settlement through CCP.

Direct member of RTGS


Potential Impact of IFRS on Fund SizeFund Governance

Industry Specific Guidance may need to evolve at country level

Change in value between trade and settlement day to be recognized

Appropriate classification of Investments

Fair Value Measurements

Realized / Unrealized losses / gains in investments

Inventory accounting method may change taxable income

Transaction Costs Accounting

Threshold of Contingent Liabilities

Consolidation of Funds under control

Risk Management Disclosure

Risk Reporting


Investment Value Buffer

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

30

50

70

90

110

130

150

170Investment Reserve + Investment Fluctuation ResreveDI Fund (Actuarial + Surplus)Investments Book ValueInvestments Market Value

INR Billions INR Billions

Fund Governance


Jury is Out

Active or Passive Management ?

Trading Portfolio ?

Asset Class Diversification ?

More risk management instruments ?

Best method for credit lines / back-stops ?

Governance Angle – Arms length from the Central Bank

Legal Authority for New products / avenues

Fund Governance

Flexing Fund Muscle in the Market - Risks

Market Signaling

Depositors Perception

Shallow G-Sec Market

Book profit vs. Return


Canons of Taxation on Fund

Exempt from Income Tax between 1962 and 1987 (25 years)

Now, Among top 10 Corporate Tax Payers in India

Taxed like any mercantile company - no special status for premiums

Demand of Service Tax on par with non-life insurance diffused

Substantial amounts locked up in dispute with Tax Authorities

Premium being tax deductible in the insured bank’s hands, cost impact is less in case of profit making banks compared to loss making banks

Fund build-up during non-crisis time thwarted by higher tax liabilities

Pay Box mandate compounds inability for tax planning

Taxation


Fund build-up in non-crisis time

Year Gross DI Claims Tax Liabilities provided for

1999-00 6.35

27.36

0.76

12.96

2000-01 5.55 1.69

2001-02 4.45 2.67

2002-03 1.63 5.79

2003-04 9.38 2.03

2004-05 10.01

27.06

3.23

55.56

2005-06 2.94 10.99

2006-07 3.23 13.56

2007-08 1.80 14.92

2008-09 9.09 12.85

Total 54.43 68.51

Taxation

INR Billions

Premium @

0.05 %

0.10%


Changed financial systems dynamics -revisit of the public policy objectives and mandate for effective DI funding in India.

Weak recoveries with category-wise, region-wise skewedness do not align with core principles and is a major bane to fund recycling.

Reserve Ratio : A necessary but not sufficient measure of DIF adequacy. Both numerator and denominator warrant more country-specific ‘culturing’.

Inadequacy Mitigation - Favourable Credit Deposit (CD) Ratio , good Capital Adequacy, High Provision Coverage Ratio (PCR) etc. In Indian banking system

Litmus Tests -Fund survival of failure of the insured bank with largest liability ; severe scenario of failures, short of systemic failure of the banking system.

Framework for India specific denominator option based on loss distribution is still in search of a model in view of heterogeneity in Indian Banking.

Conclusions (1/2)


Conclusions (2/2)

The banking consolidation buzz should reckon de-‘tailed’ ’ loss distribution for DIF.

Fund Management still treated as a non-core DI function. Deposit Insurer’s investments need evolution as a body of specialized knowledge.

Market Risk to DIF is a major concern. Optimizing Holding Period Return after addressing the claim liabilities may be way to go regardless of accounting results.

Co-ordination of pay-box with bank supervisors key to LDI and better tax management. Categorization of investments should be tax efficient .

With absolute ‘mutuality’ / ‘Industry Capital ‘ nature of DIF, tax-exempted premium should be logical choice. A pay-box should not be treated as a ‘low hanging fruit’.


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Management of Deposit Insurance Fund : Indian Experience.

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