V Summary and Conclusions
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

Abstract

Banks are vulnerable to illiquidity and insolvency. Because of banks’ importance to the economy, most governments have chosen to implement a financial safety net to deal with such contingencies. A system of depositor protection that guards the holders of small deposits when their bank fails has in recent years become part of this safety net in a growing number of countries. A well-designed system of deposit insurance can strengthen incentives for good governance for banks (via strong internal governance from owners and managers, firm discipline from the markets, and effective bank supervision bank regulation).

Banks are vulnerable to illiquidity and insolvency. Because of banks’ importance to the economy, most governments have chosen to implement a financial safety net to deal with such contingencies. A system of depositor protection that guards the holders of small deposits when their bank fails has in recent years become part of this safety net in a growing number of countries. A well-designed system of deposit insurance can strengthen incentives for good governance for banks (via strong internal governance from owners and managers, firm discipline from the markets, and effective bank supervision bank regulation).

Section II of the paper demonstrated how a well-designed deposit guarantee system can strengthen incentives for owners, managers, depositors and other creditors, borrowers, regulators and supervisors, and politicians. For instance, a well-designed system can promote good internal governance from owners and managers by disciplining weak banks, forcing the early closure of critically undercapitalized institutions, making membership compulsory, and charging risk-adjusted premiums. It can encourage market discipline by offering low coverage and disclosing good information that allows sophisticated depositors and other creditors to carefully monitor the condition of their bank. Borrowers should be aware that they will have to repay their loans if their bank fails and will be encouraged to keep their loans current where offsetting is limited to past-due loans. The performance of insurers, regulators and supervisors as agents will improve where they know that they can take justifiable actions without political interference and will be held accountable for their actions to their principals (depositors, taxpayers and/or bankers). Politicians will better serve the public good when they know that their actions will become public knowledge through disclosure laws that allow an inquisitive press to monitor compliance with the nation’s conflict-of-interest laws.

The survey of current deposit insurance practices around the world shows that there is an increasing appreciation of the importance of system design. A larger proportion of systems of deposit protection are now explicit and compulsory, offer risk-adjusted premiums, are funded, have government backing, offer low coverage per depositor, and are government-run where taxpayer funds are at risk.

Nevertheless, there are still some areas of design and execution that need improvement. Coverage tends to be too high in low-income countries. Payment practices are slow, partly as a result of a trend toward excluding categories of deposits and depositors from coverage. Issues relating to what level of funding is adequate, how to equitably risk-adjust premiums, how to strike a balance between the roles of the government and the banking industry in running a system of deposit insurance require further study. The Financial Stability Forum’s Working Group on Deposit Insurance will study these and other issues to improve the operation of deposit insurance systems around the world.

Despite these improvements, and possibly partly because there are issues in deposit insurance design that remain to be resolved, financial crises have been prevalent during the 1990s. This situation has forced a number of countries to offer a blanket guarantee to restore confidence and to allow the continued functioning of the financial system while the authorities take time to design a plan for the resolution of the crisis.

Should a systemic crisis occur, the government must assess the costs and benefits of imposing a full guarantee and decide whether the benefits exceed the costs. If it makes such an assessment, this paper outlines steps that the authorities can take to make the blanket guarantee effective, tailor it to fiscal reality, and ameliorate the damage it does to the incentive structure. Comprehensive coverage should be temporary, credibly funded, be replaced as soon as possible by an explicit limited system of deposit protection that follows good practice, and be accompanied by reform to the financial system to prevent a recurrence.

Actual and Good Practices
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