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“ “ Deposit InsuranceDeposit Insurance ” ”

Introduction about deposit insuranceIntroduction about deposit insuranceProtection for your savings, in case your bank goes

burst.Deposit insurance aims to prevent them from panicking

and causing a bank run,and thereby reduces systemic risk

The downside of deposit insurance is that it creates a Moral Hazard

The state safety net could be shrunk,by splitting banks into 2 types: “ narrow bank ” , “Broad bank”

requiring every bank to finance a small proportion of its assets by selling subordinated debt to other institution.

HistoryHistory

Stabilize the financial systemEnhancing public confidence and systemic

stabilityIncrease saving and encourage economic

growth

BenefitBenefit

The pitfalls of Deposit insuranceThe pitfalls of Deposit insurance •Moral Hazard : By insulating depositors from defaults,deposit insurance reduces their incentive to monitor bank closely.Also banks can take greater risks, safe in the knowledge that there is a state-financed safety net to catch them if they fall.•Adverse Selection : occur when the weak institutions choose to join a voluntary system,while the strongest remain outside.•Agency problem : This problem can occur when an agent serves his own interest rather than those of the principal who employ him

providing consumer protection for small depositors

enabling small and new banks to compete with large and \ or state-owned banks

defining the boundaries of the government’s exposure to loss

require banks to contribute to the resolution of failed peers

ObjectiveObjective

The Deposit Insurance System’s The Deposit Insurance System’s Mandate : Private or PublicMandate : Private or Public

private run and entirely privately funded government-backed and run

Narrow Mandate Broad Mandate

The System’s MandateThe System’s Mandate : Narrow or Broad : Narrow or Broad

The Narrow MandateThe Narrow Mandate

insure small depositors in member institutions compensate insured depositors in failed member

institutions promptly to minimize disruption to the economy

setting and colleting premiumsmanaging the insurance fund in a way that allows

it to satisfy its obligations effectivelyinforming the public of its role and

responsibilities ,and describing how it works

The Broad MandateThe Broad Mandate

Monitors the condition of the banking industry to estimate its potential losses and take actions to minimize or forestall those looses

Take responsibility for the resolution of insured financial institutions that have been intervened by the supervisor’s authority

InfrastructureInfrastructure

Deposit insurance systems need to be supported by a strong infrastructure of civil and commercial law.

A clear understanding of their fiduciary responsibilities by bank owners and managers

Internationally accepted accounting and auditing standardsPublic disclosure of individual bank data The system also needs to be supports by a well-formulated

lender of last resort and adequate risk-management framework in the payment system.

Deposit Insurance System

Need To Be Supported By...

Supervision,Regulation,and ResolutionSupervision,Regulation,and Resolution

having the supervisory authorities for forcing the strict resolution of problem banks ,using a swift application of a spectum of enforcement actions to be taken as soon as a bank becomes undercapitalized or show sign of weekness.

requiring and enforcing capital requirements also protect deposit insurance system.

high deductible in property reluctant to take excessive risk.

The regulatory and supervisory system should

Supervision,Regulation,and ResolutionSupervision,Regulation,and Resolution

. restricting the insured bank to holding only safe assets

in Broad mandate,The supervisor needs authority to close and liquidate or resolve insolvent banks in some other incetivecompatible manner

The regulatory and supervisory system should (ต่�อ)

Requiring subordinated DebtRequiring subordinated Debt

Its holders are at the back of the queue for their money if the bank gets into trouble and they have no safety net

To sell its debt,the bank will have to persuade informed investors .If it cannot convince them it cannot operate

Requiring subordinated debt is feasible only for large publicly traded banks

All countries need a firm framework for the resolution of Troubled banks.If it does not already exist, the establishment of a system of deposit insurance provides an opportunity to design and enact a legal and institutional framework that will help authorities to intervene in troubled bank

Legal framework will help to avoid costly delaysBroad mandate case,the resolution framework should

require that the bank pass to the government-run deposit insurance agency for resolution immediately after it has been intervened by the supervisory authority.

A Framework for Resolving Individual banksA Framework for Resolving Individual banks

Deposit insurance is best suited for an economy with a relatively large number of banks operating according to the same rule

Deposit insurance is not suit for country which have

Country specifics

1 . size-that is,one or a few very large banks and some or many smalls ones2. ownweship – that is,a few dominant state-owned banks that may carry explicit or implicit guaruntees of all their deposits3 . soundness – that is , a few well managed and solvent banks togetherwith a significant number and share of insolvent and/or nonviable banks

Ownership:State-Owned BanksOwnership:State-Owned Banks

Government commonly institute a system of deposit insurance when there are a few,large state owned banks that have implicit guaruntees and a number of smaller or newly-chartered private banks.

