III A Survey of Deposit Insurance Practices
- G. Garcia
- Published Date:
- January 2000
A recent survey of 85 different systems of deposit protection found that of the 85, 67 countries offered an explicit, limited deposit insurance system in normal times (see Table A1 of the Statistical Appendix).46 They are the focus of the survey that follows.47 As Table 2 shows, four of the surveyed countries are in Africa, 10 are in Asia, 32 are in Europe, four are in the Middle East, and 17 are in the Americas.
|Sri Lanka||France||Romania||El Salvador|
|Taiwan Province of China||Germany||Slovak Rep.||Guatemala|
|Ireland||Ukraine||Trinidad & Tobago|
|Italy||United Kingdom||United States|
Year of Origin of Limited Deposit Insurance Systems
Although two of the three systems in the United States (one for commercial banks and the second for savings associations) were started in the 1930s, it was not until the 1960s that other countries began to adopt the deposit insurance systems that are still in existence.48 Eight schemes were initiated in the 1960s, and nine in the 1970s. As the incidence of banking crises escalated in the 1980s. 19 schemes were initiated during the decade. Thirty new limited systems commenced during the 1990s, as banking problems continued to escalate on all continents. (See Figure 2).
Figure 2.Decade of Origination of Explicit Deposit Insurance Systems
Source: IMF staff survey.
The survey, whose results are presented in the Statistical Appendix tables, will be used to throw some light on common practices. Later, the survey will also be used to examine the extent to which good practices have been adopted, and where they have been disregarded.50 It finds that countries are increasingly adopting provisions that temper incentive problems, but certain deficiencies remain in some instances.
The Deposit Insurance Agency: Role and Responsibilities
There are basically two models for the role and responsibilities of a deposit insurance agency. Under a narrow construction, the deposit insurance system’s obligation is to pay depositors of failed banks when instructed to do so by the appropriate authority, which is frequently the bank supervisor, and to acquire the funds by collecting premiums and building a fund or by imposing ex post assessments. The deposit insurance agency in 34 countries plays such a narrow role. The alternative model for the agency is much more comprehensive. The agency takes charge of failed banks and resolves them according to the country’s laws. The deposit insurance agency in 33 countries carries a broad range of responsibilities that often includes anticipating bank problems and resolving failed banks. The narrow construction dominates in Europe, but broader responsibilities are common in Asia and the Western Hemisphere. Moreover, a number of countries have recently broadened the role for their agencies or they are considering enlarging those responsibilities. None is known to be considering reducing that role.
Table A1 of the Statistical Appendix shows that, to avoid the problem of adverse selection, 62 of the systems surveyed are compulsory.51 Nevertheless, seven schemes are voluntary and three of the voluntary schemes (those in the Dominican Republic, Sri Lanka, and Switzerland) do not impose risk-adjusted premiums as an alternative means to combat adverse selection.52
While objectives are not investigated by the survey, they can sometimes be inferred from deposit insurance practices. For example, if the objective of the system is primarily to protect small depositors, a country is likely to include all institutions that are licensed to accept deposits (particularly, small deposits) from the public. To reduce unfairness to well-supervised institutions, the country makes an effort to oversee all insured institutions to the same strict standards. But, where a country is more interested in maintaining financial stability, it may confine membership to those classes of institution that it considers to have systemic importance. In this case, membership may be focused principally on commercial banks. There may also be subsidiary insurance schemes for smaller, or less systematically important groups of institutions, such as savings associations and credit cooperatives.
Table A2 of the Statistical Appendix examines these issues and finds that countries typically attempt to cover (in one or more insurance system) all institutions that take deposits. Confining coverage to licensed commercial banks tends to be the exception, not the general rule (column 2, Table A3). Countries typically require the branches and subsidiaries of foreign banks that are operating (taking small deposits) within a country to belong to the system (column 3, Table A2). Countries in the European Union may relax this requirement somewhat by granting exemptions to foreign institutions that are covered by their home system of deposit insurance, although they may allow them to join if coverage in the host country’s system is more generous than the home scheme. Country authorities typically see their responsibility to protect their citizens. Thus, they typically do not insure the deposits that domestic-banks take offshore (column 4, Table A2). The survey noted two exceptions to this general practice. The first covers countries of the European Union, which often offer coverage to customers of their banks anywhere within the European Union. The second exception is countries that are particularly dependent on foreign deposits and fear the impact of their loss on the domestic financial system.
Funding the Deposit Insurance System
Funding for the system of deposit insurance has to be adequate, and has to be seen by the public to be sufficient, if the system is to succeed in compensating depositors and maintaining public confidence. To this end, there are a number of issues to be addressed. They include whether (1) funding should be mainly private, but have public backing in emergencies: (2) the system should accumulate a fund or impose ex post levies: and (3) whether to give to depositors or the insurance system legal priority over the assets of the failed bank.
A deposit insurance system that is privately funded encourages bankers to keep their institutions sound. All but one of the 67 of the explicit, limited systems in the survey are privately funded by their member institutions. Only Chile offers an exception: its system is fully funded by the government.
