Management of Deposit Insurance Fund - PowerPoint Presentation

1. Management of Deposit Insurance Fund : Indian Experience

2. Presentation Outline About DICGC Funds Adequacy Management Governance TaxationConclusion Indian Experience

3. The Oldest Pay Box in the WorldSnapshot - As on 30 September 2009Fund (Actuarial Liability)18.170.39Surplus157.483.35Total175.653.74Insurable Deposits40,182.40854.94Insured Deposits22,570.45480.22Fund / Reserve Ratio0.78 %0.78 % INR Billion U$D BillionNo. of Insured BanksNo. of Deposit A/CsA/Cs fully Protected2,287(Commercial 169 + Coops 21181.35 billion1.20 billionU$D 1= INR 47About

4. 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 IndiaThree Balance SheetsAbout

5. DIF - Source and Application SourceApplicationBy Premium (including interest / penalty for delayed remittance)1. To Settlement of Insured Deposit Claims2. By Investment Earnings3. By Share in Recovery by Liquidators4. 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 used5. 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

6. INR BillionDIF – Contributors to Gross RevenueAbout

7. DIF – Disposal of Gross RevenueConsolidated for 10 years period 1999-00 to 2008-09 (in INR Billions)To Net Income TaxTo Investment DepreciationsAbout

8. Pay Box Trident on FundDI Fund Assessment Deposits understated ?Claims submitted by liquidators not overstated ? Is recovery and its sharing with DICGC just ? Direct and Indirect Tools  AboutTackledTackledBeing TackledSince 1962INR Billion41 % 8 % 11 %Comm. Coop All

9. Relevance of Reserve RatioFund Adequacy No Hard / Soft Target Reserve Ratio PrescribedNumerator BiasDenominator Bias Free Surpluses are the major component The capital not counted – available in case of need. Actuarial Liability counted as part of ReserveYearCapital (INR)1961:10 Million1972:15 Million1973:100 Million1981:150 Million1984:500 Million Estimation Error – Depositor-wise Aggregation Reporting Error –Coverage & quality of reporting Time Lag –Insurable Deposit Vs. Insured Deposit ‘Going Concern’ prejudice – Back Testing ResultsInsured Deposit Ratio : Back Testing for Coop Banks%Standard Deviation of 12.41

10. Actuarial Liability - DIFActuarial Liability = PV of Claim Outflows - PV of Earnings InflowsBroad 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.(INR Billions)Actuarial Fund Back TestingFund Adequacy

11. Fund / Reserve RatioFund Size(INR billion)Fund Ratio(Percent)Fund Adequacy

12. Category-wise Loss DistributionHistorical Mortality RiskToo Big To Save ?Fund Adequacy Residual ‘tail’ risk well-covered

13. Deposits DemographyCAGR 19.11 %Deposits Growth Fund Viability Fund Adequacy

14. Multi-factor Stress TestingA Member of Financial Stability Unit (FSU) set up by RBI Deposit Insurance FundIncreased Bank FailuresIncreased CoverPremium HikeTax ExemptionRecapitalization by RBIFund Adequacy

15. 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 PremiumDICGC assisted merger policy for legacy weak coop banks (2009)20050.10 %20040.08 %19930.05 %19710.04 %19620.05 %

16. 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 RebalancingFund ManagementLiability Driven Investments (LDI)

17. Investment Policy Structure Purpose / Scope of Policy Investment Objectives Investment Processes Investment Accounting / Valuation Reporting and ReviewingAuthorized InvestmentsInvestment CommitteeDelegation of AuthorityStandard of PrudencePortfolio StrategiesCounterpartiesDealing through BrokersFund ManagementONLY CENTRAL GOVT SECURITIES

18. Investment ApproachC. Maximization of ReturnsA. Managing Deposit Insurance FundB. Maintenance of orderly cash flowPrincipal 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 ReviewsFund Management

19. 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

20. Total Returns RouteFund ManagementAll Index of Clearing Corporation of India (CCIL) %

21. 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

22. 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

23. Investment Value BufferINR BillionsINR BillionsFund Governance

24. 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 / avenuesFund GovernanceFlexing Fund Muscle in the Market - Risks Market Signaling Depositors Perception Shallow G-Sec Market Book profit vs. Return

25. 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

26. Fund build-up in non-crisis timeYear Gross DI ClaimsTax Liabilities provided for1999-006.3527.360.7612.962000-015.551.692001-024.452.672002-031.635.792003-049.382.032004-0510.0127.063.2355.562005-062.9410.992006-073.2313.562007-081.8014.922008-099.0912.85Total54.4368.51TaxationINR BillionsPremium @0.05 %0.10%

27. 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)

28. 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’.

29. Comments or Questions, Please Thank You for your valued attentionEmail: jkdash@rbi.org.inwww.dicgc.org.in