DEPOSIT INSURANCE: BACKGROUND, CORE PRINCIPLES AND SYSTEM OVERVIEWS - PowerPoint Presentation

1. DEPOSIT INSURANCE: BACKGROUND, CORE PRINCIPLES AND SYSTEM OVERVIEWSDavid Walker, Secretary General IADIDavid.Walker@iadi.orgPresentation to New Zealand Treasury and RBNZ Staff Wellington: 28-29 January 2019

2. Presentation outlineBackground and rationale for deposit insuranceIADI and deposit insurance systems around the worldIADI Core Principles for Effective Deposit Insurance SystemsThe financial crisis, lessons learned and new challenges in deposit insurance

3. I. Background and Rational for Deposit Insurance

4. What is DEPOSIT INSURANCE and why is it important?Financial Consumer ProtectionTo protect unsophisticated, retail and/or small-scale depositors in case of a bank failure. Confidence and StabilityDepositors are far less likely to ‘run’ on banks in the event of a failureMore orderly resolutionProvides for the orderly closure/resolution of banks and mechanism(s) to recover costs from the industry.Greater CertaintyLimits 100% implicit guarantees common in many jurisdictions with no explicit deposit insurance.Advantages of Deposit Insurance Systems (DIS)“Deposit insurance” is a system established to protect depositors against the loss of their insured deposits in the event that a bank is unable to meet its obligations to the depositors.

5. Limitations of deposit insuranceSystemic crisesAlthough DIS can reduce incidence of retail “runs” it cannot by itself deal with a broad – based systemic banking crisis Needs preconditions Preconditions for effective DIS include sound legal frameworks, supervisory, regulatory and accounting systemsMoral HazardA DIS (as with other elements of the safety-net) contributes to stability. However, if poorly designed, it may increase risks – i.e. moral hazard.

6. ALTERNATIVES TO DEPOSIT INSURANCE AdvantagesDisadvantagesReliance on Market DisciplineRelies entirely on marketsGreater propensity for bank runs and govt. bailoutsDepositor PreferenceDepositors have a greater chance of recovering losses Doesn’t provide a mechanism to reimburse depositors quicklyNarrow BanksBanks invest in risk free assets onlyMajor restructuring of banking system requiredGovernance IncentivesVery strong incentive for investors & governing minds to control riskDiscourages investment and directorships in banks Subordinated DebtProvides for more market disciplineNot all banks can participate

7. Mitigating Moral Hazard and PreconditionsA well-designed financial safety-net contributes to the stability of the financial system. However, if poorly designed, it may increase risks, notably moral hazard. Moral hazard arises when parties have incentives to accept more risk because the costs are borne, in whole or in part, by others. In the context of deposit insurance, protecting depositors from the threat of loss insulates them from the consequences of unsafe and unsound bank practices, and can lead to greater risk-taking by banks. Deposit insurance, like any insurance system, must be designed to mitigate the impact of moral hazard on the behaviour of shareholders, bank management and depositors. Such mitigation is a function of the overall design of the system. Moral hazard is also mitigated by other safety-net participants.

8. More specifically: Key design features of the deposit insurance system aimed at mitigating moral hazard include: limited coverage levels and scope; differential premiums; andtimely intervention and resolution by the deposit insurer or other participants. The financial safety-net creates and supports appropriate incentives to mitigate moral hazard through several mechanisms, including meeting important pre-conditions such as: the promotion of good corporate governance and sound risk management at individual banks; holding parties at fault responsible for losses; effective market discipline; and the enforcement of strong prudential regulation, supervision, resolution, and laws and regulations. The assessment of the extent to which moral hazard affects a deposit insurance system is based on an evaluation of the effectiveness of supervision, legal framework, and the intervention and resolution regimes.

9. II. International Association of Deposit Insurance (IADI) and Deposit Insurance around the World

10. HistoryEstablished in Basel in 2002 with 25 Founding MembersMembership in 2018 – 83 Members, 10 Associates and 14 Partners Key AdvancementsIADI Core Principles for Effective Deposit Insurance Systems (CPs) – issued in 2009 and revised in 2014 CPs have been incorporated into IMF/WB FSAPs and FSB Peer ReviewsCP Handbook for Assessors published in 2016Research & GuidanceResearch and guidance under development in areas such as: funding; financial inclusion, crisis management and asset recoveriesIADI Biennial Research Conference in Basel – May 2019IADI Annual survey and databaseTraining & Capacity BuildingGlobal/Regional conferences, seminars and technical workshopsJoint FSI-IADI conferences and policy implementation meetingsWebsite and on-line tutorialsMissionTo contribute to the enhancement of deposit insurance system effectiveness by promoting guidance and international cooperationOverview of IADI