As discussed in Section II, an underfunded scheme will prove to be an obstacle to closing failed banks and so may lead to costly forbearance.53 Countries usually decide that they want the government to back up a well-run system of deposit insurance that is met by unexpected demands on its resources and is in need of additional funds in order to carry out its responsibilities. Consequently, many countries make provisions for the government (preferably, but not always through the ministry of finance) to assist a depleted fund with loans. While 66 of the explicit, limited systems have private funding. 55 have access to public funding. Some have already received financial help from official sources to get the system started or to cope with a systemic banking crisis: others expect to obtain it when they need assistance (column 3, Table A3). To contain moral hazard among bankers, banks must be required to repay their loans, including those from the government.
The Canadian government goes further in requiring that the Canada Deposit Insurance Corporation (CDIC) pay a “credit enhancement fee” to the government when it borrows funds in the private markets. The rationale is that, as a Crown Corporation, the CDIC can borrow at a lower rate than it would if it were a private corporation. The fee covers the difference. Thus, when the CDIC borrows it pays a private market rate.
As mentioned in the discussion of good practices, a reticence to commit public funds would be understandable where a deposit insurance scheme is privately run because of potential conflicts of interest. The information in two of the tables in the Statistical Appendix (Tables A4 and A8) brings to light cases where such conflicts of interest may exist among ex post systems. The two tables show that seven of the privately administered ex post systems do have access to back-up funding from the government. In two other instances, however, the authorities explicitly deny that they offer backup funding. The situation is unspecified and unclear in the other three instances. Only one ex post system (in the Netherlands) is operated by the government.
Ex Post Schemes and Funded Deposit Insurance Schemes
A country has a choice between funding its system of deposit insurance ex ante by regularly charging premiums to member banks and accumulating them in a fund, or imposing a levy on surviving member institutions after a member bank fails. As shown in column 4 of Table A3, most (58) countries have opted for a funded system.
However, nine countries—Austria, Bahrain, Germany (for its private system). Gibraltar, Italy, Luxembourg, the Netherlands, Switzerland, and the United Kingdom—fund their systems solely or mainly by imposing a levy on members after a bank fails and its depositors need to be compensated. Export funding is more popular in Western Europe that elsewhere. That popularity is waning, however: Germany instituted a government-run funded scheme is 1998, France changed from an ex post to a funded system in 1999. Bahrain has draft legislation to fund its system, and Italy is reported to be considering switching to a funded system.
Contrasting Ex Post and Funded Deposit insurance Systems
Differences need not be inherent in the design of the two different forms of deposit insurance systems; but in practice, they exist. There are, in fact, a number of differences—some important—between funded and most ex post systems.54 First, five of the ex post schemes began in Europe in the late 1970s and early 1980s, which is earlier than many of the funded schemes.55 Second, ex post schemes were often initiated by groups of bankers seeking mutual protection, whereas funded insurance systems have more typically been sponsored by the government, third, seven of the ex post systems have remained both privately funded and administered. (Bahrain’s and Gibraltar’s privately funded systems are jointly administered.) Four of the ex post, privately administered schemes have government backing, however—a situation that presents potential conflicts of interest.
Funded schemes appear to be more rule-based and offer less discretion for the administrators and less uncertainty for those insured than ex post systems. The reason may be that ex post systems are privately run by their member institutions and they lack the authority of a government agency to promulgate and enforce rules. So, typically, private systems have not transparently specified members’ responsibilities regarding sharing the costs of compensating depositors. They also often lack backstop funding from the government: are limited in their roles and responsibilities: and, because they are privately run, have difficulty in obtaining information from the supervisor and the central bank. Given that good practices recommend transparency and sharing information, it is perhaps not surprising that most recently created systems have opted to build a government-sponsored fund.
One of the notable ambiguities in ex post systems concerns the base on which the insurance obligation is to be calculated. While four ex post countries base the insurance obligation on insured deposits and another uses total deposits, the base is less specific in Germany’s private schemes. Italy, the Netherlands, and Switzerland (Table A4).
One of the principal differences between ex post and funded systems is in the coverage they offer. Ex post schemes typically offer low coverage. For example, Austria, Luxembourg, the Netherlands, Switzerland, and Bahrain all offer coverage at less than per capita GDP (see Figure 1). Only Italy (at 5.5 times per capita GDP) and Germany’s private system offer coverage above the commonly used rule-of-thumb of twice per capita GDP. In addition. Austria (for business deposits). Gibraltar. Luxembourg, and the United Kingdom also impose a haircut on deposits under their systems of coinsurance.
There is likely to be a difficulty for a government-run central bank or supervisory agency to pass confidential information on financial condition of a member bank to a privately run bankers’ club that is operating an insurance system. Deposit Insurance staff in Argentina and France have explicitly mentioned this difficulty. Germany’s private system requires its members to be audited and classified by the Auditing Association of German Banks, which can impose disciplinary measures.
