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Deposit insurance systems - lessons from the crisis for CESEE banking systems

Deposit insurance systems - lessons from the crisis for CESEE banking systems. Małgorzata Iwanicz-Drozdowska Budapest , 23 June 2010. AGENDA. Theoretical background DIS before the subprime crisis DIS after the first wave of the subprime crisis Financial strength of DISs

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Deposit insurance systems - lessons from the crisis for CESEE banking systems

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  1. Deposit insurance systems - lessons from the crisis for CESEE banking systems Małgorzata Iwanicz-Drozdowska Budapest, 23 June 2010

  2. AGENDA • Theoreticalbackground • DIS beforethesubprimecrisis • DIS afterthe first wave of thesubprimecrisis • Financial strength of DISs • CESEE as host countries • Whatshould be changed ?

  3. theoreticalbackground (1) • Deposit insurance (orguarantee) system (DIS) is an important part of the financial safety net • As M. Friedman said, introduction of DIS inthe USA was „the most important structural change in […] monetary system in the direction of greater stability since the post-Civil War tax on state bank notes” (1959)

  4. theoreticalbackground (2) • But DIS has to be properlydesigned • „A deposit insurance system islike a nuclearpower plant. Ifyoubuilditwithoutsafetyprecautions, youknowit’sgoing to blowyouoffthe face of theearth. And evenifyou do, youcan’t be sureitwon’t.” (L.W. Seidman, FDIC Chairman,1985-1991) see: Coreprinciples for effectiveDISs (BSBC, IADI, 2009)

  5. theoreticalbackground (3) • Moral hazard is one of the most importantissuesrelated to DIS • According to coreprinciples (no. 2): Moral hazard should be mitigated byensuring that the deposit insurance system contains appropriate design featuresand through other elements of the financial system safety net • Researcherstried to evaluatetheimpact of existence of DIS on banks’ risktaking, banks failures and banking crisis • Results do not show clear relation

  6. theoreticalbackground (4) • Wheelock & Wilson (1994), Alston, Grove & Wheelock (1994) – no relationbetweenexistence of DIS and number of bank failuresintheAmericam banking sector • Karels & McClatchey (1999) – no relationbetweenexistence of DIS and risktakingbehaviourinthe American credit unions’ sector (the same for Canadian banks – Gueyie & Lai, 2003)

  7. theoreticalbackground (5) • Thies & Gerlowski (1989), Grossman (1992), Wheelock (1992), Demirguc-Kunt & Detragiache (2002) – thereis a relationbetweenexistence of DIS and banking problems • Hovakimian, Kane & Laeven (2003) – introduction of explicitdepositinsurance has had adverse effects in environments that are low in political and economicfreedom and high in corruption (sample of 56 countries).

  8. theoreticalbackground (6) • Gropp & Vesala (2004) – introduction of DISsin EU-15 reducedthelevel of riskinthe banking sector, but incase of big banks riskremainedunchanged • Angkinand & Wihlborg (2010) - relationship between banks’ risk taking and explicit deposit insurancecoverage can be described as U-shaped (sample of 32 countries)

  9. DIS beforethesubprimecrisis (1) • Somebuilt-inmechanism for mitigatingmoral hazard • For depositors: limited level of coverage, co-insurance • For banks: risk-basedpremiums, DIS financing by banking sector (self-financing)

  10. DIS beforethesubprimecrisis (2) • For depositors: limited level of coverage, co-insurance • Limited level of coverage: inall EU countries (exceptprivate system for German banks) and in non-EU CESEE countries • Co-insurance in 11 EU countries, withinin 6 CESEE – EU Members

  11. DIS beforethesubprimecrisis (3) • For banks: risk-basedpremiums, DIS financing by banking sector • Only8 Europeancountriesuseriskbasedpremiums: Finland, France, Germany, Italy, Portugal, Sweden, Turkey and Romania • In all EU and otheranalysed CESEE thereis banking sectorfinancingwithsomemechanism for additional (emergency) financing

  12. DIS afterthe first wave of thesubprimecrisis (1) • Beforethecollapse of Lehman Brothers and Icelandicproblemsthere was no politicalwillingness to increasethelevel of guarantees on the EU levelorchangetheway of DISsfinancing • After LB collapse and Icelandiccrisispromptdecision to increaseguaranteesup to 50.000 EUR and then to 100.000 EUR and cancellation of co-insurance.

  13. DIS afterthe first wave of thesubprimecrisis (2) • 10 countriesdecided to introduce 50.000 EUR (orclose to) guarantees, 10 countries – 100.000 EUR, 3 countries – coverageremainedunchanged (France, Germany*, Italy) • Somecountriesdecided to introduceblanketguarantees (Austria – only for individuals, Denmark, Greece*, Ireland*, Slovakia, Slovenia) – de facto state financing • Furtherworks on EU level on DIS, also on financing

  14. Financial strength of DISs (1) • Difficult to measuresincethereare no strongtheoreticalguidelines and thereis a lack of publiclyavailable data • Basic measures: (1) accumulated fund related to eligibledeposits and (2) accumulated fund related to covereddeposits. • Itisreasonable to measurethe financial strength of DISsincase of ex anteormixedfinancing (21 EU countries; most of CESEE, exceptSlovenia)

  15. Financial strength of DISs (2) Source: owncalculationsbased on EC data

  16. Financial strength of DISs (3) Source: owncalculationsbased on EC data

  17. Financial strength of DISs (4) Source: owncalculationsbased on ECB, EC data

  18. Financial strength of DISs (5) Source: EC, 2006

  19. CESEE as host countries (1) • DISsfrom CESEE arerelativelystrongerwithbetterdesignedfinancing (ex ante) • For depositorsactualsafety and soundnessisbased not on nominallevel of guarantees, but on financial strength of DIS

  20. CESEE as host countries (2) • Branches and home country rule • Howimportantarebranches of CIs? • Ishome country rulereallyworking?

  21. CESEE as host countries (2) • Branches and home country rule • Howimportantarebranches of CIs? • Ishome country rulereallyworking?

  22. CESEE as host countries (2) • Branches and home country rule • Howimportantarebranches of CIs? • Ishome country rulereallyworking ?

  23. CESEE as host countries (2) Source: owncalculationsbased on ECB data

  24. CESEE as host countries (2) • Branches and home country rule • Howimportantarebranches of CIs? • Ishome country rulereallyworking? (Icelandiccase -> Icesave, Kaupthing Edge)

  25. CESEE as host countries (2) * Fund for alltypes of CIs Source: owncalculationsbased on banks, ECB and EC data

  26. CESEE as host countries (3) • Host countriesshouldevaluate financial potential of home country DIS and lookcarefullyat host CI financial standing • In case of systematicallyimportantCIs host countrieshave to „rely” on too big to faildoctrine and wellsituationin public finance of home country

  27. Whatshould be changed ? (1) • Financingscheme – ex anteonlywithwelldesignedemergencyfinancing (e.g. additionalpremiums, issue of securities, governmentloan) • Riskbasedpremiums and „admissionfee” for newestablishedCIs • No blanketguarantees • Re-introduction of co-insurance

  28. Whatshould be changed ? (2) • Access for host countries to supervisoryreports on hosted bank and the financial potential of home country DIS • In order to have clear pictureitisnecessary to collect and publish data related to „eligible” and „covered” depositsineach country • Itisnecessary to improvetransparencyinDISs’ reports (e.g. level of accumulated fund) • …

  29. Thankyou for yourattention! E-mail address: Malgorzata.Iwanicz-Drozdowska@sgh.waw.pl

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