These can help to build the system’s resources and somewhat redress the state institutions’ competitive advantage

FragilityFragility

Explicit deposit insurance should be installed when the banking system is sound

Countries are often impatient and reluctant to wait for this opportune time ,however deposit protection can prospone a banking debacle,but it is unlikely to prevent one

Some country may have more lefitimate reasons for starting a system of deposit insurance .

Deposit insurance can create incentive incompatibilities that weaken the banking system and make the cost of insurance prohibitive. Thus, a deposit protection system needs to be designed to provide a set of inducements to encourage all of the parties involved to act in ways that serve to strengthen the banking system

Avoiding Moral HazardAvoiding Moral Hazard

The steps that can be taken The steps that can be taken to contain Moral Hazardto contain Moral Hazard

Make the Deposit Insurance System Transparent : Transparency is essential because it allows bank customers to protect their interests

Define Deposits : Both the deposit insurance agency and institutions covered by that agency carry a responsibility to publicize which deposits are insured and which are not

Information for the Supervisor and the Deposit Insurance Agency : The supervisor needs accurate and timely information on the condition of each bank .

The deposit insurance authority with broad mandate needs to know the condition of banking industry in general and of weak institutions that mightimpose costs upon it so that it may plan for payouts and choose resolution strategies

Finding a way for the supervisor in a deposit insurance agency to share information and satisfy each agency’s specifics information needs is a challenge. However,the law should specify what information the deposit insuer is entitled to receive and what information the supervisor is obliged to convey promptly.

Disseminating Information : Supervisors will want to disseminate as much of their information as is competitively equitable to enable the public to protect its financial interests and help keep the banking system sound through market discipline.

Coverage : Which classes of depository institution should be required to join the system of deposit insurance , which financial instrument to cover , and to when extent to cover them

Which Institutions to cover? : A country may choose to institute a seperate scheme to cover such depository institutions .This scheme may offer lower coverage, or change higher premiums in order to cover the additional risks attendant on inferior prudential

Which Instrument to cover ? : Which instruments to cover by deposit insurance and the limits on, and exclusions from, coverage.

The type of deposits to be included, and establish that both principal and interest would be covered 1 ) Deposit insurance of all types that are dominated in domestic

currency , should be covered 2) Promissiory notes that are often tssued by finance companies

would be covered by the system if finance companies are allowed to join the scheme

3) Both principal and any accured interest that has not already been added to the principal would be coverd

4 ) For trust accounts, one person should be designated to represent the group,which would be entitled onle to coverage for a single person

5 ) Foreign currency deposit : where foreign currency deposits are widely used , and particularly ,The deposit insurance system may insure foreign currency deposit to promote financial stability

Which Instrument to Exclude ? : The exclusion of bearer instruments can be justified because it would be impossible to implement the required limitations on coverage

Other Nonessential Exclusions : The careful supervision cen prevent problems about insider who often receive special privileges

•Some countries exclude deposits carrying excessively high interest rates from coverage.

•The supervisor should deal with such problems rather than encumber the deposit insurance system with a supervisory responsibility.

Extent of Coverage : The deposit insurance scheme should be designed to protect small depositors .Excluding larger depositors to monitor the condition of their bank carefully.

Coverage for Each Deposit or each Depositor : Compensation should be paid up to the limit on the sum of depositor in any member institotion.

Amount of Coverage : The aggregate amount of coverage offered to each depositor in any bank should be relative low.

Coinsurance : Coinsurance has the advantage of assuring depositors of the prompt repayment of at least part of deposit.It is often run on a sliding scale,so that the depositror recover.

Should the Coverage limit be indexed to inflation ? The ideal situation is one where a country has low inflation

Netting Deposits Against Loans : When a depositor is also a debtor of the failed bank , his/her deposit should be netted against the loan. However, should not be offset a good borrower.

The insured parts of deposits of all kinds be netted against

•claims that have have already fallen due

•promised, but undelivered,subscription from shareholders

•damage assessments against owner and manager.

Reducing adverse selectionReducing adverse selection

Make membership compulsory

Risk adjustment premium

Make membership compulsory :Make membership compulsory :

membership in the system should be mandatory for all institution located in the country. Otherwise,only the weakest institution will join and the system will not be financially viable.