11. Growth in IADI membership: 2002-18

12. Deposit Insurance Systems around the World – 2018 Survey ResultsIADI’s 2018 global survey of deposit insurance and financial safety net frameworks received responses from 135 deposit insurers. Key highlights are: Governance and mandates of Deposit Insurers (DIs) The majority (75%) of DIs are legislated and administered by the public sector, although around 25% are privately administered. Three quarters of DIs are legally independent entities and remainder incorporated in the central bank or supervisory authority. Approximately 30% of DIs are assigned a “pay box” mandate – focusing only on payouts. Approximately 40% of DIs have a “pay box plus” mandate, which typically include resolution functions (e.g. financial support and purchase and assumption powers).About 30% function as “loss- or risk-minimisers” acting as resolution authorities and in some cases conducting supervision.  

13. MANDATES OF DEPOSIT INSURERS More pay box plus and loss minimisersTendency for DIs to play a greater role in resolution

14. MANDATES BY REGIONPay-boxPay-box PlusLoss MinimiserRisk MinimiserOthers2008 2017

15. Membership and coverageMembership is mandatory for institutions in almost all jurisdictions, with banks being the dominant institutions. Coverage limits range from below 1,000 USD to still a few systems with blanket guarantees. Average level of Coverage was around 75,000 USD per depositor per institution (median around 54,482 USD) and has risen substantially over the last ten years. FundingNearly 90% of DIS are funded by ex ante contributions. Of remaining jurisdictions relying on ex post funding, a number are in the process of implementing an ex ante funding.An increasing number of ex ante funded DIS have the authority under certain conditions to raise additional ex post contributions. 

16. Average Coverage Limit Coverage Ratio (%)92.1% of deposit insurers have a statutory coverage limit whereas 7.9% of deposit insurers provide full (blanket) coverageAverage coverage limit up sharply from 2009 to 2017Estimated 93.3% of individual depositors are covered by their current DIS (Source: IADI Annual Survey 2009~2017)200920178755,00075,000(in USD)(%)Median 54,482HIGHER AVERAGE coverage LIMITS

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18. COVERAGE BY REGION Coverage proportions (% of # Depositor accounts fully protected) and (% of Value of Deposits fully covered)Issue of appropriate coverage levels – best practice specified in CPs.Note: Asia-Pacific (APRC), Africa (ARC), Caribbean (CRC), Eurasia (EARC), Europe (ERC), Latin America (LARC), Middle-East (MENA), North America (RCNA)

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20. Trends in deposit insurance Nearly 50% of DIs levy premiums on a flat rate basis; higher proportion of loss and risk minimisers charge premiums on risk-adjusted basis.

21. Trends in deposit insurance

22. Depositor Payout and other Resolution FrameworksSome form of special resolution regime for banks exists in around three quarters of jurisdictions. Depositor payout and liquidation are the most common resolution tools.Next most common are purchase and assumption (P&A), bridge bank and open bank assistance tools. 33% of DIs have the authority to act as either receiver/liquidator, conservator/administrator or both.Payout time frames are being reduced -- but 7-day payout a challenge for many systems.

23. Various payment methods are available for reimbursing depositors. * Others: stored value card, mobile banking, prescribed account etc.< Payment Methods >< DIA Access to Records >More than half of DIAs are given access to an institution's financial and depositor’s records prior to bank failure. Reimbursement Check(44%)

24. PAYOUT SPEED On an average, around 50% of DIAs are able to pay out in 7 days; risk minimisers more compliant; Europe and Asia more compliantCompliant jurisdictions can share their experience and provide TA to other jurisdictions

25. III. IADI Core Principles for Effective Deposit Insurance Systems

26. IADI Core PrinciplesCore Principles for Effective Deposit Insurance Systems were approved by IADI and the BCBS in June 2009 and first Methodology completed in December 2010.IADI revised Core Principles (CP) completed and endorsed by the FSB in November 2014. Handbook completed in 2016.An assessment of compliance with the CPs is a useful tool for jurisdictions that are implementing, reviewing or actively reforming a DIS. Key objectives:Improve the effectiveness of deposit insurance systems (DIS) in protecting depositors and contributing to financial stability...…ensure the CPs are adaptable to a wide range of country circumstances, settings and structures, andmitigate moral hazard.

