Republic of Serbia
Financial Sector Assessment Program Update: Technical Note on Deposit Insurance

This Technical Note discusses key findings of the assessment of deposit insurance in Serbia. The deposit insurance scheme is managed by the deposit insurance agency (DIA), which has a multi-faceted mandate. Consequently, few DIA staff is actively involved in the core mandate of deposit insurance fund (DIF) management. DIA revenue sources are volatile, and DIF related revenues are used to subsidize non-DIF related activities. To improve transparency and ensure sustainability of the DIF, the legal framework should be amended to clarify the use of DIF resources and cap the use for operating costs.

Abstract

This Technical Note discusses key findings of the assessment of deposit insurance in Serbia. The deposit insurance scheme is managed by the deposit insurance agency (DIA), which has a multi-faceted mandate. Consequently, few DIA staff is actively involved in the core mandate of deposit insurance fund (DIF) management. DIA revenue sources are volatile, and DIF related revenues are used to subsidize non-DIF related activities. To improve transparency and ensure sustainability of the DIF, the legal framework should be amended to clarify the use of DIF resources and cap the use for operating costs.

Background

1. This note focuses on the deposit insurance scheme. An analysis of the deposit insurance agency (DIA) is provided to the extent that it is relevant to the management of the deposit insurance scheme and no detail analysis of the other functions performed by the DIA, e.g. bank resolution, is included. Policy recommendations on the bank resolution are included in the Aide Memoire.

The Deposit Insurance Agency

2. The deposit insurance scheme is managed by the DIA, which has a multi-faceted mandate. The DIA was established as the legal successor to the Agency of the Federation for Deposit Insurance and Bank Rehabilitation, which dated from 1989. The DIA is in charge of the deposit insurance fund (DIF) management and payout functions, and is also the designated bank resolution agency for closed bank resolution (see Box 1 for a summary of bank resolution framework). In addition, the DIA is tasked by GoS to manage state- and socially-owned bank shares on behalf of the state, and collect GoS debt in the context of the Paris-London club negotiations. An organizational chart is presented in Figure 1 below.

Figure 1:
Figure 1:

DIA organizational chart

Citation: IMF Staff Country Reports 2010, 151; 10.5089/9781455205677.002.A001

3. Consequently, very few DIA staff are actively involved in the core mandate of DIF management. The DIA employs 36 staff, of which 27 are permanent. Only five staff are involved in DIF management. In addition to its permanent staff, the DIA employs temporary staff under Swiss grant funding to advise the agency in the management of state-owned banks and temporary staff in a (donor) project implementation unit for DIA and for other agencies. Worryingly, the DIA does not have an IT department, but has outsourced its functions to the IT department of Beogradska bank that is under bankruptcy administration with DIA.

Bank resolution framework

The present framework foresees only closed bank resolution options (i.e. resolution upon license withdrawal by the National Bank of Serbia), namely liquidation or bankruptcy. A bank is put in bankruptcy when the court estimates that the bank assets are smaller than the bank liabilities, while it is put in liquidation when the court estimates that there are enough assets to repay all creditors. In both cases the DIA is the agency in charge of administering the process. The Government is amending the bank resolution framework to expand the resolution toolkit and include also open and closed bank purchase and assumptions and bridge banks. The responsibility of restructuring open banks rests with the National Bank of Serbia, while the resolution of closed banks will remain with the DIA.

4. DIA revenue sources are volatile and DIF related revenues are used to subsidize non-DIF related activities. The DIA’s sources of revenues include: (i) DIF premium and interest; (ii) fees obtained from collection of GoS debt to private companies in the context of the Paris-London club negotiations (3% of the debt collected); and, (iii) fees from bank resolution upon completion of the process (fees amount to cost incurred by DIA). In line with best practices, the DIA budget is annually approved by its Supervisory Board. In 2007, the bulk of the DIA revenue was generated by donors’ grants, while in 2008 most revenue came from interest on DIF resources (70 percent of the DIA revenues)—DIF operating expenses amounted only to 32 percent of the DIA expenses.

5. The legal framework is ambiguous as to whether DIF resources can be used to cover running costs of the DIA. Article 12 of the DIA Law identifies two sources of funds for the Agency: (i) the DIF, according to the purposes specified in the DIF law (Art 13); and, (ii) others. However, the Law on the DIF (Art 7) clearly specifies that DIF resources cannot be used for purposes other than those related to deposit insurance.

