Deposit Protection Arrangements: A Survey

This paper is a survey of deposit protection arrangements and it compares the key elements of deposit protection schemes around the world. There are more implicit arrangements that guarantee deposits than explicit ones, but there has been a growing tendency since the 1980s for countries to adopt explicit ones largely in response to emerging problems with their financial systems.

Abstract

This paper is a survey of deposit protection arrangements and it compares the key elements of deposit protection schemes around the world. There are more implicit arrangements that guarantee deposits than explicit ones, but there has been a growing tendency since the 1980s for countries to adopt explicit ones largely in response to emerging problems with their financial systems.

I. Introduction

Most countries have adopted a comprehensive system consisting of lender of last resort facilities by the central bank, deposit guarantees of various forms, regulation, and supervision to ensure the stability of the financial system. Deposit guarantee has sometimes been seen as one way of protecting both the financial system and depositors; in some cases, increased supervision in addition to depositor protection has been tried while in two countries, less supervision but a strict disclosure regime without depositor protection was seen as a means of promoting a sound and efficient banking system.

This paper is a survey of deposit protection schemes and it is the first part of a broader project on deposit guarantee arrangements. It compares the key elements of various deposit protection systems around the world. It was motivated by the need for such a survey. 1/ The paper is partly based on responses to a 1992 Questionnaire on Bank Supervision and Deposit Insurance to country desk economists in the Fund, which posed in the area of deposit insurance the following questions: (1) is there a formal arrangement and, if not, how is the implicit system established; (2) what kind of legislation establishes the formal deposit guarantee scheme; (3) is the arrangement a mere government guarantee or is there a fund; (4) who bears the financial liability for compensating depositors; (5) which deposits are covered; and (6) what are the coverage limits. A total of 142 Fund member countries were surveyed and the response rate was about 73 percent. 2/ After identifying the explicit and implicit systems, the information from the Questionnaire was supplemented by other information from Fund reports and other sources. It needs to be emphasized that countries continuously change their schemes in response to developments in the financial system and while an attempt was made to update the information at end-May 1995, it is likely that some of the information (especially those on the European Union member states) would already be out-dated by the time this paper is published. The discussion is on the basis of the following regional grouping: Africa, Asia, Europe I, Europe II, the Middle East, and Western Hemisphere. 3/

The paper first identifies countries under two types of deposit protection arrangements: explicit and implicit. Most industrialized countries have explicit deposit guarantee arrangements. There is, however, an absence of such schemes in most parts of Africa and Asia (including most New Industrialized Countries (NICs)). There are also recent developments where explicit (Argentina) and implicit deposit guarantees (New Zealand) have been officially rescinded and replaced by tougher disclosure and other standards although Argentina reinstituted a deposit guarantee in April 1995. Subsequently, the paper deals with explicit systems, identifying the types of deposits and institutions covered and the coverage limits. A number of arrangements maintain a fund for reimbursing depositors and the paper looks at how these funds are administered, and the sources of funding. Section II describes the key features of deposit protection arrangements and how the schemes in the various countries fit within the features. Section III presents some conclusions.

A country case summary of the various explicit systems is provided in the Appendix. 1/

II. Arrangements for Protecting Bank Deposits

1. Types of systems

Deposit guarantee is only a part of the various arrangements for protecting the financial system and, therefore, not all countries operate formal deposit insurance schemes. Although a formal scheme may not be in place, there could be an implicit guarantee of deposits to the extent that governments may go out of their way to guarantee the stability of the financial system. In these cases, depositors have assurances implied by government action either through precedence or stated intention. Two types of guarantees are therefore identified: explicit guarantees, where formal deposit protection arrangements exist, and implicit guarantees, where it is taken for granted or based on past experience that the government is bound to take steps to protect the banking system.

The basic features of implicit arrangements are: (1) the absence of written law such that legal obligation is absent and possible assistance can be judged by past behavior (tradition) of the government or by statements of officials; (2) absence of laid down rules regarding the coverage limits and form of compensation while funding by government in the event of failure is discretionary; and (3) the absence of earmarked funds for assistance. 2/ Table 1 shows that implicit deposit protection systems are more prevalent in developing countries where most banks are government-owned and the governments expected to resolve bank failures. In such cases, private banks may be allowed to fail. Under an implicit system, both small and large depositors may be protected. Similarly, troubled banks may or may not be liquidated and as mentioned above, private banks could be liquidated while publicly-owned ones may possibly be rehabilitated or merged with stronger banks, thereby saving the government the immediate cost of reimbursing depositors. The advantage of implicit systems is that the government does not have to set aside a fund for that purpose. On the other hand, the government may be forced to fund the system once a need arises. If government funding takes place, bank owners typically bear little costs while taxpayers bear the brunt of the cost of the salvage operation.