27. IADI Core principles for effective deposit insurance systems16 Core Principles Public policy objectives Mandate and powers Governance Relationships Cross-border issues Crisis management Membership Coverage Sources and uses of funds Public awareness Legal protection Dealing with parties at fault Early detection and intervention Failure resolution Reimbursing depositors RecoveriesDeveloped in 2009 and revised in 2014.Incorporates best practices of deposit insurers and views of organizations such as the BIS, IMF, World Bank and European Forum of Deposit Insurers.Reflects lessons learned in past financial crises. Are being utilized in deposit insurer self-assessments, IMF-WB FSAPs and FSB peer reviews.Key Characteristics

28. IADI Core principles for effective deposit insurance systems16 Core PrinciplesMethodology: 96 Essential CriteriaHandbook: “How To” GuidebookCPs strengthened in 2014/16 to promote more credible deposit insurance systems and to better integrate with other reforms (e.g. FSB Key Attributes).GeneralSpecificFlexibilityMandatory ex-ante funding 7-working day payout targetSufficient coverageMore PrescriptiveEnhancing operational independenceImproving accountabilityStrengthening Governance FrameworksEmphasise contingency planning and coordinating frameworkNew Crisis Management PrincipleOn use of DI funding in resolutionEnhanced info. sharing/co-ordination More Safeguards

29. IADI Core Principles – more detail

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34. Interaction of CPs with other StandardsBasel III and TLAC New capital, liquidity and stress testing requirements.Total Loss-absorbency Capacity (TLAC) established.Link between Liquidity Coverage Ratio (run-off rates) and IADI Core Principles compliance.BCBS Core PrinciplesBasel Committee on Banking Supervision (BCBS) Core Principles for Effective Banking Supervision (BCPs).IADI CP 13 on early detection and timely intervention integrated with BCPs.Financial Stability Board (FSB) Key AttributesKey Attributes introduce new resolution tools such as bail-in and recovery and resolution planning.Emphasize high level information sharing within jurisdictions and in cross-border situations (e.g. Crisis Management Groups). IADI CPs closely aligned with Key Attributes (e.g. CP6,9 and 14).

35. Assessing the Core PrinciplesAn assessment of compliance with the Core Principles is a useful tool for jurisdictions that are implementing, reviewing or actively reforming a DIS. The assessment should identify strengths and weaknesses in the existing DIS, and form a basis for improvement or remedial measures by the deposit insurer and policymakers. An assessment should focus on the DIS and its relationship to the financial safety-net functions which support it. The methodology can be used in multiple contexts: as part of the IMF and World Bank FSAP reviews;self-assessments conducted by a DI – including the IADI Standards Assessment and Reporting Program (SATAP); as a basis for providing bi-lateral or multi-lateral technical assistance; use by private third parties such as consulting firms hired to conduct assessments; and  peer reviews and thematic assessments conducted by the FSB.

36. CORE PRINCIPLESEssential CriteriaCompliance AssessmentImplementation PlanAnd StrategyCorrective ActionPlanAssessment RatingCompliantLargely CompliantMaterially Non-CompliantNon-CompliantNot ApplicableEssential criteria met w/o any significant deficienciesOnly minor shortcomings; authority able to and intends to achieve full complianceSevere shortcomings/ practical implementation weakNo substantive implementationCompliance Assessment Process

37. Worldwide, 29 jurisdictions had either conducted assessments of their compliance with the IADI Core Principles (or had undergone FSAPs) by year-end 2018(Jurisdictions carried out a formal compliance assessment)North AmericaCaribbeanLatin AmericaEurope*AfricaMiddle-East & North AfricaEurasia* 1Asia-PacificAlbania, Austria, Croatia, Czech Republic, Kosovo, Moldova, Poland, Serbia, TurkeyKenya, NigeriaIndia, Korea, Malaysia, Philippines, Samoa, Thailand, VietnamCanada, United StatesBrazil, Colombia, Mexico, UruguayEcuadorSaudi ArabiaTrinidad and Tobago, JamaicaJurisdictions having conductedFormal iadi CP assessments

38. (Number of jurisdictions with the assessment result)*Based on 2014/09 CPs implementation progress: compliance “GAPS”

39. IV. Financial Crisis, lessons learned and new challenges

40. I. The financial crisis and deposit insuranceThe global financial crisis of 2007/8 showed that deposit insurance is a critical element of the financial safety-net in promoting stability.Different jurisdictions used different responses to protect depositors -- depending on crisis impacts and robustness of pre-existing arrangements:Some jurisdictions required little or no direct changes in deposit insurance arrangements (e.g. Indonesia, Japan, Korea, Canada);Others needed to significantly enhance their systems (e.g. Australia and UK); andWhile others with existing systems were forced to temporarily adopt blanket guarantees (e.g. Ireland, Hong Kong SAR, Malaysia and Singapore) due to regional and other factors.