Guarding Fund Resources
Investing fund assets wisely will guard fund resources. The survey noted—in column 5 of Table A3—that many systems place their resources in domestic government securities. Some encourage investment in safe assets abroad. Unfortunately, a number of deposit insurance systems invest their funds in domestic banks, which places them in jeopardy.
Granting Depositors or the Deposit insurance System/Deposit insurance Agency Legal Priority
From their actions, half of the countries surveyed (where information was available) perceive the fiscal advantages of giving depositors priority over a failed bank’s assets to be more important than the incentive risks. The other half assess the balance differently. Table A3, column 6, shows that 31 of the countries surveyed gave legal priority to depositors or the deposit insurer, but 30 countries did not. In other countries, such as Hong Kong SAR and Malaysia, priority is/was used as a way to protect depositors without establishing a formal system. (Malaysia found legal priority insufficient on its own to maintain depositor confidence during the Asian crisis and also introduced an explicit full guarantee. Hong Kong SAR is considering introducing a limited system of deposit insurance.)56
Choosing When to Begin
A country must make an important decision regarding when to introduce a deposit insurance scheme. Beginning one too soon before the banking system has been strengthened can lead to risky behavior at weak banks that will lead to major expenditures in resolving failed banks and can cause the system to become insolvent. Yet, countries are often tempted to begin a limited, explicit system when a crisis is imminent or in progress in the mistaken belief that it will avoid or cure the crisis. Limited coverage will not prevent uninsured depositors from running to safer havens. Even without a systemic crisis but fearing runs, the authorities may consider setting the coverage rate high—perhaps too high.
If the public perceives that all banks are weak, there is a risk of a “flight from the system and from the currency” to banks abroad. Otherwise, there will be a flight “to quality” from weak banks to safer institutions within the country. Only full coverage can (but not necessarily will) counter flights to quality and from the currency. Thus, to initiate a limited deposit insurance system when there is a risk of deposit runs, is to invite such runs. Setting high, but limited, coverage does not resolve the dilemma. Not only may there be runs by those depositors who hold deposits above the limit; but politically, later reducing the coverage level in order to reduce moral hazard will prove very difficult.57 faced with a systemic crisis, a country has two main courses of action to avoid runs; retain its existing implicit guarantee; or institute a full, explicit, temporary guarantee. Questions concerning the placement of a full guarantee and its removal are addressed in more detail in Section IV.
Controlling Administrative Costs
Limiting administrative costs is an additional way to protect system resources. The staff may be kept small, but may be supplemented in emergencies by borrowing skilled employees from other agencies. The scheme (particularly a narrow system of deposit insurance) may also be managed by another agency, where it would remain largely dormant until needed. While the survey did not inquire systematically into such practices, column 6 of Table A8 of the Statistical Appendix provides some information on country practices with regard to running the deposit insurance scheme.
Setting a Target for the Fund
Many countries find it useful for the deposit insurance agency to set a target level for the fund (usually expressed as a percentage of total or insured deposits) that would allow it to attain and retain financial viability and avoid the financial deficiencies that lead to forbearance for troubled banks and/or insolvency of the fund. Private funding needs to be sufficient to meet all demands that can be expected to be placed upon it in normal times and in moderately adverse circumstances. When the insurance system is new, the target will be initially set after forecasting the income and expenses (including outlays to compensate depositors of failed banks) of the fund. The largest then provides an indication of the premiums that need to be set, and subsequently whether they should be reduced when the fund exceeds its target level, or raised to replenish a depleted fund. Setting an appropriate target demands a realistic assessment of the condition of the banking industry, the size and timing of the financial demands that are likely to be placed on the fund, the system’s ability to borrow when necessary, and the industry’s ability to pay the necessary premiums without prejudicing its profitability, solvency, and liquidity.58
Canada has adopted a different approach. It requires its system to estimate its future losses and to make provision for them. Such provisions form a part of the accumulated fund, which may not be sufficient to compensate depositors in the interval before the failed bank’s assets are sold. Should the CDIC need liquidity or underestimate the demands that are placed upon it, it can borrow from the markets or the government to supplement its small fund. This process involves partial reliance on ex post funding to repay the borrowed funds.
Column 2 of Table A4 shows that 29 countries (most of which have a funded system) maintain a target level for the fund, which is often expressed as a desirable percentage of insured deposits. Eight have explicitly not set a target. Gibraltar, Italy, and the United Kingdom have small targets for covering administrative expenses in their ex post schemes, but small size does not reflect on the adequacy of the capital resources of the system in these countries. The target in funded systems ranges from a low of 0.4 percent of all deposits in Poland to the very high levels of 20 percent of insured deposits in Kenya, and an unrealistically high 50 percent in Ecuador. The level of accumulation actually achieved by most countries falls below the targeted level. Funding deficiencies are not universal, however. Ukraine reports a healthy balance of 10 percent of insured deposits in its fund. Tanzania approximates the target for its fund, and the United States’ balance in its funds exceeds their targets. (Italy exceeded its low target for meeting administrative expenses until the fund recently became depleted by bank failures in the southern region). Figure 3 shows the varying targets to which countries aspire and the levels (expressed as a percentage of insured deposits) that they actually maintain.