Risk- adjustment premium Risk- adjustment premium ::

The objective of risk adjusting premiums is to require riskier institutions that are more likely to call upon assistant from the deposit insurer to pay more coverage

- One straight forward method is to ask bank to pay premiums based on their risk adjusted asset,rather than on their deposit- A second approach is to charge lower premium to banks that have higher capital ratios and/or supervisory rating

Minimizing Agency ProblemMinimizing Agency Problem

1 ) Political interference : The agency need to be support by a clear legal and regulatory framework to limit political interference

2 ) Regulatory capture : is a situation where the deposit insurance agency serves the bans rather than the interst of the public problem arise only when a privately fund has government financial backing . It can be solve by having the government run the scheme even though , It is owned by the banks

To minimizing agency problem banking system should avoid these problems

Minimizing Agency ProblemMinimizing Agency Problem

3 ) Interagency friction : is a lack of cooperation between or within financial regulatory agency to remedy this problem,The objective and function of different financial authorities must be clarified.

Promoting CredibilityPromoting Credibility

The design of the deposit insurance agency can importantly influence its credibility. The agency should be design to be independent but accountable and have adequate management and staffing

Independence: Refer to status within the government and to freedom from political pressure and domination by the banking industry .

Accountability : the authorities must maintain its books and record a transparence way and be subject to the same audit rules as other public entity The records of a public deposit insurance agency must , therefore,be subject to published annual audit conducted by the Office of the Auditor General or its equivalent.

. Staffing : The propose deposit insurance agency could have a small staff in a country where there is not a large number of insure institution and failure are rare.

Public Relation: Such a program require that the deposit insurer issue publication that keep the public inform about coverage under the guarantee.

-The staff must be granted legal protection against lawsuits

-Staff would need analytical skill and high integrity

A financial issued that need to be resolved before setting up a system is “How to fund the system”.Resolving this issues will improve the financial position of the system and reduce its need to call on government resources for back up

Ensuring Financial IntegrityEnsuring Financial Integrity

There are 2 separate philosophies reguarding fund size

1 ) Aim to have a fund large enough to self sufficiently compensate when bank failure occur in a normal time.

2 ) Reduce fund size but only to a level that enable a system to borrow ,to pay depositor in failed bank.

Optimum fund size :

Start up Funding : A newly established system may receive initial contribution for bank/Central Bank / Government. Where are strong initially to foot the bill they should do so.

Ongoing Funding-Premium : Insurance fund would be accumulate and member would be required to pay premium at the rate of “ X ” percent per year based on total deposit

- Premium would be levied as needed to cover expenses and build, maintain or rebuild the fund to its target level

Deposit Preference : Giving depositors and / or the insurance fund preference over the assets of the failed bank increases their share in the value recovered and reduces the fund’s net outlays , while increasing the share of losses borne by others .– The choice between granting priority and not

granting it is judgement call. Yhe choice would be influenced by an assessment of the balance between a fiscal need and deposit insurance system efficiency in recoveries.

Managing Fund Assets : Another defense of the fund is to invest fund resources wisely.

When investing fund resources :– Should be in vested in government securities.– Should determine the most appropriate maturity.– Sholud have market interest on the fund and safety– Even government paper may not always be

sufficiently liquid insurance system may wish to invest in government securities abroad

Back-up Funding : It could have a government guarantee,a right to borrow without limit from the treasury/the national debt office,ihe central bank ,or from the market.

The Government Guaruntee : The following points should be considered when a government guaruntees the deposit insurance agency:

• The fund may need a government guarantee to be credible with the public.

• The agency should have the power to borrow according to rules but wiyhout any limit on the amount needed to restore its viability from the treasury/debt agency or the central bank and issue bonds and notes in the markets.

• The government’s guaranteeof the deposit insurance system would ensure that any central bank liquidity support is repaid

• Agency would need to seek prior approval ( From the ministry of finance and central bank ) regarding the timing of borrowing from the markets

• The agency should have the authority to impose special ,additional ,ex pose assessment on all member institutions,as need ; for example,to repay borrowed funds.

