The paper surveys the characteristics of explicit systems of deposit insurance in 68 countries. It compares these actual practices with a set of best practices that has been adopted by IMF staff for their advice to member countries. These best practices seek to establish a system of deposit insurance that provides incentives for all parties—whether they are directly or indirectly affected by the guarantee—to keep the financial system sound. The paper discerns some convergence toward best practices in recent years, but notes several areas where improvements in the incentive structure are still necessary.
that has government backing and is run by the government. The United Kingdom has a privately-funded and privately-runDIS. The United States has a government-run system that is privately-funded but has explicit government backing. (There are also instances of privately-funded and privately-runDIS that have, usually informal, government backing; but these are likely to give rise to conflicts of interest.) While the private deposit insurance agency could have a limited agenda, a government-run insurance agency could have wider roles and responsibilities.
A well-designed deposit insurance system (DIS) will provide incentives for citizens to keep the financial system sound. However, a poorly designed DIS can foster a financial crisis. This paper, therefore, makes recommendations for creating and running a limited, incentive-compatible, DIS. The paper also examines factors in the decision to grant, temporarily, a comprehensive guarantee, and the design of that guarantee, should a systemic financial crisis nevertheless occur. It concludes with guidance on the removal of that guarantee.
level, or raised to replenish a depleted fund. Setting an appropriate target demands a realistic assessment of the condition of the banking industry, the size and timing of the financial demands that are likely to be placed on the fund, and the industry’s ability to pay the necessary premiums without prejudicing its profitability, solvency and liquidity. 12
Countries usually decide that they want the government to back up a well-runDIS that is met by unexpected demands on its resources and is in need of additional funds in order to carry
regimes,” in cases where they did not pre-exist.
13. To circumvent the constraints of the EU state aid rules, some countries may also resort to using privately run, voluntary DIS . 22 Such DIS may pre-exist, or be established, in addition to the mandatory (typically publicly run) DIS to circumvent state aid rules. However, this increases costs and risks for the banking sector. Moreover, a voluntary DIS offering (unlimited) guarantees exposes the state to contingent fiscal risks if the guarantees ultimately need to be backstopped by the government to preserve
This paper argues that in the European Union (EU) deposit insurance funds are too difficult to use in bank resolution and too easy to use outside resolution. The paper proposes reforms in three areas for the effective management of bank failures of small and medium-sized banks in the European Union: making resolution the norm for dealing with failing banks; establishing a common DIS for the European Union; and increasing funding and backstops for deposit insurance while removing constraints on their use for resolution measures. Without these changes, the European Union will continue to be challenged by banks that are too small for resolution and too large for liquidation.
Uncertainty about the riskiness of new financial products was an important factor behind the U.S. credit crisis. We show that a boom-bust cycle in debt, asset prices and consumption characterizes the equilibrium dynamics of a model with a collateral constraint in which agents learn "by observation" the true riskiness of a new financial environment. Early realizations of states with high ability to leverage assets into debt turn agents optimistic about the persistence of a high-leverage regime. The model accounts for 69 percent of the household debt buildup and 53 percent of the rise in housing prices during 1997-2006, predicting a collapse in 2007.