WSBI-ESBG response to the FSB consultation towards stakeholders on deposit insurance systems

06 September 2011

In the World Savings Banks Institute's and European Savings Banks Group's view, with regard to the functioning of deposit insurance within the safety net, two central aspects (interdependence between the individual parts of system and double-edged nature of components) seem worth being explicated.

In order to get a grip on financial systems and to restore market stability, regulators strived for the establishment of safety nets. Today, these nets basically consist of four individual parts or stabilisers:

1. safeguarding of liquidity by the central banks with the “lender-of-last-resort” function;
2. prudential supervision at the micro and macro levels;
3. the liquidation procedures for insolvent banks; and
4. the deposit insurance schemes (DIS).

From the ESBG and WSBI point of view - with regard to the functioning of deposit insurance within the safety net - two central aspects, which were drastically revealed during the financial crisis, seem worth being explicated:

First, there is significant interdependence between the individual parts of the system, which entails that the weakest of the individual safety elements in the system as a whole always determines the degree of existing financial market stability.

Second, financial system safety nets and each of their individual components are characterised by their double-edged nature in so far as - contrary to their intended function - they can have equally significant destabilising effects on financial markets if they undermine market discipline and create moral hazard problems.

The investors and bank management ultimately rely on the DIS (and thus primarily in others) to cover the costs resulting from their risky behaviour, while they reap the profits, which is thus a perfect example of moral hazard.

Therefore, the ´benefits´ of a DIS (investor protection and prevention of bank runs) should always be weighted against its ´costs´ (weakened market discipline and greater responsibility).

The tendency to greater investor protection and thus less market discipline will be somewhat mitigated by the risk-based contributions that are provided for by the Directive. These contribution payments, however, concern only the incentive structure of the bank management and do not find any equivalence on the investor level.

In the ESBG and WSBI view, this should be considered as a ´potential gap in the design of DIS’.

Proposals

• Co-insurance: The argument goes that a portion of losses to be borne by depositors raises depositors’ awareness of the fact that every bank ultimately has a certain risk of insolvency. As a consequence, they would take a greater interest in the bank’s business policy.
• An additional charge on high-interest deposits. This surcharge will be paid to the deposit insurance fund and thus remains in the financial sector. All financial institutes offering interest rates that are unusually high compared to market average, are called to notify the stock of such rates every four months and to pay the respective surcharge to the fund. The rationale for this measure is the attempt to restrain the ´fight for deposits´ among banks by surpassing each other in offering higher interest rates, since this competition reduces banks’ return and makes credits dearer.

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