Figure 3Insurance Fund Targets and Actual Levels Attained
Source: IMF staff survey.
The Premium Base
As deposits are the entity that is insured, most systems use deposits as the base on which to charge premiums or to calculate the levy needed to compensate depositors under ex post assessments. Charging premiums on all of the deposits that a bank holds is easier to administer than to charge selectively. Twenty-seven countries do so, but many consider charging premiums on categories of deposits that are not eligible for insurance inequitable. Thirty-six countries, therefore, low charges against insured deposits (Table A4. column 4).
Some systems (six) impose charges on the total value of deposits in those categories that are eligible for insurance. These are referred to as “insurable deposits” in Table A4. Seven others, such as Austria, Belgium, Canada, Guatemalam, Sweden, Peru, and Taiwan Province of China, go farther and charge only for the amount of deposits that would be compensated if the bank were to fail. That is, premiums are paid on the sum of deposits that lie below the limit of coverage. That amount is referred to as “amount covered” in Table A4.
The latter procedure is more equitable in that it avoids this cross-subsidization of insured deposits by noninsured deposits, but it can be much more difficult to administer. In many cases, the information available (for example, the English translation of a country’s deposit insurance law) was not sufficiently precise to determine whether premiums were charged on insured categories of deposits or only on the amount actually covered. These cases are listed as “insured deposits” in the table. Clearly, calculating correctly the amount of deposits actually insured involves knowing the size distribution of the deposits of each depositor in each insured bank. Not all countries collect the information necessary to make this calculation, especially on a regular basis.
A few countries use a base other than deposits. For example, Norway bases its charges on risk-adjusted assets. Poland charges premiums on deposits but sets an upper hound to those premiums that is based on risk-adjusted assets.
A scheme that relies on an accumulated fund will need to charge adequate premiums. Table A4 shows that 58 systems charge premiums at regular intervals. The size of the premium needed to maintain a healthy fund will depend on the current condition of the banking system and its future prospects. Premiums charged in 1999 ranged from a temporary zero percent of deposits for strong banks in the United States.59 and a regular low of 0.005 percent in Bangladesh, and a high of 2 percent in Venezuela, which has experienced severe banking problems in the mid–1990s (see Table A4 of the Statistical Appendix). Figure 4 shows a distribution of premiums by size, and deposit base. The mode of the distribution is 0.15 percent and the medium lies in the band between 0.2 an 0.3 percent.
Figure 4.Premiums on Total Deposits, Insurable Deposits, and Covered Deposits
Source: GDP per capita for 1999, World Economic Outlook
1Weighted by total deposits, IFS.
Without detailed knowledge of the condition of each country’s banking system and deposit insurance system, judging whether the premiums being charged are adequate to cover immediate outlays or to accumulate a fund sufficient to survive the next banking crisis is difficult. However, it is noticeable that the actual level of the accumulated fund falls well below its target level in one-third of the 29 countries that maintain a target, suggesting that premiums in these countries are not currently adequate to meet the needs they face. Moreover, lax accounting permits systems in some countries to report misleadingly healthy levels of accumulated resources.60 In addition, premiums in other countries that do not set a target may also be insufficient to cover the risks that the system faces.
Adjusting the premiums that banks pay for risk is conceptually a challenging process. In addition, there are at least two practical problems to risk-adjusting the premiums banks pay for the deposit guarantee. Solving these problems may be expected to elicit country-specific responses.
The first problem is accurately forecasting the degree of risk that a bank places on the fund—it is a skill that is currently undeveloped. Moreover, the risk premiums imposed by the deposit insurance agency need to be based on objective criteria so that they can be justified to the bank and the courts, should the bank challenge the ruling. Two popular candidates for inclusion in the calculation of a bank’s risk to the deposit insurance system are capital adequacy and supervisory rating. Some countries use one, some the other, while others, including the United States, combines capital adequacy and CAMELS rating into a composite measure. There are disadvantages to these measures, however. Capital adequacy, even when accurately measured, tends to be a lagging indicator of bank condition, and is also subject to manipulation through a bank’s system of loan classification and provisioning. Although supervisory ratings are kept confidential in most countries, they will be revealed if the bank’s annual accounts report the premium the bank is paying.61 An alternative, more direct approach to risk-adjustment (used by Norway. Poland, and Germany’s system for savings and cooperative banks) is to charge fiat-rate premiums on risk-adjusted assets instead of deposits, so that banks with less risky assets pay less for their insurance.62 This approach saves the banks some effort because they have already calculated the risk-adjusted assets in order to assess their capital adequacy. However, it may place undue emphasis on imprecisely measured risk-adjusted assets.
A number of other countries use a complex formula to assess risk (Argentina, Canada, Italy, Kazakhstan, Romania, and Taiwan Province of China). To retain confidentiality and track risk accurately, the calculation of the risk premium can be designed to be complex; yet there is a valid argument for simplicity, transparency, and accountability in premium setting. The just-mentioned characteristics may be desirable when the financial system is sound, but are unattainable when it is weak. Thus, countries may want to announce their intention to risk-adjust premiums and then set a timetable for successive stages of widening the premium band so that the banks have time to make complementary adjustments as they wish.
