In a setbacks to depositors of the Punjab and Maharashtra Cooperative (PMC) Bank, the Reserve Bank of India, in its proposed plan to merge the bank with Unity Small Finance Bank Ltd (USFB), has imposed multiple restrictions on access to deposits at- above Rs 5 lakh that depositors can receive from the Deposit Insurance and Credit Guarantee Company (DICGC). In addition, no interest will be payable on interest-bearing deposits in the transferring bank (PMC Bank) for five years.

The RBI, however, invited until December 10 the suggestions and objections of members, depositors and other creditors of the transferring bank and the beneficiary bank (USFB).

What is the scheme?

The scheme of arrangement states that depositors of PMC Bank will receive up to Rs 5 lakh (depending on their account balance) from DICGC in accordance with the rules. However, those with higher deposits in PMC Bank will face restrictions. Retail depositors will have access to additional amounts of up to Rs 50,000 after two years from the date set, up to Rs 1 lakh at the end of the third year, up to Rs 3 lakh after four years and up to Rs 5.5 lakh after five years.

Beyond that, they will not receive any amount for the next four years. It is only after 10 years that they will receive the rest of their deposit.

What are the restrictions on interest?

After March 31, 2021, no interest will accrue on any interest-bearing deposit with the transferring bank for five years. Regarding the balance of any current account or any other non-interest bearing account, no interest will be due. Interest of 2.75% per annum will be paid on the retail deposits of the transferring bank, which will remain in circulation after five years from the date fixed.

What happens to the other deposits?

From the fixed date, 80% of the uninsured deposits outstanding to the credit of each institutional depositor of the transferring bank will be converted into perpetual non-cumulative preferred shares (PNCPS) of the USFB with a dividend of 1% per annum payable annually. . After 10 years, the beneficiary bank may consider additional benefits for these PNCPS holders, either in the form of an increase in the coupon rate, or a call option, after approval by the RBI.

The remaining 20% ​​of institutional deposits will be converted into USFB stock warrants at a price of Rs 1 per warrant. These will also be converted into shares of USFB at the time of the initial public offering.

For any other liability of the transferring bank, USFB will only pay principal amounts, as they become due, to creditors under agreements made between them before the date fixed.

What happened at PMC Bank?

Following the detection of fraud, in September 2019, inspections showed complete erosion of capital and substantial erosion of the bank’s deposits. The RBI issued “all inclusive instructions” to the bank under Section 35A read with Section 56 of the Banking Regulation Act, 1949 (10 of 1949) with effect as of the close of business on September 23 2019 to protect the interests of depositors. He also replaced the bank’s board of directors on September 23, 2019 and appointed a director in its place. RBI then decided to prepare a merger scheme.

In February 2021, Centrum Financial Services Ltd as promoters, along with Resilient Innovation Pvt. Ltd as a “co-investor”, has expressed interest in acquiring PMC Bank through an appropriate merger program with a new small finance bank to be registered. On October 12, the RBI licensed USFB Ltd, and it started doing business from November 1. USFB was established with a capital of around Rs 1,100 crore, with provisions for a further injection of capital.

What does this mean for term deposits?

Unlike investors in stocks and bonds, bank depositors benefit from the highest levels of security on their funds. However, there is an element of risk: if the bank collapses, there may be a delay in repaying their FDs, they may not be able to withdraw beyond Rs 5 lakh, or they may face depreciation in some cases. Lately, depositors have struggled to immediately access their funds in PMC, Yes Bank and Lakshmi Vilas Bank.

As the RBI imposes withdrawal restrictions to have time to develop a resolution plan for the failing bank, it can undermine depositors’ confidence in the banking system. To ensure the safety of funds, a depositor with, say, Rs 15 lakh can park Rs 5 lakh each in three banks, providing full security to the total amount. For those with higher deposits, it is better to put the money in the big banks, as they usually have a more effective risk culture.

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What about deposit insurance?

Currently, in the unlikely event of bank failure, a depositor can claim a maximum of Rs 5 lakh per account as insurance coverage. Coverage is provided by the DICGC. Depositors with more than Rs 5 lakh have no legal recourse to recover funds if a bank collapses. Deposits in public and private sector banks, local banks, small financial banks, regional rural banks, cooperative banks, Indian branches of foreign banks, and payment banks are all insured by DICGC. The premium is paid by the banks to the DICGC and should not be passed on to the depositors. Banks currently pay a minimum of 12 paise on each deposit worth Rs 100 to DICGC as a premium for insurance coverage.

Last year the government increased the amount of insurance to Rs 5 lakh from Rs 1 lakh.