RBI proposes to bring risk-based deposit insurance premiums, plans to implement Basel III norms

The Reserve Bank of India (RBI) on Wednesday, October 1, proposed four key reforms for India’s banking sector aimed at enhancing its resilience and competitiveness.

Under the proposal, announced by RBI Governor Sanjay Malhotra, banks will move from the existing flat-rate deposit insurance premium to a risk-based system, where banks with higher ratings will pay lower premiums. This is being done to incentivise better risk management and strengthen financial stability in India.

The safer banks with better risk management could potentially pass on lower insurance costs to customers. As this would make riskier banks pay more in premiums, it could encourage banks to operate more safely and reduce the overall chances of bank failures.

In the long run, this can lead to a more trustworthy banking system with enhanced transparency.

Other banking reforms

The RBI also proposed implementing the Expected Credit Loss (ECL) provisioning framework with prudential floors to all scheduled commercial banks, excluding Small Finance Banks, Payment Banks and Regional Rural Banks, and All India Financial Institutions (AIFIs) starting from April 1, 2027.

This means that banks will have to set money aside in advance before issuing loans, on the basis of expected losses from borrowers who might default, to ensure that they are always financially prepared. This would make banks more financially resilient, reducing the risk of bank failures.

RBI is also planning to introduce updated Basel III capital adequacy norms for commercial banks from April 2027. A draft on a standardised approach for credit risk will be issued by the central bank soon.

Base III norms are international rules that tell banks how much capital they must hold to stay safe. The RBI is planning to adopt updated Basel III rules for commercial banks, which will include a standardised approach for credit risk, setting guidelines for how banks calculate the risks of different loans.

As per the proposal, loans to safer sectors, like MSMEs (small businesses) and residential real estate/home loans, will be considered less risky and given lower risk weights. This means banks will need to hold less capital against these loans when compared to riskier loans.

The RBI has also finalised guidelines on how banks can invest and manage different types of business activities. Earlier, banks were restricted from doing similar businesses as their group companies. However, under the central bank’s proposal, this restriction has been removed.

Now, bank boards can decide which businesses to run based on their strategies. This will offer greater flexibility to banks in business planning and investment.

“These measures align our regulatory framework with international standards, adapted to India’s national priorities, and strengthen capital adequacy for banks and financial institutions,” the RBI said.

Governor Malhotra said that these reforms are expected to ensure effective risk management, promote responsible lending and provide greater flexibility to banks, offering increased protection to depositors.

These reforms were announced, alongside the RBI’s policy decision to keep the repo rate unchanged at 5.5% and retain the neutral stance. This is the second consecutive Monetary Policy Committee meeting in which the central bank has maintained the status quo.