6. To improve transparency and ensure sustainability of the DIF, the legal framework should be amended to clarify the use of DIF resources and cap use for operating costs. The DIF Law should be amended to unambiguously clarify that DIF resources can be used for DIF operating expenses, but with a cap. Best practice is to use not more than 50 percent of interest earned on invested DIF’s resources to cover operating expenses, with the remaining revenues dedicated to building the deposit insurance fund. Although the current use of interest earned on DIF resources is well below this threshold, such cap should be introduced in the DIA and DIF laws going forward to ensure long-term sustainability of the DIF. It is also advised that the DIA statements be published annually on its website.

7. The authorities should develop a medium term strategy for the DIA, including a funding strategy for non-DIF related activities. The DIA currently undertakes several tasks, which though on an interim basis, appear to employ most of its staff. Moreover, some key functions like IT have been outsourced with no clear legal ownership of the data and the system. The multiplicity of functions performed by the DIA could obscure the institutional focus and mandate, dilute staff technical skills and even generate conflicts of interest. A medium-term strategy and institutional development plan should be prepared for the DIA—a funding plan for non-DIF activities should be at the core of such strategy.

The Deposit Insurance Fund

8. The DIF fully or partially complies with 11 out of 18 Core Principle for Effective Deposit Insurance Systems1. The DIF fully complies with five principles, is partially compliant with a further 5 and is non-compliant with 6 principles, while it is not possible to determine compliance with one of the 18 core principles. Core principles and more details on compliance or non-compliance are presented in Box 2 below, while a full assessment is included in Annex 1. Key issues identified in the course of the assessment are presented in the remainder of the technical note.

Core principles for Effective Deposit Insurance Systems

In June 2009, the BIS and the International Association of Deposit Insurers (IADI) published a joint paper providing core principles for effective deposit insurance systems. The paper aims at providing guidance for deposit insurance schemes in regular times, not in time of crisis, as insurance agencies are not intended to deal by themselves with systemic crises. A list of the core principles is provided below.

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9. Following recent amendments, the DIF covers households and SMEs accounts up to EUR 50,000 per depositor per bank and payouts should be started within three days of bank closure. In 2005, the DIF coverage was established at EUR 3,000 per household per bank. However, in response to the banking crisis, the level of coverage was expanded to Euro 50,000 per depositor per bank in December 2008. At the same time, the list of covered depositors has also been extended to include sole entrepreneurs and SMEs. Finally, the amendments shortened the period by which the DIA has to start paying insured depositors from 30 days to three days.

10. Depositors of liquidated banks and bank employees remain outside the DIF coverage. Depositors of banks in liquidation are outside of the DIF coverage; hence, they have a claim on the liquidated banks for the full amount of their deposit2. Based on the recent amendments, however, the liquidator should start payment of the deposits within three days3. If the liquidated bank does not have liquid assets to meet the 3 days payout period, the liquidator (i.e. DIF) is required by law to extend a loan to the liquidated bank for the total amount of the insured deposits. For the amounts above the insured amount, the depositors still hold a claim against the bank in liquidation, however, if the DIF has extended a loan to the liquidated banks, its claim against the liquidated bank takes precedence in the order of priority. Finally, individuals or entities connected to the bank are excluded from coverage and, based on the definition used by the DIF, bank employees are considered individuals connected to the bank

11. Depositors of liquidated banks and bank employees should be brought under the DIF coverage. The current set-up can favor the depositors of liquidated banks over all other depositors as in principle they can recover the full amount of their deposits4. Hence, it is recommended that the legal framework be amended to equate the treatment of the depositors of bank in liquidation to those of banks in bankruptcy. This is in line with international practice and based on the principle of availability of deposits. While individuals that can influence banks risk management and governance should be outside the DIF coverage to avoid collusion, the exclusion of bank employee deposits from DIF is excessive to the extent that regular employees have no impact on banks’ risk management and governance. Therefore, the DIF is advised to revise the definition of connected parties accordingly.