Table 1.

Types of Deposit Protection Systems in the Countries Surveyed

article image
Sources: Questionnaire; Recent Economic Developments; and Staff Reports. Last update: May 1995.

In Africa, deposit protection is predominantly in the form of implicit government guarantee, mainly because the financial systems are not very well developed and the banks are predominantly government-owned. Even in such cases, only a few countries such as Ghana and Senegal, have reimbursed depositors. In most countries banks have not been allowed to fail.

In Asia, 12 out of the 20 countries surveyed have implicit schemes, while in the industrialized countries, only Australia has an implicit system. In the Middle East most countries have implicit arrangements and almost one-half of the countries in the Western Hemisphere have implicit arrangements, including Brazil, Ecuador, and Jamaica (see/Tables 1 and 2).

A new approach was adopted by Argentina and New Zealand where there were explicit statements regarding the absence of government guarantee of deposits. In the case of New Zealand, an implicit guarantee was rescinded (and replaced by strengthened disclosure requirements) while in Argentina an explicit deposit arrangement was abolished (in favor of supervision-cum-disclosure) to put in place systems that make depositors and managers and owners of banks responsible for their actions. Following the Mexican crisis, banks faced massive deposit withdrawals in Argentina and the government set up a US$2.5 billion fund to help banks, and reintroduced an explicit deposit guarantee in April 1995.

Under explicit deposit protection, the arrangement is normally explicitly stated in a statute. First, some kind of legislation, whether the constitution, central bank law or banking law would require the establishment of a guarantee system (see Tables 3 and 4). Typically the statute would specify the types of institutions and deposits covered, coverage limits, management and membership, funding arrangements, and procedures for the resolution of bank failures.

Table 2.

Regional Distribution of Deposit Protection Arrangements 1/

article image
Source: Questionnaire; Recent Economic Developments; and Staff Reports.Last update: May 1995.

Due to the lack of some information on Bangladesh, El Salvador, Greece, Poland, Slovak Republic, and Sweden, the numbers may not add up and does not necessarily match totals in Table 7. Under “Administration”, Iceland has one official and one private.

Table 3.

Explicit Deposit Protection Arrangements--Agency, Statute, Management, and Membership

article image
article image
Sources: Questionnaire; GAO (1991); and Talley and Mal (1990).Last update: May 1995.Note: n.a. means either not applicable or not available.
Table 4.

Comparison of Deposit Protection Arrangements--Summary of Survey Results

article image
article image
article image
article image
Sources: Questionnaire; Recent Economic Developments; and Staff Reports. Last update: May 1995.Notes: n.a. means either not applicable or not available.

Implicit: Implicit Guarantee; Explicit: Explicit Guarantee.

Government: Government Guarantee; Fund: Insurance Fund; Implied: Implied Guarantee; Other: Other Guarantee.

Central Bank: Central Bank Act; Dep. Ins. Act: Deposit Insurance Act; Constitution: Constitutional Guarantee; Fin. Law: A Law on Financial Institutions

Budget: Government Budget; Central Bank: Central Bank; Banks: Participating Banks; Other: Other Arrangement.

Banks may imply contribution while Central Bank and Budget could be either contribution or loans.

In Africa there are only four explicit arrangements (Kenya, Nigeria, Tanzania, and Uganda). Those in Kenya and Nigeria have not been often used because banks have not been allowed to fail. The arrangements in Tanzania and Uganda are very recent. In Asia, seven countries have explicit arrangements, but of these systems, Marshall Islands and Micronesia are extensions of the U.S. system. All the European Union (EU) member states currently operate some form of explicit deposit guarantee arrangement. There are eleven arrangements in the Western Hemisphere and of these, those in Argentina, Canada, Chile, the United States, and Venezuela have been actively used to protect depositors.

2. Types of deposits covered under explicit arrangements

Deposits are funds lodged at banks for various purposes and the variety of deposits depends on the sophistication of the banking system. Deposits include transaction and payroll accounts, demand deposits, savings deposits, time deposits, and certificates of deposit (CDs). The owners of such deposits would include individuals, enterprises, government agencies, money managers, investment companies, brokers, other banks, nonprofit organizations, and pension funds.