The second problem is that a degree of subsidy is inherent in insurance. If premiums were to precisely represent a bank’s risk to the fund, they would become prohibitively expensive for already weak institution’s. This observation reinforces the argument that the gradations in risk-adjustment should be introduced slowly, so that institutions can adapt their behavior over time by improving their management control practices in addition to reducing their risk exposure and thus the subsidy they are to receive from their stronger peers.
Given the difficulty in executing an equitable system of risk-adjusting premiums, a surprisingly large number of countries attempt to do so. The systems in 24 countries (Argentina, Canada, Colombia, Ecuador, El Salvador, Finland, France, Germany’s private system, Hungary, Italy, Kazakhstan, Macedonia, Mexico, Norway, Peru, Poland, Portugal, Romania, Sweden, Taiwan Province of China, Turkey, the United States, and its two Asian island protectorates—the Marshall Islands and Micronesia) currently set risk-adjusted insurance premiums (column 6, Table A4).63 This is a marked increase in number from earlier in the decade of the 1990s.
Limiting the coverage offered by the system of deposit insurance is the most common way to contain the moral hazard that deposit protection offers both to banks and their depositors. The actual objectives chosen for the system will influence a number of decisions that have to be made. These decisions include: (1) what types of institutions should be eligible to join the system; (2) which financial instruments should be covered: (3) which types of depositors should be covered and which excluded: (4) the amount that is covered; (5) whether the basic amount should be covered in full or whether a haircut should be imposed on the covered amount under a system of coinsurance: and (6) deciding whether to switch to full coverage in a systemic emergency. This survey examines country practices with regard to all of the seven questions.
While country objectives were not explicitly surveyed, clearly they will influence membership and coverage. It is, for example, possible to discern from countries’ behavior with regard to coverage that in most countries, consumer protection is one of the top priorities for a system. Deposit insurance is designed to conserve the time and money of the small depositor for whom it is not feasible or not cost-effective to monitor the condition of his/her bank. Protecting the stability of the financial system by promoting confidence and avoiding bank runs is a second high-priority objective. Resolution of a number of conceptual and practical issues follow from a careful explication of the system’s priorities.
Limited and Full Coverage
Currently, almost all countries place limits on the explicit coverage they offer. Six countries (Ecuador, Honduras, Japan, Korea, Mexico, and Turkey) that normally have explicit but limited coverage, have temporarily, but explicitly, extended full coverage during times of acute financial distress (see Table A5 of the Statistical Appendix).64 These countries plan to return to limited coverage when they can. An additional three countries without a system of deposit insurance (Indonesia, Malaysia, and Thailand) have explicitly extended full coverage during their financial emergencies, and all but Malaysia have already announced their intention to convert to limited coverage when their crises are over.
Setting the Limits on Coverage
The coverage limit should be low enough to encourage large depositors and sophisticated creditors to monitor and discipline their bank. Sophisticated depositors exert this discipline by demanding higher deposit rates from weaker banks in compensation for the higher risk of loss they are accepting; in other circumstances, depositors may withhold funds entirely from a particularly troubled bank.
There is a wide range to the limits that a country sets for its deposit insurance system, but there is greater uniformity in the European Union, where a minimum coverage (€20,000 in the year 2000) is prescribed. Translating the limits countries offer into either 1998 dollars or euros, coverage ranges from the dollar equivalent of a low of SI 20 in Ukraine to a high of $253,520 in Norway (excluding countries offering a full guarantee). While Germany’s official scheme offers limited coverage. Beck (2000) argues that the private system offers virtually unlimited coverage to customers of member commercial banks. Corrective discipline is exercised by fellow members, which will he assessed ex post to meet deficiencies, rather than by depositors.
Any given limit expressed in dollar values (as in column 2 of Table A5) will be more generous in a country that has a low level of per capita income than where incomes are higher. While IMF staff typically uses the world average of per capita GDP as a rough rule of thumb for appropriately limiting coverage, coverage observed in the survey is sometimes high and can considerably exceed the rule-of-thumb limit. Consequently, Figure 1 shows coverage per capita country by country and Figure 5 shows that the weighted average coverage ratio worldwide is 2.4 times per capita GDP: with the highest average in the Middle East and the lowest in Europe. The weighted average is lower at 2.1 times per capita GDP. This number falls to 1.8 times per capita GDP if the largest country, the United States, which has relative high coverage, is excluded. The individual country offering the highest per capita coverage is Oman, which guaranteed up to 8.8 times 1999 per capita GDP. The lowest ratio for coverage that appears in the survey is that of Ukraine, which covers only a small fraction of per capita GDP.
Figure 5.Deposit Coverage by Continent (weighted)
Source: IMF staff survey.
