On 13 January 2011 ECRI-CEPS arranged the seminar 'What Deposit Insurance Scheme for Europe?' due to recent bank failures that have dramatically illustrated the insufficient harmonisation of deposit insurance in the EU. Memories of the run on Northern Rock (2007) or the failing Icelandic banks (2008/09) are fresh in many depositors’ minds. Designing an efficient scheme to underpin the single financial market is therefore a key policy priority. After all, a DGS should be integrated within a system of financial stability.

At EU level, deposit insurance is regulated by the 1994 Directive on deposit guarantee schemes (DGS), but the minimum harmonisation approach adopted at that time has proven largely insufficient. The Directive left much room for national differences regarding the coverage level as well as types of insured deposits/depositors. It did not specify any financing requirements for DGS or obligatory reserves of fundsFinancial Times (Alex Barker in Brussels and Ralph Atkins in Frankfurt) wrote 28 November 2011: EU-wide guarantee scheme for banks urgedNational governments will fail to address the funding shortfall weighing down European banks without urgently adopting a pan-European guarantee scheme, finance experts advising the continent’s top banking regulator have warned.

A watered-down version of the plan, to be discussed at a gathering of ministers on Wednesday, will involve national governments continuing to underwrite bank bonds, as around 15 European Union countries have done since 2008, while coordinating more closely on the exact terms and levels of fees. Since the summer many banks have effectively been shut out of funding markets because of the sovereign debt crisis, a trend that is likely to make many institutions reliant once again on state support to attract investors. Almost a third of euro-denominated bank bonds sold in the first quarter of 2009 were backed by state guarantees and a big portion of this debt is expiring, with bonds worth about €140bn maturing next year, according to Dealogic. In a letter arguing that national schemes alone will be insufficient to meet these funding requirements, a group of finance experts advising the European Banking Authority are calling on government’s to reconsider and “urgently adopt a European approach”. “Given that so many sovereigns are themselves unable to borrow at sustainable rates this national level approach will not work at this time,” the experts wrote, in a letter to finance ministers.

“The interconnectedness of the EU banking system is so high that the inability of banks in troubled countries to fund and recapitalise themselves through the markets is weighing all EU banks down.”

The letter is signed by the six academics and think-tank members on the EBA’s banking stakeholder group, including Daniel Gros of the Centre for European Policy Studies, Rudi Vander Vennet of Ghent university and Sony Kapoor of Re-Define. Germany has led opposition to the idea of “joint syndicates” to underwrite bonds, arguing the proposals would make German taxpayers liable for hundreds of billions of bank debt, mostly in peripheral eurozone economies. The European Commission is expected in coming days to adjust its state aid rules to account for the creditworthiness of countries offering guarantees, so that banks pay smaller fees to buy guarantees from governments with weaker credit ratings. However the tweak to the fee rules may be too little to make some national guarantee schemes workable, given the painfully high borrowing rates faced by some eurozone countries. Some funding strains could be alleviated through more action by the European Central Bank, which is considering steps to make it easier for banks to obtain its liquidity by broadening the range of assets it accepts as collateral. The ECB may also offer banks loans lasting as long as two or three years. Such moves, the ECB’s equivalent to “quantitative easing”, would be in addition to an already announced offer of 13-month liquidity in December.

Eurozone bank lending to the private sector accelerated last month, providing unexpected relief for the ECB as it mulls fresh action to prevent financial sector weaknesses pushing the region deeper into recession. However, the pace of growth remained modest by historic standards, hid regional variations and did little to dispel fears that eurozone banks’ shrinking balance sheets and funding difficulties could severely restrict the flow of credit to the real economy in coming weeks and months – in turn, hitting economic activity.

When the financial crisis hit, the colossal failure of some DGS to honour and manage depositors’ national and cross-border claims led to major government interventions. To alleviate the pressures, the EU decided in the midst of the crisis to increase the minimum coverage to € 50,000 and later € 100,000, but left the remainder of deficiencies to be addressed in a more elaborate proposal.

The question thus arises how to design a scheme for the single market. Should deposit insurance be integrated into an EU financial safety net? Should there be another form of a pan-European scheme, possibly a 28th regime or a single fund? Taking these questions as a point of departure, speakers assessed the Commission’s proposal and share their insights on remaining problematic issues.

Anyway, aim is to protect the system (not institutions, shareholders). There is need for legislative convergence, within the EU as well as international (Basel III, IADI). The role lender of last resort, DIS and laws concerning insolvency should be gathered up together. DIS allows public authorities to close banks more easily.

Argueing, it can also be said that a deposit insurance scheme is a recept for trouble and really a good cause. During uncertain times disadvantages fall into the background. In normal times, however, there is talk of moral hazard. A scheme puts up wrong behaviour amoung depositors and financial institutions. Depositors will have no stimulus to pay attention at which financial institution they put the money, because thinking is not necessary anymore. After all, their risk disappeared and shifted to the guaranteeing financial institutions and eventually to the taxpayer. A scheme is also an invitation for excessive risk taking financial institutions to enter the savings-market. Such institutions offer high rates by investing the money in risky loans and investments
Having thought of it that way, a scheme will undermine financial stability. IMF and the World bank researched the efficiency and pointed out a destabilized effects. Arranging a fund in advance and risk related fees is semblance.