Under explicit arrangements, the statutes specify the types of deposits that would be covered and reimbursed in case of the failure of a bank; this normally ties in with the objectives for the arrangement (Table 6). Where the aim is broad, most types of deposits are covered. Table 6 shows the types of deposits covered under explicit deposit protection arrangements. Austria, the Czech Republic, Kenya, Luxembourg, the Netherlands, and Turkey restrict coverage to households.

Table 5.

Comparison of Explicit Deposit Insurance Schemes--Coverage and Funding

article image
article image
article image
Sources: Questionnaire; Recent Economic Developments; Staff Reports; Internal IMF reports; GAO (1991); and Talley and Mal (1990).Last update: May 1995.Note: n.a. means either not applicable or not available.

June 1994 end of period exchange rate.

Also has two unfunded systems for cooperative and savings banks.

Savings banks DIF does not cover interbank deposits; no limitations set for commercial banks DIF.

Currently no limit.

Premium is risk-based. Basic average limit is US$100,000 but funds in different ownership categories are separately insured.

Table 6.

Types of Deposits Covered Under Explicit Arrrangements

article image
article image
article image
Source: Questionnaire; Recent Economic Developments; and Staff Reports. Last update: May 1995.

Interbank deposits not covered under Savings Banks DIF.

Interbank deposits, deposits in foreign currency, deposits in branches of foreign banks, and deposits in branches in other countries are treated differently by the various arrangements. Most schemes exclude interbank deposits. Germany and the Philippines cover all deposits except interbank deposits. The justification for the exclusion of interbank deposits is that they are banks’ funds, and banks are deemed to possess the capability for assessing the financial health of others and, therefore, expected to be in a position to minimize their exposure to risk. However, unless the coverage limit is very high, interbank deposits may be an insignificant amount.

Twelve countries do not cover deposits in foreign currency. Foreign currency deposits are sometimes excluded because of the difficulty in specifying the limits due to changing exchange rates. The holding of foreign currency deposits could also have a very limited effect on the payments system if it constitutes an insignificant share of total deposits. Colombia, El Salvador, and France exclude foreign deposits while covering all others. 1/ Table 6 shows that a number of countries exclude either interbank deposits or foreign deposits. Japan, Nigeria, Tanzania, Uganda, and the United Kingdom exclude both interbank and foreign currency deposits.

The exclusion of deposits in branches of foreign banks implies that some depositors in the host country may suffer losses in the event of the failure of those branches. In the EU and the United States, branches of foreign banks are covered but this is not the case in Japan. On the other hand, the exclusion of deposits in other countries is often based on the argument that those deposits would normally not have any impact on the home country’s payment system. In the EU, only Germany requires that branches in other countries be insured; Japan also excludes coverage of Japanese banks’ branches abroad. The host country could also require that deposits with branches of foreign banks be guaranteed. Under some arrangements, such as in Italy, the legislation requires that deposits in foreign branches be insured only if the host country does not offer coverage. 1/

3. Types of institutions covered

The types of institutions covered depend on the objectives of the arrangement. Where it is to promote the development of some particular group of institutions such as savings banks, only those institutions are covered as in the case of the Dominican Republic. Where the purpose is to maintain an existing structure (such as in Germany, India, and the United States), all groups of depository institutions are covered but sometimes by separate agencies. In other cases, there are separate agencies for other reasons as in Belgium, Finland, Iceland, Norway, and Spain (see the Appendix). To a large extent where the government seeks to promote or protect some institutions, there is government participation in the funding and administration of the agency. Also, the extent of government involvement sometimes determines the institutions covered: where there is no government involvement, only the private commercial banks are involved. On the other hand, where the purpose is to protect the entire banking system, the legislation requires that all banks be covered.

4. Coverage limits

Coverage refers to the financial liability of the insurer to the depositor in the event of the inability of the insured to honor the depositor’s claim. The statutes governing deposit protection arrangements often specify when an institution is deemed to be incapable of paying depositors and stipulate procedures for reimbursing insured depositors. For instance, under the EU guidelines, an institution is considered insolvent if that institution fails to refund deposits 10 days after a claim has been made. 2/ The longer it takes to compensate depositors, the faster the spill-over effects to other institutions--both distressed and sound banks.