As Figure 6 shows, countries typically cover a high percentage of the number of deposit accounts. Excluding countries offering a comprehensive guarantee, the percentage of accounts covered in full is typically over 90 percent, although it is lower in Kenya, Nigeria, Sri Lanka, and Tanzania (see Table A6 of the Statistical Appendix). As is appropriate, the guarantee covers a typically much smaller percentage of the value of deposits, ranging from negligible in Estonia and Sri Lanka, to 12 percent in Tanzania, to a high of 76 percent in Norway (see Figure 7).
Figure 6.Percentage of the Number of Depositors Covered
Source: IMF staff survey.
Figure 7.Percentage of the value of Deposits Covered
Source: IMF staff survey.
Adjusting the Limits on Coverage
Coverage can be adjusted upwards over time to relied higher GDP and faster rates of inflation. If the coverage ratio was initially set very low because the system fund needed time to build its resources, the level can be raised as the fund matures. The adjustments can be made by indexing coverage or making, preferably rare, adjustments. There is both an advantage and a disadvantage to indexing coverage levels. The advantage is that it avoids setting unduly high limits initially: the disadvantage is that it will be hard for the public to keep abreast of repeated changes in the coverage level. Also, indexing coverage typically results in unrounded numbers, whereas round figures are easier to remember and use.
Applying the Limit Per Deposit or Per Depositor
Conceptually, a country could apply its coverage limit to each and every deposit that a depositor held anywhere in the country. This would allow a depositor to split his/her funds into a number of accounts at the same bank and gain virtually unlimited coverage. Far fewer countries do this today than did a few years ago. There has been a shift from per-deposit to per-depositor coverage since the earlier surveys (Kyei 1995: Lindgren and Garcia 1996). In fact, per-deposit coverage is offered in only one country (the Dominican Republic) today.
Most countries apply their limit to the sum of all the deposits that a customer holds at any particular bank. This arrangement allows a depositor to obtain coverage above the limit by splitting his/her funds across a number of banks. This relaxes the limit somewhat, but does not allow (he largest depositors to obtain full coverage. Some countries might warn to go further and seek to limit coverage at any point in time to the sum of any individual depositor’s accounts across all banks, regardless of the number of accounts held in any or all banks. In fact. Chile attempts to do this by imposing a limit on coverage available in any year on deposits held by any single depositor anywhere in the financial system.
Some countries attempt to strike a balance between discouraging moral hazard and avoiding systemic runs by adopting a system of coinsurance. In 20 deposit insurance systems (those in Austria, Bahrain, Bulgaria, Chile, Colombia, the Czech Republic, the Dominican Republic, Estonia, Germany, Gibraltar, Ireland, Italy, Kazakhstan, Lithuania, Luxemhourg, Macedonia, Oman, Poland, Portugal, and the United Kingdom) the depositor loses a small percentage of the covered deposit but is reimbursed for the majority by the system. (See column 5 of Table A5). The haircut commonly ranges from 10 percent to 25 percent, but some countries, such as Bulgaria and Kazakhstan, have multiple tranches on which they impose successively higher haircuts that range up to 50 percent of the initial deposit. To protect “windows and orphans,” it is preferable to cover a very small deposit in full and coinsure above that level. This dual arrangement will reduce the incentive for retail runs while maintaining market discipline. In fact, 15 countries impose a haircut on all of the insured deposit, while only five use coinsurance above the basic coverage limit.
Which Deposits to Cover and Which to Exclude?
Most countries aim to protect small depositors while requiring larger depositors to monitor the condition of their bank and contain moral hazard. Of the two contrasting approaches used to achieve these two objectives, one makes the objective of deposit protection politically and conceptually clear, while the other is easier to administer and effect speedy compensation.65
The survey revealed that eight systems cover deposits of all types and 21 cover most kinds (see column 2 of Table A6). However, 17 systems exclude all foreign currency deposits and nine schemes in countries that are in, or aspire to he in, the European Union exclude some non-EU currency deposits from coverage. Some countries that cover foreign deposits (for example, France, Honduras, Jamaica, Latvia, and Ukraine, among others), pay out in domestic currency to help protect the system from exposure to foreign exchange risk. Fifty-four systems do not cover interbank deposits. Thirty-three systems exclude government deposits and 34 countries explicitly do not guarantee the deposits of insiders who could use privileged information to take advantage of the guarantee. Twenty-three countries explicitly exclude illegal deposits in their deposit insurance laws. Nine countries exclude deposits that pay exceptionally high rates. This exclusion serves to discourage weak institutions from bidding for deposits and gambling for recovery with the proceeds and raising the costs of intermediation for their stronger competitors. Eighteen countries guarantee only, or mainly, household deposits. Evidently, as shown in Figure 8. a large number of countries find it worthwhile to undertake the administrative burden of giving preference to less sophisticated depositors—probably for political rather than financial reasons.
Figure 8.In Practice: Exclusions in the Year 2000
Source: IMF staff survey.
