A draft deposit protection fund bill, prepared by the State Bank of Pakistan, provides compensation for loss to depositors in case an insured commercial bank fails to meet its obligations.

However, missing in the broad parameters of the DPF is the definition of ‘protected deposit’ which needs to be included to make it more effective.

Perhaps, the authorities were not pushed so far for establishing a separate deposit protection institution due to Sec 58(2) of the Banking Companies Ordinance 1962 which accorded priority payment to every depositor of the banking company a sum of one hundred thousand rupees or the balance at his credit, whichever is less. There was added comfort from Sec 5 (4) of the Banks (Nationalisation) Act, 1974 which guarantees safety of bank deposits by the federal government. The DPF Act willsubstitute the protection now available.

The DPF is to compensate the depositors for losses incurred by them to the extent of protected deposits in the event of failure of a ‘member’ —a banking company or a financial institution— which may be notified and required to pay premium to it under the provisions of this Act. All scheduled banks, unless, exempted by the DPF board, shall compulsorily be DPF members and liable to pay the prescribed premium.

Regardless of the number and size of various deposits, the DPF shall provide protection up to an amount determined by it from time to time. The protected amount shall be inclusive of any interest accrued or return due as on the notification date by the SBP to the effect that normal operations of a member has been closed or suspended as a result of its insolvency or any judicial or regulatory action.

The DPF has no role in the issue of such notification or monitoring and supervision of the scheduled banks, for which the SBP is solely responsible. As and when the SBP declares a protected institution as a failed institution, DPF will come into play.

It is feared that if there is delay in issue of notification or proper regulation and supervision of such a protected bank,, the depositors may blame the central bank for loss of their deposits in excess of the protected deposits. The respective roles of DPF and the SBP may be further reviewed to avoid such complications in future.

The DPF shall pay the liabilities of the failed institution to its depositors up to the amount protected and the DPF shall owe no interest on these amounts. The maximum amount of deposit protected under Section 58(2/3) of the Banking companies Ordinance, 1962 is Rs100,000. The DPF may consider revising this amount upwards after thorough analysis of existing deposits of which at least 90 per cent should be fully protected.

The Act mentions a number of exceptions to the protected deposits by persons such as: (a) persons who have been granted preferential interest or return by the bank in deviation from the announced terms and conditions; (b) members of the board of directors and senior management of a bank including chief executive officer and key executives; (c) partners of auditing firms responsible to certify the bank’s financial statements; (d) persons having acquired rights to a deposit after the SBP notification regarding closure or suspension of bank’s operations; (e) spouse, dependent lineal ascendants and descendants and dependent brothers and sisters of persons specified in items (b), (c) and (d) above; (f) any bank whose deposits are in its name and on its account; and (g) government or government institutions. Also, protected deposits shall not cover deposits arising out of or related to transactions or actions constituting money laundering.

The exceptions particularly those specified in items (b), (c), (d) and (e) in the preceding paragraph may be not be easy to be administered by DPF/SBP. The board, chief executive and key executives of the bank as well as the partners of the auditing firms may not like exemptions of their respective deposits from the protected deposits. In case such persons open their personal accounts with other protected banks, this may give a wrong impression about their own bank.

The draft Act provides that the general superintendence, direction and management of the affairs and business of DPF and overall policy making in respect of its operations shall vest in the board which shall consist of the following five members: (a) a SBP deputy governor nominated by the SBP; (b) Three members appointed by the SBP central board, and (c) managing director. DPF will be a fully owned corporation of the SBP.

The scheduled banks are sitting smug due to existing deposit protection in the Banking Companies Ordinance, 1962 and there is no demand to enforce deposit insurance. They presently are not paying any premium or fee for protection. Enforcement of the DPF Act will oblige them to pay the premium and to comply with other requirements. There is potential for dispute on matters such as the determination of deposit amount and the premium due on such deposits from the protected bank. There should be a provision and forum for the resolution of such disputes.

Presently, the SBP is working with the government for major revision in applicable laws, namely the draft Banking Act and the draft Banking Companies Act. For financial stability purposes it is considered appropriate that application of DPF may wait for enactment of the relevant laws and prudential regulations which may be revised due to banking debt trouble in many countries.