To clarify a new bail-in doctrine, created because of the troubles of Cyprus, P. de Grauwe drafted April 2013 in the commentary 'A recipe for banking crises and depression in the eurozone' issues, items and recommendations on this subject. The most significant effect of the Cypriot crisis is that the rules governing the resolution of future banking crises in the eurozone have been rewritten. According to the new bail-in doctrine future bailout operations will involve deposit holders. Those who hold deposits of more than €100,000 now know that if their country gets into financial trouble and has to ask for support from other eurozone countries, they are likely to lose part or all of their savings.

The new template guiding the resolution of future financial crises will have negative consequences, on two counts; it increases the systemic risk and makes future bank crisis more likely and it will impose large economic costs on countries subjected to the bail-in treatment. To reduce the moral hazard risk, the regulation of banks should go much further than what has been achieved today. The imposition of tighter regulation, including much higher capital ratios; a separation of investment banking and commercial banking; and caps on time-deposit interest rates is a better approach than the bail-in option, which will have enormous economic consequences for the countries of the eurozone that have transferred much of their sovereignty to the creditor nations in the north of the eurozone.

For a comprehensive report please see ECRI POLICY BRIEF NO. 4 (MARCH 2011). Conclusion and recommendations from this report:

Sixteen years after the first EU legislation, the challenge to harmonise deposit protection schemes remains. During the crisis, a number of DGS proved unreliable and serious cross-border tensions emerged in handling payouts. As a result, increasing the efficiency of deposit protection schemes emerged as a policy priority. But to what extent should schemes be harmonised in the EU and what roles should they
have?
The Commission’s 2010 proposal is a first step forward, covering a number of aspects of DGS, such as the harmonisation of scope of coverage and deposit/depositor eligibility. This will increase consumer protection in many countries and limit incentives to locate savings in markets with higher coverage levels, as the same amounts and types of deposits will be insured throughout the EU.
The proposed financing requirements and targeted fund size of deposit insurance are necessary, because past experience has demonstrated that the fund availability was not sufficient to handle consumers’ claims following bank failures. The target level of 1.5% of eligible deposits appears reasonable, as experiences have been positive in the US with the FDIC target level at 1.15-1.5% of insured deposits.
But it implies that several DGS have to change from ex post to ex ante funding and have to create considerable reserves. This comes at a high cost for credit institutions, in addition to the new standards for capital and liquidity requirements stemming from Basel III, and possibly other rules.
While the Commission’s proposal certainly has its merits, a number of issues are left open, for example what further roles deposit insurers should take on. As argued above, there are strong reasons to equip deposit insurers with a mandate beyond the simple pay box function, and including them in the wider financial safety net. If that role was extended to intervention measures, European DGS would need to be equipped with adequate powers and tools. Such mandate would only make sense if banks’ resolution procedures were clearly aligned as well. DGS should
be assigned a clear role in the European stability framework; limited reporting requirements to the EBA is not sufficient. And their role should be
reconsidered now, as the regulatory response to the crisis should embrace the entire safety net in order to avoid any inconsistencies.

An important omission in the Commission’s proposal is governance structures and the ultimate liability of private and public DGS. Would it be better to have a pan-European scheme administered by the public or private sector? For the time being, both governance structures exist at the national level. Yet, no matter how well a DGS is designed, there always remains an implicit responsibility on governments to step in as
the lender of last resort, as was largely the case during the crisis. This ultimate liability of the public sector is a strong argument in favour of publicly administered pre-funded deposit insurance.
Out of the three possible pan-European schemes discussed above, the only efficient, reliable and sustainable solution is full harmonisation, meaning the creation of a single European deposit insurance scheme. The network structure always leaves regulatory gaps, as does a 28th regime. With full harmonisation, many challenges posed by the existing variety in national deposit insurance schemes would
disappear, for instance related to the scope of coverage, payout procedures and – most important – the branch vs subsidiary treatment of foreign banks.

For the time being, however, full harmonisation is difficult to enforce, as some member states and national interest groups are already manifesting their dissent over the Commission proposal. Pleas by national governments and interest groups that stronger harmonisation of deposit insurance is not in line with the subsidiarity principle can be disregarded, as DGS of a different nature cannot coexistcoexist
in a single market and European action to address deposit insurance challenges is more effective than action taken at national or local level. The problems that have arisen to protect and reimburse depositors across borders call for more harmonisation, since a network approach is clearly insufficient.

The member of the European Parliament, group of the Progressive Alliance of Socialists and Democrats, rapporteur on the DGS proposal:

• do not promise what is not feasible (confidence in the banks);

• take into account the political acceptance. Is a 7-days pay back period feasible?;

• there is the point of view from banks and the point of view from consumers;

• it is about to keep the bank alive, key importance for the client.

FSCS brought forward, amoung other things,

• a Pan European DGS;

• mutual borrowing and funding ex ante and ex post;

• de Larosière report;

• corporate governance structures and IMF assessment.

Financial Stability Roles: Checks and Balances

IADI - EFDI conference September 2010

Large scale support to institutions "too big to fail" has increased:

• moral hazard when counterparties believe that they will never suffer a loss;

• potential fiscal costs of a rescue and the accompanying public outrage;

• the risks that the home country will not have the resources to rescue a bank ("too big to save")

The Bank Recovery and Resolution Directive puts in place a legislative framework that is consistent with the Financial Stability Board's key attributes for effective resolution regimes. The BRRD therefore creates the potential to make banks resolvable and bring an end to the too-big-to-fail phenomenon).