Full Coverage in a Crisis
Ecuador, Honduras, Japan. Indonesia, Korea, Malaysia, Mexico, Thailand, and Turkey currently offer coverage in full to depositors and creditors of all types and also most other liabilities. Chile covers demand deposits in full to protect the payment system, but offers limited coverage on other types of accounts. The comprehensive coverage in six of these countries (Ecuador, Honduras, Japan, Korea, Mexico, and Turkey) overrides the regular deposit insurance coverage in these countries. The other three countries previously had no explicit system.
Most of these countries began offering full coverage when they perceived a financial emergency, with the intention of replacing full emergency coverage with a limited system after the banking system had been restructured to soundness. Sweden, Finland, and Jamaica also offered full coverage during their financial crises but have already retracted it and replaced it with a system of limited coverage. As discussed further in Section IV. Indonesia, Malaysia, Thailand, and Turkey plan to replace their comprehensive guarantees when their crises are over, but have not specified a time for doing so. Ecuador plans to limit coverage in the year 2001, Japan and Honduras in 2002, Korea by the end of 2000, and Mexico plans to complete phasing qui its blanket coverage by 2005.
Timing the Repayment
The speed with which a depositor regains access to his funds affects the value of the coverage offered. Delay reduces any stated coverage value according to the time-value of money and the inconvenience imposed on the depositor by the delay. Whatever the degree of coverage, small depositors at failed banks typically need access to their insured funds rapidly. In effect, delaying payment reduces the value of coverage and increases systemic uncertainly. Thus, it behooves the deposit insurer to compensate insured depositors immediately, but certainly within 30 days; otherwise, the credibility of the system can be undermined, depositors may run from weak banks, and the retail payment systems may be disrupted. Depositors, finding themselves without their transactions and savings balances, may curtail their expenditure, which can cause or exacerbate a recession. The FDIC’s practice of paying compensation within three days is a good example of prompt payment. In many countries, however, the survey found that repayment is remarkably slow. The EU Directive allows countries three months to make payment, but allows them to extend the time period in unusual circumstances. (Column 4, Table A7.)
Correct alignment of the deposit protection scheme with respect to three topics facilitates control over agency problems.66 The first necessity is to ensure adequate funding. The second is to specify clearly the system’s role and responsibilities. They were discussed earlier. The third is to design an appropriate organizational structure.
In the quest for potential independence and appropriate accountability, in 29 countries the deposit insurer constitutes a separate, independent legal entity (see column 6 of Table A8). Nevertheless, in a number of instances, it was, either in law or in practice, under the control of a government agency, which is usually the central bank or the ministry of finance, but is sometimes the bank supervisor. The deposit insurer was found to be subordinate to the central bank in one-third of the countries, and to either the ministry of finance or the supervisory agency in another third. Even so, the deposit insurance agency does not normally have the power to grant or withdraw bank licenses, to supervise, or to provide lender-of-last-resort credit to failing banks, because that would detract from the stature of the supervisor and possibly diminish its effectiveness.
The Board of Directors
The survey shows that privately run systems are operated by bankers, who also typically are included on the boards of jointly run systems, while less frequently on government-run systems (see column 6, Table A8). Government-run schemes typically include representatives of the supervisory agency, the ministry of finance, and the central bank represented ex officio on the board of the deposit insurance agency. In relatively few instances, the chairman and the majority of the board are worthy, experienced, but independent members of the public with no current ties to the banking industry.
Good practices suggest that the government should provide back-up funding. Consequently, leaving financial decisions to a board of bankers is likely to result in an underfunded scheme. Nevertheless, the privately run schemes in Argentina and Germany have been successful to date. However, bankers can form a consultative committee to advise the board of a publicly funded deposit insurance scheme. There is a wide dispersion in arrangements regarding the running of the system. Thirteen schemes are privately administere, 39 are run by the government, and 16 are jointly operated (columns 3–5, Table A8). The authorities are able to exert some influence over some privately run schemes, such as those in Argentina and Brazil.
The danger of banks providing insufficient private resources to maintain the solvency of the fund, as they hope to be subsidized by a government, appears to be a reality in more than half of the systems surveyed. Nine of the privately run systems and 12 of the 16 jointly run systems have financial backing from the government. The remaining privately run schemes and 4 jointly operated systems, however, have attempted to avoid this particular agency problem by refraining from providing government financial support. In some cases, the law is silent on the subject of funding; in others, government financial backing is explicitly foresworn. However, whether those governments that have made a precommitment not to fund the system can sustain this commitment in face of an underfunded system remains to be seen.
Trends and Convergence to Good Practice
A number of major changes in deposit insurance practices can be observed in comparison to the earlier surveys of Kyei (1995) and Lindgren and Garcia (1996). A summary comparison between the present survey and that of Kyei (1995) is presented in Table 3. It shows that there are many more (67) explicit systems in 2000 than there were in 1995. since a number of the countries listed in Kyei (1995) as having implicit schemes have replaced them with formal, explicit schemes in a major shift toward following good practices. In addition, other countries that were not included in the survey by Kyei have also recently put in place explicit systems.
|Number of Deposit|
A number of other trends have developed since Kyei’s survey, First, the increase in formal systems has been marked in Europe, where the number has risen from 23 in 1995 to 32 in 1999. There has been no increase in the number (4) of systems in Africa, although six Central African countries agreed to form a regional system of deposit insurance in 1999. A year later, however, only two of the signatories have ratified the agreement, which will not go into effect until all do so. There has also been some growth in the number of systems in the Middle East and the Americas. In the Western Hemisphere, the number of explicit systems has risen to 17 in 2000 from 11 in 1995. In addition, a number of additional countries in the Americas are planning to introduce formal systems to replace their implicit ones. The introduction of new systems may be expected in Asia as countries recover from their financial crises and replace the full guarantees they have put in place with limited coverage.
