Role of Deposit Insurance in Bank Resolution Framework – Lessons from the Financial Crisis

1. Core Principles for Effective Deposit Insurance Systems and Challenges to Assessment of Safety Net FrameworkKumudini Hajra Role of Deposit Insurance in Bank Resolution Framework – Lessons from the Financial Crisis November 13-16, 2011 JODHPUR, INDIA

2. A New World for Deposit Insurers Impact of the global crisis • Depositor protection central to financial stabilization • DIA more fully integrated into the safety net • Mandates of DIAs are expanding Role of Core Principles in this new world • CPs are an important tool in: • Guiding deposit insurance reform • Guiding self assessments • Guiding IMF and World Bank FSAP evaluations • Guiding FSB in its current peer review

3. Core Principles for Effective DI Systems CP 1 Public Policy Objectives CP 2 Mitigating moral hazard CP 3 Mandate CP 4 Powers CP 5 Governance CP 6 Relationship… CP 7 Cross-border issues CP 8 Compulsory membership CP 17 Reimbursing depositors CP 9 Coverage CP 10 Transitioning… CP 11 Funding CP 12 Public awareness CP 18 Recoveries CP 13 Legal protection CP 14 Dealing with… CP 15 Early detection… CP 16 Effective resolution processes CP6: Relationship with other safety-net participants CP10: Transitioning from a blanket guarantee to a limited coverage deposit insurance system CP14: Dealing with parties at fault in a bank failure CP 15: Early detection and timely intervention and resolution

4. Analytical Framework Design features for expanded mandates CP15. Early detection and timely intervention and resolution CP16. Effective resolution processes Links to broader safety net CP14. Dealing with parties at fault CP10. Transitioning from a blanket to limited coverage CP 7. Cross-border issues Strategic role CP1. Public policy objectives CP2. Mitigating moral hazard CP3. Mandate Organizational issues for DI CP4. Powers CP5. Governance CP13. Legal protection CP12. Public awareness Design features for DI CP8. Compulsory membership CP9. Coverage CP11. Funding CP17. Reimbursing depositors CP18. Recoveries

5. Challenges for Core Principles Focus of Core Principles • CPs refer to deposit insurance system not to the agency • The deposit insurance system involves all safety net players • Supervisors • Resolution agencies • Deposit insurers • International differences in role, responsibility of DIS • Mandate of DIA differs internationally. • Narrow mandate systems -- payout • Paybox plus -- some resolution functions • Risk minimizer

6. Principles for Broader Safety Net Role in Safety Net • CP6: Relationship with other safety-net participants • CP14: Dealing with parties at fault in a bank failure • CP15: Early detection and timely intervention and resolution • CP16: Effective resolution processes

7. CP 6: Relationship with other safety-net participants A framework should be in place for the close coordination and information sharing, on a routine basis as well as in relation to particular banks, among the deposit insurer and other financial system safety-net participants. Issues • Explicit and formal arrangements for information sharing • Advance and essential information to prepare for payouts • Planning forward-looking scenarios

8. CP 14: Dealing with parties at fault in a bank failure A deposit insurer, or other relevant authority, should be provided with the power to seek legal redress against those parties at fault in a bank failure. Issues • Examination of those responsible internally for bank failure • Sanctions for responsible parties – consultation with lawyers

9. CP 15: Early detection and timely intervention and resolution The deposit insurer should be part of a framework for the early detection and timely intervention and resolution of troubled banks. Issues • CP 15 is for early detection of financial distress and timely decision to intervene; CP 16 is for process of failure resolution • Role for DI in early warning, intervention and failure resolution framework • Whether the framework is effective – relates to overall safety net • Rights of shareholders

10. CP 16: Effective resolution processes Effective failure-resolution processes should allow the deposit insurer to reimburse depositors promptly; minimise resolution costs and disruption of markets; maximise recoveries on assets; and, reinforce discipline through legal actions in cases of negligence or other wrongdoings. Issues • Allocation of responsibility for bank resolution should be clear, including that for systemic institutions • Resolution framework can be rendered ineffective by flaws in legal framework and overlap in responsibilities • Adequate tools for resolution • Ensure least cost resolution of a failing bank

11. Assessment Challenges An assessment must evaluate the safety net • Evaluate safety net functions outside the DIA • Requires complementary skills in team • Requires knowledge beyond DI • Evaluate the role of DIAs within safety net Assessment methodologies • Assessment of pre-conditions • Reviewing legal and institutional framework • External sources • FSAP reports • IMF and World Bank Reports

12. Lessons Pilots have pointed to some lessons: • Clarity about difference between PPOs and mandate • Reducing overlap of CP 15 and 16 • Bringing all governance issues under one CP • Understanding powers relative to mandates

13. Next Steps The Core Principles and Methodology is a dynamic document • Lessons point the way to more robust assessment procedures. • Handbook under continual revision • At some point, revise the CPs themselves • IADI -- work with members to ensure effectiveness • IMF/World Bank to continue assessment evaluation

14. Thank you