Table 5 shows that limits are established either for each account (per deposit) or for each individual (per depositor). The disadvantage with the limits on each account (“per deposit”) is that depositors can increase the coverage limit through multiple accounts or through third parties if it is not restricted to one depositor. Under a “per depositor” limit, if an individual has a demand deposit and a savings deposit in the same institution, both accounts are put together and the limit applied to the sum. In Peru, if a depositor has accounts with more than one failed institution, reimbursement will be applied to deposits of only one institution. The table shows that only four explicit schemes (France, Italy, Luxembourg, and Switzerland specify coverage limits per deposit account. Between the coverage limit and the type of deposit, however, it is possible to manoeuvre for a multiple of the stated limit, especially if the rules are not clear on joint accounts and those held on behalf of customers, such as pension funds.1/

Coverage limits also vary across countries. Where the objective is to protect small depositors as in the United Kingdom, coverage is limited to individuals and to an amount deemed to be the average deposits of that group, currently approximately £20,000. However, if the resolution of a failed institution results in a merger or rehabilitation, the objective would have been more than met since it would, in effect, cover uninsured depositors as well. On the other hand, enterprises will be covered, and coverage extended to some uninsured depositors if the objective is wider than the mere protection of small depositors. For instance, in Italy the coverage limit is between Lit 200 million and Lit 1 billion, while in Germany it is set in terms of the liable capital (paid up endowment capital and reserves) of the respective bank per depositor.

Where the arrangement also seeks to reduce moral hazard on the part of depositors, there is an element of coinsurance under which the insured is responsible for some amount of the loss, while the insurer is liable for the remainder. Coinsurance is established either as a deductible where the depositor loses a specified percentage of the covered amount, say 75 percent in the case of the United Kingdom, or is responsible for a specified fraction of the loss at various levels of coverage, say 100 percent of the first Lit 200 million and 80 percent of the next Lit 800 million in the case of Italy. The systems in Chile, Colombia, the Czech Republic, Ireland, and Portugal, entail some form of coinsurance. In France, insurance coverage excludes excessively remunerated deposits and in Argentina, the central bank has the option to exclude from the coverage, deposits with yields more than 2 percentage points above a specified reference rate. At the end of the spectrum is 100 percent coverage under which all deposits are covered, such as in Kuwait and Norway. Some arrangements also specify how the coverage limit should be adjusted--either through indexation or periodic adjustments. Such adjustments may reflect inflation as in Peru or personal income growth as in the Netherlands. Under the U.S. system, the coverage limit has been raised five times, the last increase was in 1980 from US$40,000 to the current US$100,000 per depositor.

5. Management and membership

Four main administrative types of explicit deposit protection arrangements are identified: (1) purely government-owned and officially administered, which is funded by the government. These tend to have the highest potential for moral hazard, because banks have no share in the cost of resolving failed banks; (2) officially-administered by a public corporation and partially funded by banks; (3) jointly-administered by representatives from banks and the government and funded by banks; and (4) privately-administered, where depositories self-insure each other (mutual insurance scheme) without government involvement. The fourth arrangement puts part of the burden of bank failures on banks themselves and, therefore, forces them to regulate, supervise, and examine themselves although this would require government assistance if the resolution cost was so high as to affect the entire system; thus, it could imply some form of implicit government guarantee. Table 2 shows that 21 arrangements are officially-administered, 9 privately-administered, and 11 jointly-administered. These are distributed as follows: all the 4 arrangements in Africa are officially-administered; Asia has 4 official, 1 private and 2 joint; Europe I, 5 joint and 7 each for official and private; Middle East, 1 private; and Western Hemisphere, 6 official, and 4 jointly-administered funds.

Membership of a system, whether voluntary or compulsory, depends on the legislation. From the survey, the level of development of the financial system does not seem to have any bearing on whether membership was compulsory or voluntary (see Table 3). There does not seem to be a direct correlation between the type of membership (whether compulsory or voluntary) and how the funds are managed. Table 7 compares the membership and management of the explicit arrangements: of the 21 officially-administered schemes, membership was compulsory for 14, while out of 9 privately-administered, membership was compulsory for 6. For the 11 jointly-administered arrangements, membership was compulsory for 6. It is often argued that membership should be compulsory so that risks would be spread throughout the banking system and to ensure that the banking system is not made up of adversely selected banks--sound uninsured banks and unsound insured banks. Under those voluntary systems where the premia are risk-based, some banks--if allowed to--may choose to withdraw when they discover that the reckless activities of other banks tend to increase premium assessments.1/

Table 7.

Comparison of Membership, Sources of Funding, and Management in Explicit Deposit Insurance Schemes

article image
article image
article image
Sources: Questionnaire; Recent Economic Developments; and Staff Reports.Note: Totals may not match Table 2 as some information excludes E1 Salvador, Greece, and Slovak Republic; n.a. means either not applicable or not available.Last Update: May 1995.

