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DEPOSIT PROTECTION BOARD. COVERAGE OF DEPOSIT INSURANCE. Presented at the IADI Africa Regional Committee Annual Conference (ARC) on The Benefits of Deposit Insurance in Africa. DAR-ES-SALAM,TANZANIA :29 – 31 JULY 2010 BY: J M CHIKURA CHIEF EXECUTIVE OFFICER
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COVERAGE OF DEPOSIT INSURANCE Presented at the IADI Africa Regional Committee Annual Conference (ARC) on The Benefits of Deposit Insurance in Africa. DAR-ES-SALAM,TANZANIA :29 – 31 JULY 2010 BY: J M CHIKURA CHIEF EXECUTIVE OFFICER DEPOSIT PROTECTION BOARD ZIMBABWE
Outline • Introduction • Scope of Coverage • Types of Coverage • Setting the Coverage Limit/Level • Adjustment of Coverage Limits • Extent of Coverage • Concluding Remarks
Introduction • Deposit insurance coverage (DIC) is one of the key issues in designing deposit insurance systems. • Coverage issue covers scope and level. The issues are which classes of depository institutions should join the scheme, which financial instruments to cover and to what extent to cover them? • Core Principle (see core principle 9) - Policy makers should define clearly in law, prudential regulations or by laws what an insurable deposit is. The level of coverage should be limited but credible. It should cover adequately the large majority of depositors to meet the public policy objectives of the system. • The level/limit determines the potential liabilities of the DIS and also influences the extent to which depositor’s confidence in the banking system can be promoted by the scheme.
Scope of Coverage • Scope of coverage need to match the public policy objectives of the DIS. • Insure all financial institutions? Deposit taking institutions are the prime targets of a DIS • Cover all types of retail deposits. • Insure foreign currency deposits if material i.e. Hong Kong, Indonesia and Philippines are some examples of DIS which insure both local and foreign currency deposits • Decision is complex & depends on the country’s particular circumstances i.e. the total value of the retail foreign currency deposits
Determination of Insurable Deposits Basic considerations include: • the relative importance of different types of deposits in the banking sector, • ease of determining ownership of the deposits, • nature and purpose of the deposits • Simplicity is key as exclusions can slow down process of payment
Most deposit insurers exclude the following instruments from coverage: • Interbank deposits, • Government deposits • Deposits held by bank directors and officers, • Bearer instruments, • Foreign currency deposits • High interest rates typically paid by troubled banks • Both eligible and non eligible deposits for DIS coverage should be clearly defined by law or private contract so that depositors know with certainty.
Types of Coverage Level/Limit • Limited/partial coverage • Full coverage • Blanket coverage Which option to pursue is mainly determined by the public policy objective emphasis.
Limited/ Partial coverage • Protects depositors only up to a certain amount and/or a given proportion of account balance. • Practiced where main public policy objective is to protect depositors, especially the small & unsophisticated ones. • The idea is not to interfere with the market discipline • Limited DI coverage for some African DIS ; • Nigeria : Banks (N200 000-US$1 709 Micro Finance:N100 000): Kenya(SH100 000-US$1 330): Zimbabwe (US$150) :Tanzania(SH1 500 000 - US$850) . • DI coverage in Africa the lowest compared to Europe , Asia and the US. • Current coverage range: Euro zone , 50 000 to 100 000 Euros whilst coverage in Asia ranges from US$5 300 in the Philippines to US$86 000 in Japan (Walker:2007).
Advantages of Limited Coverage • gives full protection to small depositors. • gives the banking system at least some protection against contagious bank runs. • preserves some degree of market discipline by exposing large depositors to potential loss
Disadvantage of Limited Coverage • Might not offer the banking system a large measure of protection against bank runs because large depositors are also believed to have the capability to precipitate a run when a bank is perceived to be in financial difficulty. • Therefore the objective of contributing to the stability of the financial system may suffer. • The Northern Rock episode is a reminder that DIS with low levels of coverage are not effective in preventing bank runs. The Financial Services Compensation scheme had a limit of 35000 pounds when Northern Rock suffered a bank run in 2007. • Zimbabwe also experienced bank runs between 2003 and 2006 despite the existence of a limited cover deposit insurance scheme.
