The Deposit Protection Corporation Bill-2016 was finally passed by the Senate unanimously on 17th June, 2016. The Bill was moved in the house by Minister for Law and Justice Zahid Hamid on behalf of Minister for Finance Ishaq Dar and was aimed to ensure an effective banking system in the country.
According to the statement of objects and reasons, deposit insurance was considered an integral safety-net to ensure the soundness of the banking system and protect small depositors of a bank in case of its failure.
The Deposit Protection Corporation (DPC) will be a fully-owned subsidiary of the State Bank and ensure the soundness of the banking system. It was emphasised that this arrangement will yield maximum synergy and cost-saving due to the close co-ordination of the DPC with the SBP’s supervisory functions and resources.
The establishment of such an institution in the country was of course long overdue. While most of the other countries had this arrangement in place, Pakistan could not institute the necessary safeguards to protect the depositors of the banks in case a deposit taking institution failed and was unable to honour the repayment of its liabilities.
This was despite the fact that the banking system in Pakistan was now mostly private-owned subsequent to the privatisation of the dominant state-owned institutions and the entry of new banks. The share of public sector banks had dropped from 92 percent in 1990 to 19 percent in March, 2015 but the legal framework, originally promulgated for nationalised banks, had not kept pace with this development.
While the deposits of all state-owned banks were protected through government guarantees at the time of nationalisation, denationalisation coupled with the entry of new banks had left the safety of deposits to an arbitrary and implicit depositors’ protection thought to be provided by the government and the SBP.
The Bill is justified on grounds that the existing system of implicit deposit protection creates a huge moral hazard. In order to reduce this moral hazard and to protect small depositors, it was proposed to introduce an explicit depositor insurance scheme to compensate the depositors up to a prescribed limited amount in case of a bank’s failure.
While we fully agree with the aims and objectives of the Bill to establish an insurance cover to protect the depositors, it is hard to say that the question of moral hazard would be fully settled or overcome through this measure.
It is true that small depositors need to be protected due to a highly negative impact on their lives in case of their bank’s failure but the cost of insurance to be paid has to be borne by either the State Bank or the government.
This means that the burden of expenditure in both the cases would fall on the budget which has to be paid by taxpayers who were not at all involved in the bank’s operations or its failure.
It may be mentioned that State Bank’s profits are also credited into the federal government’s account. Anyhow, banks’ failures in Pakistan have been few and far between which means that a lower burden on the budget could be expected.
Since the depositors could have more faith in the soundness of the banking system due to the guarantees of repayment provided by the new Bill, the deposits of the banks could increase to a certain extent, helping the banking system to extend more credit and play a greater role in the economy of the country.
It would, nevertheless, be advisable for the SBP to improve its monitoring standard of banks so that the probability of a bank’s failure and the cost of insurance cover remain low.