12. The present level of deposit insurance might encourage market participants to take excessive risk in the long-run; hence it should be gradually decreased. As a result of the coverage increase in December 2008, both by amount insured (up to Euro 50,000) and by broadening the scope beyond household depositors, 99 percent of the deposits of the whole banking system by number and 90 percent by volume are covered by the DIF. Such high coverage may encourage excessive risk taking by the banking sector, especially by smaller banks. To enhance the credibility of DIF coverage and mitigate against moral hazard, the scope of the coverage should gradually be reduced or at least narrowed starting with the most sophisticated depositors when the risks of deposit flight have abated. While coverage of EUR 50,000 is required for EU members, this higher coverage is warranted on the basis of the higher GDP per capita of EU members.

13. In parallel, the draft Law on Banking Sector Stability should be approved to give the authorities latitude to protect the depositors in time of crisis. Based on the law, the Government (upon proposal of the National bank of Serbia) can declare a systemic crisis, subject to prior opinion of the Ministry of Finance and DIA. Under such circumstances, blanket guarantee on all deposits and, if needed all bank liabilities, can be extended. More details on the Law and on the Crisis Framework are included in the Technical Note on the Crisis Management Framework.

14. The current DIF size appears adequate to cover the failure of a mid-size bank and no premium increase seems warranted at this time. In the absence of a risk assessment model, the rule of thumb is that a deposit insurance scheme should be able to deal with small and medium size bank failures, as opposed to systemic bank failures or systemic crises. With a fund size of EUR 75 million at 2008 YE, the DIF can perform adequately by covering 9 of the smallest banks collectively or any of the 20 smallest banks individually. The fund has a coverage ratio of 1.8 percent (measured as the size of the fund to the amounts of eligible deposits)5, which is in line with similar figures in other new EU member states (see Table 1 below).

15. To better target the fund size, the DIF needs to develop risk assessment capacity and employ actuarial tools to assess if its reserves are commensurate with the risks. To be able to target the right size of the fund, the DIF should develop a risk assessment model of the banking sector and use the information received from the NBS to monitor risk levels in the sector. Best practice indicates that the fund size should be determined by a combination of the following: size of exposure; effectiveness of supervision and intervention; macro-economic situation; corporate governance standards in the banking sector; level of risk taken by the banks; number and diversity of insured banks; size of largest bank; priority of depositors in liquidation; level of capital in banks; emergency funding arrangements available to the DIF; and, speed with which DIF investment can be liquidated and risk level of such investments. 6

Table 1.

Coverage ratio new EU member states, 2005

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Source of these data: EC, Joint Research Centre- Investing the efficiency of EU DIFs

16. The DIF should establish emergency funding arrangements to cover systemic crisis or failure of a systemic bank. As of end-September 2009, the DIF did not have sufficient financial resources to cover the insured depositors of any of the largest 16 banks individually or more than the sum of the 9 smallest banks in the system. Different articles of the DIF law list additional funding sources when DIF resources are insufficient. These include an extraordinary premium up to 0.4 percent annually and, should these not suffice, borrowings. In addition, the DIF law also mentions that the DIF is fully backed by GoS. Despite these provisions, no emergency funding arrangements have been set-up and no line-item included in GoS budget, which is a pre-requisite for GoS support. It is advised that the DIF arrange contingecy funding at the earliest either by: (i) including in the Law on Banking Sector Stability the possibility of obtaining an emergency line of credit from GoS under urgent procedures; or, (ii) negotiating a standby line with the EBRD or private banks. Details of best practice funding arrangements and examples of funding arrangement sources are presented in Box 3 below.

17. The DIA has operational limitations in effectively handling large scale payouts, as it does not have a payout strategy nor an adequate IT system. The DIA does not have any internal policies on payout processes and in the past it used an ad hoc approach. Processes were conducted in part manually and in part automatically (i.e. by using a software), thus hampering accuracy as no logical controls could be applied. Moreover, different software was used at different times. First the DIA used Access, then Oracle, and then it reverted back to Access. The Oracle database and software, which is technically more appropriate than Access, was never implemented partially due to understaffing at the DIA IT department. The introduction of legal amendments aimed at shortening the payout period has further emphasized the need to develop and approve such a strategy and an adequate IT system.

Emergency funding - various models

Emergency funding arrangements of DIF around the world vary. Some are explicit (e.g., the DIF law specifically mentions the various options), and others are implicit (the DIF law simply mentions government backing of all DIF obligations). Some DIF, for which emergency funding arrangements are explicitly spelt out, have gone further and actually put in place lines of credit. Best practice funding arrangements are explicit (as these reduce uncertainty in times of crisis) and allow for fast funding availability. Moreover, they do not include increased premia amongst the possible sources either in times of crisis or if the resources required are large. Sources for funding arrangements can include public entities, governments or, more rarely, central banks, international institutions, and private banks. Examples of the various funding arrangements are presented below.