Full coverage • Protects all depositors , 100% of account balances. • This is often adopted if public policy objective emphasizes the maintenance of banking stability.
Advantage of full coverage • Full protection is preferred from a stability point of view, as it reduces the motivation for a run on a bank. • Disadvantage of full coverage • Full protection erodes market discipline and increases the problem of moral hazard.
Blanket coverage/guarantee • Offers full protection to both bank depositors and creditors. • Usually applied during banking systemic crisis that threatens the payment system. • Transition to limited /partial coverage should commence as soon as possible. • Blanket guarantees for a temporary period is often advocated but with government funding. • This approach has been used in Indonesia, Jamaica, Japan, Malaysia and Thailand.
Advantages of blanket coverage • In a banking crisis, blanket coverage may strengthen depositors’ confidence as it covers all depositors and creditors fully thereby preventing bank runs and capital flight. • Blanket guarantee also gives authorities time to implement bank resolution strategies.
Disadvantages of blanket coverage • Blanket guarantees are a strain on the fiscus as they involve huge funding requirements. • Full protection erodes market discipline and increases the problem of moral hazard if the blanket guarantee is retained for too long.
Setting the Coverage Level/Limit • Majority of schemes are explicit limited deposit insurance schemes. • It is in fact regarded as the best practice. • The question is how do we determine an appropriate level of coverage for a limited/partial coverage?
Key Considerations Depositor Profile • The coverage limit can be set through an examination of data on the number of deposit accounts and their size distribution. • This provides an objective basis for determining the proportion of accounts and total deposits that will be covered. • The selected coverage level should protect the majority of depositors, at least 80-90% of depositors should be covered in full. • Using this approach alone has however been criticized as it does not take account of the macroeconomic condition of the country within which the banking system operates.
GDP • Another means of assessing the adequacy of coverage is to use a uniform measure such as GDP per capita. • Coverage should be set in the region of one to two times per capita GDP (Garcia:2000). • However this approach may fail to produce the desired result due to the following reasons; • Income distribution is not the same in different countries, • what is considered a “small depositor” depends on the particular situation of a country and may not be captured by a single parameter such as the level of GDP. • Need for striking a balance between discouraging destabilising bank runs by small depositors, while maintaining market discipline from large depositors
Funding • The coverage level can also be set after taking into account the size of the DI fund.
Other Considerations in Setting Coverage Limit • Economy • Country ‘s economic and financial environment/development. • Coverage of other DIS • It is also imperative to take into account coverage limits in other countries with similar development, phase of financial industry or culture .
Adjustment of Coverage Limits • Need for continuous review of coverage limit from time to time • Should inflationary changes be tracked? • Some countries do index to inflation • Need for coverage number to remain clear in the minds of depositors
Reasons for Adjusting Cover • To maintain a credible deposit insurance cover in response to inflationary pressures. • To transition from a blanket coverage regime to a limited coverage one. • Coverage can also be adjusted in response to the growth of real income. • Adjustments should not occur too often as this might end up confusing the public ,at the same time adjustments should not be too infrequent such that the DI fails to meet its public policy objectives.
Power for adjusting coverage limit vests with either; • External governmental bodies- Legislature, Minister of Finance, Central Bank, eg USA, The Philippines , Taiwan and Canada or; • The Governing Boards of DI Agencies have such powers as in Zimbabwe, Malaysia and Nigeria.
Extent of Coverage • Coverage level applied on a per depositor per bank basis • Joint account holders need to appoint a primary depositor • Netting off deposits against loans is done but only those loans in default
Concluding Remarks • Disclosure of coverage limit and scope as well as other benefits and limitations under the DIS must be effectively communicated to depositors and all stakeholders in order to build public confidence in the DIS. • Limits and coverage must be adequate. • During a systemic crisis public confidence can be maintained by; -Increasing the coverage limit, -Expanding the range of products covered; and -Implementing systemic stabilization measures eg, blanket guarantees.
Concluding Remarks (cont) • DIS should not use government guarantee as a device to attract deposits from other jurisdictions. • IADI guidance through the “core principles” enable policy makers to decide on DI coverage that best suits their peculiar economic and financial environment. • Thank You !