Funding by government only

6. Funding arrangements

The insurer of depositors must have the resources to make good the guarantee promised. It is, therefore, necessary to have funds (reserves) or sources of funds as contingency against claims. Without such funds, the scheme could go bankrupt. The problem, however, is that unlike normal insurance where it is possible to actuarially determine the risk and therefore fix the premium accordingly, it is difficult to predict the probability of bank failures and therefore fix risk-based premia. Risk-based premium would tend to reduce moral hazard on the part of banks. Only the United States has a risk-based premium system, which began in 1993 and is assessed on the basis of capital ratios and other relevant information (see Appendix). There is a provision under the Hungarian system that allows the Fund to levy extra premia on individual banks if they pose higher insurance risk and in Argentina, the premium paid by banks may be increased based on risk indicators determined by the central bank.

In Italy, branches of foreign banks and foreign branches of Italian banks (if covered) pay higher premia. In other arrangements, a flat premium is assessed. When reserves are too low compared with claims, there may be a tendency to postpone the closure of insolvent banks (because the Fund otherwise would itself become insolvent), but such delays could eventually cost the Fund and/or government more. At the same time, a very high level of reserves could imply higher taxes if the government is the source of funding; on the other hand, if funding is by banks it could reduce their profitability.

Table 5 shows the various funding arrangements. Under a number of arrangements (Chile, Japan, Nigeria, the Philippines, Portugal, Taiwan Province of China, and Uganda), the government or central bank provides the initial capitalization for the fund and banks are levied premia based on their covered deposits, total deposit liabilities, total assets, or some specified liabilities. The size of the fund depends on the objectives, the lowest being for systems that guarantee only individual deposits up to a very low limit. There are two types of funding arrangements: funded or unfunded arrangements. Under funded schemes, banks pay premia or special assessments into an established fund, while in unfunded arrangements, a fund is not permanently maintained but the government or central bank reimburses depositors when claims are made or insured institutions are called upon to make contributions when claims are made. Under the unfunded arrangements in Italy, Luxembourg, the Netherlands, premia are assessed and called when claims are made on the institution.

Under some funding arrangements, such as in France, Italy, Nigeria, and the United Kingdom, in addition to the premia or periodic assessments, there are callable or supplementary funds in anticipation of claims. In some cases there are target levels for the Fund, such as US$2 billion or 5 percent of total deposits for Argentina, a minimum of £5 million and a maximum of £6 million for the United Kingdom, DKr 3 billion for Denmark and 1.25 percent of insured deposits for the United States. 1/ For a number of arrangements (e.g., the Czech Republic, India, Nigeria, Tanzania, the United Kingdom, and the United States), the legislation specifies a contingent liability in excess of the reserves to be made available in a loan basis in the event of depletion of the fund. Nine of the arrangements studied are unfunded, while thirty-four are funded. Banks are the main source of funding for thirty-one schemes.

Only a few systems (Canada, Japan, Mexico, Taiwan Province of China, and Turkey), base their premia on insured deposits, most others appear to base the premia on total deposits.

III. Conclusion

This paper has reviewed deposit guarantee arrangements in about a hundred countries. Most countries began to establish deposit protection schemes in the 1980s. Some of these, especially the explicit arrangements, were set up largely in response to emerging problems in the financial system. All industrialized countries, with the exception of Australia and New Zealand, have explicit deposit protection; while among the Asian NICs, only Taiwan has an explicit scheme. The techniques used by countries in achieving their objectives vary. The arrangements are not always mandatory and the characteristics vary by way of government involvement--they are government-administered, privately-administered or joint government/private depending sometimes on the level of state participation in the protection of depositors.

In a few cases, particularly in the Western Hemisphere, the deposit protection agency also performs the function of bank supervisor, while in a number of industrialized countries such as France, Germany, Japan, and the United Kingdom, deposit insurance is mainly for the purpose of protecting depositors and only complementary to regulation and supervision.

Funding arrangements also vary. In a number of cases, the insurance fund is capitalized by the government or central bank and annual premium is assessed and contributed to the fund, which in some cases have minimum and maximum target levels. In other cases, funding is assessed ex post depending on how much it is required to pay depositors or to salvage a failing bank.

New Zealand has adopted a novel arrangement under which deposit protection assurances have been rescinded in favor of disclosure requirements which make bank owners and depositors responsible for their actions.

Finally, looking into the future for deposit protection arrangements, The Baltic countries, Russia, and other countries of the former Soviet Union, Central and Eastern Europe are considering or have began introducing explicit arrangements, in the