Public sources: Bulgaria, Estonia, Sweden have an explicit mention of government support. In case of need, governments finance the DIF from current reserves and subsequently budget adjustment are approved through parliament. Occasionally, the DIF borrows from central banks (e.g., Russia, Poland, Slovakia, Spain).

Private sources: The Romanian DIF has an open line of credit with several Romanian banks, which is guaranteed with future premium collected. The Czech DIF can issue bonds. However, as the procedures to issue bonds can be long, the Czech DIF registered shelf issue of bonds with the securities and exchange commission. The Bulgaria DIF can require banks to pay the annual premium in advance (e.g., banks have to pay a premium for 2010 in 2009).

International institutions: The Bosnian DIF has access to a line of credit from the EBRD with a government guarantee.

Sources: Investigating the efficiency of EU Deposit Guarantee Schemes - European Commission, Joint Research Centre, Unit G09, Ispra Italy; 2007. Webpages of the listed DIFs.

18. The recent draft payout procedure is adequate and should be tested and adopted as soon as possible. The payout procedure, which is now in final drafting phase, consists of internal policies on the whole payout processes (such as staffing arrangements and responsibilities, flow of documents, detailed instructions for transferring data from bankrupted bank, control functions, process of the calculations, control of insured amounts and similar) and templates for the related documents. The draft payout procedure is adequate; however, as the process is technically and technologically complex, it should be tested upon completion and prior to approval.

19. In parallel to the development of a payout procedure, software is being designed by IT experts of Beogradska bank. The hardware and software should be purchased by the DIA. IT experts from Beogradska bank are working on the development of software that will cover the three phases of deposit payout (transfer of data from bankrupted bank to the DIF, reimbursement process via payout agents, and recording reimbursements in the DIF). Currently, part of the IT equipment belongs to the DIA, but most of it to Beogradska bank. It is not advisable that equipment is placed outside the DIA premises - because of potential risk of misuse, loss, lack of controls etc. Hence, it is strongly advised that the DIA purchase all the equipment and software rights and recruit IT staff.

20. The law should provide for legal protection to DIF staff for decisions taken in good faith. The current DIA and DIF laws do not provide for the deposit insurer, and individuals working for the deposit insurer, to be protected against lawsuits for their decisions and actions taken in “good faith” while discharging their mandates. While this has not yet occurred in Serbia, in other countries depositors have sued individuals working in deposit insurance schemes due, for example, to delays in payout. To address this issue, the Law on the DIA and DIF should be amended and provide such legal protection.

21. The DIF should develop a public information campaign on an ongoing basis. The DIF does not conduct public awareness campaigns on an ongoing basis, nor has it identified a target audience. Information is crucial especially in a time of crisis; hence a structured information campaign should be designed and implemented as soon as possible.

Recommendations

22. Key recommendation include in this technical note are summarized in the table below.

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Annex 1

Comparison of Serbian DIS with Core Principles for Effective Deposit Insurance Systems

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1

BIS/IADI Report on “Core Principles for Effective Deposit Insurance Systems”, Basel, June 2009.

2

The Serbian legal system distinguishes between bankruptcy of banks (when the court estimates that the bank assets are smaller than the bank liabilities) and liquidation of banks (when the court estimates that there are enough assets to repay all creditors–amongst which depositors). The depositors of banks in liquidation are therefore outside of the DIF coverage, as it is assumed that their claims can be covered by the sale of the bank assets (depositors are high on the list of priorities).

3

Amendments were introduced to ensure that claims of the depositors of banks in liquidation, that subsequently are found not to have enough assets to cover liabilities (hence banks that should have been declared bankrupted to start with), are left unpaid. This happened in the past and depositors protested vigorously.

4

Depositors of liquidated banks will not be better off than depositors of bankrupted banks if, after initial payout of the liquidator up to insured amount, no assets are left in the bank to compensate the depositors for the amount over the insured amounts.

5

Although this is a crude indicator, it is the only one available, as the DIF does not have a risk assessment tool.

6

Source: IADI: Funding of Deposit Insurance Systems, July 2008

Republic of Serbia: Financial Sector Assessment Program Update: Technical Note on Deposit Insurance
Author: International Monetary Fund