Second, more countries—more than one-third of the total—now risk-adjust their deposit insurance premiums. Only two countries (other than the United States’ protectorates in Asia) were identified in Kyei (1995) as adjusting their insurance premiums for risk. The increase in risk-adjusting countries has occurred in Africa. Europe, and the Americas. Assuming that the risk-adjustment is being well executed, this change constitutes a substantial shift toward good practices.
Third, there is a shift away from voluntary systems to compulsory schemes. Today, nine of every ten systems seek to avoid adverse selection in this way. whereas only just over half did so in the mid–1990s. The switch has occurred not only in Europe, as a result of the 1994 European Union Directive on Deposit Guarantee Schemes, but the trend has also been noticeable in the Middle East and in the Americas.67
Fourth, there has also been a trend toward funded systems. While only a few countries have switched from ex post levies to funded systems, newly created systems have almost universally been funded. (Gibraltar’s new scheme is the exception in that it follows the ex post practice of the United Kingdom.) Funded schemes are universal in Africa and Asia and have increased elsewhere to reach dominance worldwide. Schemes that maintain a fund have been observed above to be more rule-based and less ambiguous in practice than the ex post systems favored by bankers’ clubs. In this respect, the recent emphasis on funded systems is another example of convergence toward good practices.
Fifth, while must systems continue to be funded primarily by their member institutions, an increasing proportion of systems have access to back-up funding from the government, as recommended in Section II. In 2000, over three-quarters of systems have received or can expect to receive government assistance when necessary. There has been a small commensurate shift—from just under to slightly more than half—in favor of public administration of systems. This shift is to be expected as government funding is likely to be accompanied by government control. The remaining systems of deposit insurance divide themselves between privately run and jointly run schemes.
Sixth, virtually all countries now provide coverage per depositor, rather than per deposit, which tends to lower the effective coverage ratio. The reduction in the number of per-deposit coverage noted in 1996 survey has continued so that by 2000, the number had been reduced further to only one country.
There is also an increasing standardization of practices with regard to system coverage as a result of a EU directive, particularly among those countries that are, or aspire to be, members of the European Union. In the interests of competitive equity among banks from different countries, the EU directive diverges from good practice in one respect, however. By requiring the same minimum coverage limit (€20,000 by year 2000) in all member countries, the directive provides low per capita coverage in rich countries but a higher ratio in poorer countries within the European Union, which might, as a result, be more exposed to moral hazard.68 However, the mandatory coverage is so low in rich countries that it remains relatively low even in less affluent EU countries, so that moral hazard from this source is unlikely to be a serious problem. Because there is so little variation in coverage, the correlation coefficient between per capita GDP and the coverage ratio is not significantly different from zero among member countries of the European Union, suggesting that moral hazard is not a problem there. Nevertheless, it could be a problem for countries outside the European Union that aspire to join the Union and so emulate the European Union’s deposit insurance system coverage even when it is many times their per capita GDP.
Worldwide, there is a small but statistically significant negative relationship between per capita GDP and the deposit insurance coverage ratio. That is, poorer countries, on average, offer higher coverage in relation to GDP than do richer countries. Perhaps they do so to enable their banks to complete internationally and to discourage deposits from migrating abroad. The inverse relationship is evident in all regions except Europe, but is particularly strong in Africa. This result indicates that moral hazard is present worldwide, but is stronger in developing countries than in Europe.
Despite shifts in favor of good practice, areas remain for improvement. For example, some countries have not resolved the potential conflict of having a privately run system of deposit insurance with government financial support. In addition, deposit compensation practices are often surprisingly slow. This problem may be exacerbated by an increasing trend toward excluding categories of depositors from coverage. For example, a large increase in the restriction of system protection to individuals, households, and nonprofit organizations is observable, mostly he-cause former Soviet countries made explicit their old practice of guaranteeing household deposits. Such restrictions have been adopted by over one-quarter of countries, whereas only one-eighth did so in 1995. There has also been an increase (from 45 percent to 80 percent) in the number of systems that exclude interbank deposits from coverage. The change occurred in both Europe, where the EU Directive on Deposit Guarantee Schemes lists interbank deposits as a candidate for exclusion, and also in the Americas. There has also been, perhaps surprisingly in light of the recent currency crises, a trend—apparent on till continents—toward excluding foreign currency deposits from coverage. In 2000, 39 percent of countries excluded all or some deposits denominated in foreign currency.