Case study : GermanyCase study : Germany

The German Deposit Insurance System

– The German banking system: Large share of public and cooperative bank

– The German traditionallly been universal banks doing both commercial and investment banking and serving both household and firms

General Characteristics of German deposit insurance schemes

There are 3 major deposit insurance schemes in Germany

Establish under political pressureOrganization & administration has been private

from the beginningEach of 3 main German bank groups has its own

deposit insurance schemeOffset the competitive advantage that the saving

bank has due to their public ownership

General Characteristics of German deposit insurance schemes

Saving banks and cooperative bank group has both regional and national insurance schemes

The schemes of both saving and cooperative banks do not directly guarantee deposits, but rather the institution themselves

All 3 bank groups have their own auditing entities and work closely with the Federal Banking Supervisory Office and the Budesbank

Bundesbank is prohibited by law to act as lender of last resort for the deposit insurance schemes. It is rater expected that in the case of a systemic crisis, a political solution will be found without this case being predictable

MembershipMembership

Voluntary but compulsory for all members of the German Bank Assosiation

Although membership is Voluntary, non-participating banks face high barriers

Member of a deposit insurance scheme cannot use their membership for advertisement purposes

Non – member has to post the fact that it I s not a member in its General Terms and condition and in the schedule of prices displayed in the banking hall and on the application forms for opening an account

All non bank deposit are covered up to a limit of 30 % of liable capital of troubled institution

Given that minimum capital for a bank the minimum limit is 1.5 million Euro

Given that average equity size of a commercial bank is 295.6 Euro ,the average limit is around 90 miilion Euro

It is very high limits make the coverage almost complete

Coverage

Fiananed exclusively by member bannks and on a mixed ex-ante and expost basis

Member bank have to pay premium of 0.03% of “liabilities to other creditor arising from banking business” every year

Additional payment of 0.09 % for new membersBanks that have paid for more than 20 years and are

classified in the lowest risk category (A), can be exempted from premium payment

FinancingFinancing

Banks that are classified as higher risk (B or C) are required to pay an additional premium of up to250% of the regular premium.

Available fund are not publicly knowNo public fundingThe Bundesbank is prevented by the

Bundesbank act to function as lender of last resort

FinancingFinancing

Organized within the German Bank Association

Under management by –laws of private association.

No public supervisionFlexible in terns of how it assists a

troubled bank

Management Management

AuditingAuditing All member banks have to be member of the Auditing

Association of German Banks, that audits and classifies banks on a yearly basis

Cannot be used in advertisingClassification criteria are the financial situation and

quality of managementThe Auditing Association of German Banks can impose

corrective actions on the member banks if there are circumstance that increase the riskiness of the bank’s bussiness or other circumstances that violate the banking act or other laws referring to bank business

Germany EU US World Average

Explicit Yes Yes 1 68 countries

Coverage Imit 30% of equity 20000 ECU 100000 USD 3 per capita GDPเท"าCoinsurance No 10% No 17 out of 68 countries

have co-insurance

Foreign Currency Yes can be Yes Covered in 48 out of

Doposits Covered? exculded 68 countries

Interbank Deposits No No Yes Covered in 18 out of

Covered? 68 countries

Funding Funded,but Not Funded 58 out of 68 countries

additional regulated have funded schemes

funds callable

Source of Funding Banks only Not Joint Private: 15 Joint: 51

regulated Public :1

Management Private Not Public Private: 11 Joint: 24

regulated Public :33

Memership Voluntary Compulsory Compulsory Compulsory in 55 out

of 68 countries

Risk Adjusted Premiums Yes Not Yes 21 out of 68 countries

regulated have risk - adjusted

Premiums

Case study : FDICCase study : FDIC

The Federal Deposit Insurance Corporation (FDIC) preserves and promotes public confidence in the U.S. financial system by identifying, monitoring and addressing risks to the deposit insurance funds; and by limiting the effect on the economy and the financial system when a bank or thrift institution fails

. The start of FDIC insurance on January 1, 1934

It is funded by premiums that banks and thrift institutions pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities.

Savings, checking and other deposit accounts, when combined, are generally insured up to $100,000 per depositor in each bank or thrift the FDIC insures.

The FDIC insures deposits only. The FDIC is the primary federal regulator of banks that

are chartered by the states that do not join the Federal Reserve System. In addition, the FDIC is the back-up supervisor for the remaining insured banks and thrift institutions.

To protect insured depositors, the FDIC responds immediately when a bank or thrift institution fails. Institutions generally are closed by their chartering authority

The FDIC has several options for resolving institution failures, but the one most used is to sell deposits and loans of the failed institution to another institution.

Insured banks also pay the FDIC money four times a year to keep being insured.

The money the FDIC collects from banks is put into two different accounts: The Bank Insurance Fund, and the Savings Association Insurance Fund, or BIF and SAIF for short.

Issues for ReformIssues for Reform

Merge BIF and SAIFReduce statutory Restrictions on PremiumsRelaxing the Reserve Ratio Regime to

Allow Gradual Adjustments in PremiumsModify the Rebates SystemIndexing Ceiling on the Coverage of

Insured Deposits

The End