BIS: Bank failure management - the role of deposit insurance

23 August 2019

The paper reviews practices for the use of DIS resources for alternative measures. More than 30 of those DIS can help fund alternative measures, such as purchase and assumption transactions, bridge banks, or capital and liquidity support. The paper discusses how DIS support for these measures can complement bank insolvency and resolution frameworks and expand the toolbox for bank failure management.

Deposit insurance schemes (DIS) play an important role in the framework for managing bank failures. The core use of DIS resources is the payout of insured deposits in the context of a bank closure and insolvency proceeding. This limits the risk of depositor runs and ensures that protected depositors retain access to their funds.

DIS may also fulfil their mandate by funding measures that, at a minimum, preserve access to insured deposits as an alternative to payout (“alternative measures”). The use of DIS resources for purposes other than payout is reflected in international standards adopted following the Great Financial Crisis of 2007–09. The IADI Core Principles for Effective Deposit Insurance Systems provide that, subject to safeguards, DIS resources may be used for the resolution of member institutions as an alternative to payout. Similarly, the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions consider DIS as a possible source of funding for resolution.

The paper reviews the various ways in which DIS resources may be used in bank insolvency and resolution. On the basis of responses to a survey of 32 IADI members, the paper takes stock of the types of alternative measures that DIS may fund. These include purchase and assumption transactions; the transfer of deposits – and, possibly, other business – to a bridge bank; and provision of capital and liquidity support, either to prevent the failure of a stressed bank or in the context of a resolution or insolvency procedure.

The survey reveals a wide range of approaches, based on variables that include the tools available under the applicable framework for bank failure management; the mandate of the DIS; the safeguards to protect DIS resources such as the operation of any financial cap on the amount that can be used for alternative measures for a single bank; and the availability of backup funding arrangements for the DIS. These differences in part reflect policy priorities and national institutional arrangements with the safety net.

The ability to use DIS resources for alternative measures can complement bank insolvency and resolution frameworks and expand the options for bank failure management. This may be particularly helpful when the loss absorbency in a failed bank is limited – for example, because deposits form a significant proportion of its liabilities. This may be the case with medium-sized banks. Even if these banks are not systemic, their failure could raise public interest considerations that would be better met by measures that preserve their deposit books and at least some of their services rather than by liquidation and payout.

However, a number of policy considerations frame choices about the use of DIS resources. Although these options can be helpful, they may require capacity on the part of the deposit insurance authority to assess and implement more sophisticated funding arrangements; the availability of appropriate backup funding arrangements if there is a risk that measures other than payout may involve material amounts that could exhaust the available resources of the DIS; and arrangements to deal with any moral hazard incentives for banks. Safeguards in the form of financial caps, including a “least cost” principle, and, where relevant, collateral requirements can help to counterbalance these issues at the cost of lower flexibility.

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