41. Greater convergence in practices and key design featuresIncreases in coverage limitsLess emphasis on moral hazard control through low coverage, elimination of coinsurance. Expansion in mandates/powersIncrease in “pay-box plus” and “loss-minimizer” systems.Most pronounced in Europe, Middle-East and Africa.Increase in number of deposit insurer with systemic bank resolution roles.(e.g. FDIC-USA, CDIC-Canada, MDIC-Malaysia, IPAB-Mexico, NDIC-Nigeria, BGF-Poland, KDIC-Korea, KDIC-Kenya).

42. Increased emphasis on faster payout speeds30-day (and sometimes longer) standard no longer acceptable.Enhancements in information sharing and coordination More formal arrangements developed for domestic and cross-border arrangements.New focus on contingency planning and crisis management.More robust funding arrangementsShift towards increased use of ex-ante funding and differential premium systems.Quest for more effective sources of back-up funding (liquidity).Establishment of specific resolution funds in many jurisdictions.

43. II. Getting ready for the next crisis – key challenges for deposit insurers and regulatorsShifting from standards development to implenetation (e.g. IADI CPs, FSB Key Attributes, Basel III).Measuring compliance.Assessing effectiveness of reforms to-date.Overcoming resisitance to reforms.Memories of the financial crisis are receding and «reform fatigue» is emerging.Banking industry pushing back on reforms (e.g. Dodd-Frank in the United States, Basel III in Europe).Funding: Use of ex-ante funding more widespread but:Fund adequacy an issueAccess to emergency liquidity borrowing problematic in many jurisdictions; and 1 in 3 deposit insurers have no target for their fund.

44. Resolution challenges: Achieving 7-day payout.Integrating new tools such as purchase and assumption and bridge-bank powers.Special challanges with bail-in:Building up bail-inable liability stacks takes time; Treatment of insured and uninsured depositors needs to be clarrified; Funding contributions and sources of liquidity need to be considered; Mitigating contagion during bail-in must be addressed; andLimited and uneven expereince (e.g. Cyprus, Italian banks, Bank Popular) has reduced support for bail-in.Systemic bank resolution roles for deposit insurers with loss/risk minimizing manadates on the rise (8 systems now).Developing resolution plans, crisis management groups and cross-border corrdination agreements.Funding in resolution. Integrating core deposit insurance functions with Systemic Bank Resolution.

45. Powers: Assured legal access by the deposit insurer to depositor information on an ongoing basis still not widespread. Contingency planning and crisis preparedness: Many insurers still not included in system-wide crisis preparedness and planning frameworks. Evaluating effectiveness of reforms to-date uneven.Compliance assessment?Measuring credibility?Innovation: Financial innovation (e.g. FINTECH) impacts: Payment systems => lending => funding => Deposit taking?CrowdfundingInsured deposit-taking (e.g. mobile money, MPESA)

46. Special FINTECH banks (e.g. how to regulate and protect depositors?)Shadow banks: Competitor to deposit-taking institutions?Is the presence of deposit insurance contributing to the rise of shadow banks?Financial stability architecture support for deposit insurance:Basel III process (level and quality of capital has increased).Enhancements to supervisory frameworks emphasizing risk-based supervision, internal governance and risk management.

47. Helping to build more robust deposit insurance systems – IADI Strategic GoalsPromoting deposit insurance system compliance with the Core PrinciplesProviding members with technical support to modernize and upgrade their systemsAdvancing deposit insurance research and policy development010302Developing more formalized compliance assessment framework to identify gaps. Expanding the roster of IADI experts qualified to conduct assessments and support SATAP.Enhancing collaboration with the BIS, IMF, World Bank, FSB and others in utilizing the CPs.Identification and monitoring of global trends in deposit insurance. Development of research and policy positions to support deposit insurer interests.Enhance IADI’s participation and influence in international forums.Enhancing processes to identify member needs for technical support and capacity building and match with providers of assistance.Customizing technical assistance programs to meet member needs.

48. Looking ahead for deposit insurers…Support Core Principle (CP) implementation through assessment reviews/identifying “gaps” and training.Work with the BIS, IMF, WB and FSB to incorporate CPs in FSAPs, technical assistance & peer reviews.Support implementation of FSB Key Attributes and adapting to new resolution regime.Review/recalibrate deposit insurance research & guidance to support CP compliance – i.e. crisis preparedness and management guidance. 

49. Thank you for your attentionDavid WalkerSecretary GeneralInternational Association of Deposit Insurersc/o Bank for International SettlementsCentralbahnplatz 2, CH 4002 Basel, SwitzerlandE-mail: David.Walker@iadi.org15