Download final precondition july 2010

Preconditions
for
Deposit Insurance
David C. Parker
International Monetary Fund
Monetary and Capital Markets Department
Preconditions
 What do we mean by Preconditions?
 Basically, the desirable circumstances
necessary for a deposit insurance
scheme’s (DIS) success.
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Preconditions
 Deposit insurance systems are most
effective when certain external elements
and preconditions are in place
 If actions are necessary to address any
deficiencies, then a deposit insurance
system may be adopted or reformed
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Preconditions
 Some basic preconditions:
• Macroeconomic stability
• Sound, market-based banking system
• Strong prudential regulation and
supervision
• Well-developed, proper legal framework
• Strong accounting and disclosure regime
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Economy and Banking System
Assessment
 To be effective a deposit insurance
system must be:
• Consistent with both the county’s
economic and institutional settings
• Aligned with the public-policy
objectives
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Objectives
 Protect small depositors
 Promote financial stability by making
prompt reimbursement to insured
depositors in the event of a bank
failure.
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Economy and Banking System
Assessment
 Deposit insurance introduction or
reform process will be smoother if the
health and stability of the economy and
banking system are addressed
beforehand
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Economy and Banking System
Assessment
 Situational analysis :
1) Identify the conditions that could
adversely affect the economy or the
banking system
2) Assess whether a deposit insurance
system can be effective operating in such
an environment.
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Economy and Banking System
Assessment
- If corrective actions are necessary, they
should be taken before or in concert
with the adoption or reform of a
deposit insurance system
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Macroeconomic Stability
 Macroeconomic instability hampers the
functioning of markets and can distort
financial intermediation
• (i.e.) It is more difficult for banks and
their clients to judge different types of
risks in unstable times.
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Macroeconomic Stability
 The introduction or reform of a deposit
insurance system on its own will not be
sufficient to restore macroeconomic
stability
 Deposit insurance is not designed, nor can
it be expected, to resolve a systemic crisis.
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Macroeconomic Stability
 Authorities should analyze the conditions
and factors affecting the banking system
that may influence a deposit insurance
system’s effectiveness before
introduction
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Macroeconomic Stability
These may include:
- The level of economic activity
- Current monetary and fiscal policies
- Inflation
- Housing and financial assets price
- Financial markets’ condition
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Sound Banking System
 Policy makers must assess whether the
entire banking system is sound, not just
one institution within the system
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Sound Banking System
 Assessing the banking system’s health
includes:
-detailed capital adequacy evaluation
- liquidity
-credit quality
-risk-management policies and practices
-extent of any other problems
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Sound Banking System
 Assessing the banking system structure
includes:
- the number, type and characteristics
of deposit taking institutions
- the extent of competition,
concentration, interconnectedness,
and the ownership of institutions
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Sound Banking System
State dominated:
When state makes credit and investment
decisions, it would not be credible to
claim it does not back its obligations
Deposits are perceived as having full
guarantee.
Coverage restrictions are not meaningful
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Sound Banking System
 System concentration - Few very large
banks
 Would require substantial resources to
compensate insured depositors
 TBTF – inevitably need taxpayer support
to compensate insured depositors
 No DIS means: implicit, discretionary
scheme.
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Sound Banking System
Small bank failures, however, can
potentially affect financial stability
Contagion can spread rapidly to other
banks—even large banks
Deposit insurance can reduce incentives
for depositors to run from small banks
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Sound Banking System
Foreign ownership – arguments against a
DIS:
Foreign banks dominate the system
Foreign banks have impeccable
reputations
Foreign banks’ parents have capacity
and commitment to support the
subsidiary
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Sound Governance
 Sound governance means:
independence, accountability,
transparency, disclosure, and integrity
 Each safety-net participant is
operationally independent and objectives
are consistent
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Sound Governance
 All safety-net participants should be
provided with all the means necessary to
fulfill their mandates
 The safety-net framework should clearly
define the decision-making body in a
time of crisis
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Strong Prudential
Regulation and Supervision
• Directly impacts a deposit insurance
system’s effectiveness
• Only viable banks can operate and be
deposit insurance members
• In compliance with the Basel Core
Principles for Effective Banking
Supervision
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Strong Prudential
Regulation and Supervision
 The supervisory authority should:
- have an effective licensing or
chartering regime
- conduct regular and thorough
examinations of individual banks
- have a problem bank process that
includes early detection, timely
intervention, and resolution
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Strong Prudential
Regulation and Supervision
 Problem bank process should include
early involvement of DIS:
- DIS should participate in
examinations of CAMELS 3, 4 and 5
rated banks (regardless of mandate)
- DIS should be included in the
resolution process, including
enforcement actions and resolution
strategies
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Effective Legal Framework
 Should include a system of business laws
including:
- corporate, bankruptcy (particularly
banking bankruptcy), contract,
creditor rights, consumer protection,
anti-corruption/fraud and private
property laws
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Effective Legal Framework
 Highly desirable to have a special bank
resolution regime (SRR)
 At a minimum, the SRR provides for a
level of judicial review such that the
bank supervisor’s decisions cannot be
reversed—any successful appeals limited
to monetary damages
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Legal Framework Nexus
with DIS Objectives
 Promote financial stability by making
prompt reimbursement to insured
depositors in the event of a bank
failure.
 If DIS must wait to reimburse insured
depositors while bankruptcy court
appeal process runs its course,
impossible to meet this objective
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Legal Framework Nexus
with DIS Objectives
 With SRR (and with advance
preparation), DIS can make insured
depositor reimbursement virtually
immediately—either directly or via a
P&A transaction
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Effective Legal Framework
 The banking and deposit insurance
legislation must be compatible
 Trigger for insured depositor repayment
must be harmonized in banking and
deposit insurance legislation
 Information exchange between the
deposit insurance system and the
supervisor is legally established
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Effective Legal Framework
 Banking laws and regulations are updated
as necessary
 Bank supervision and DIS staff are legally
protected for actions taken in good faith.
 The deposit insurance system, or other
relevant authority, can take legal action
against the management of a failing bank
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Accounting and Disclosure
 Should include comprehensive, welldefined and internationally accepted
accounting principles
 Financial statements users must have
independent assurance that accounts:
- provide an accurate view of the
company’s financial position
- are prepared according to established
accounting principles
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Accounting and Disclosure
 Banks must publish financial statements
periodically
 Banks must have an annual independent
audit
 Investors and large depositors can use
this information to increase market
discipline
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Accounting and Disclosure
 Other key elements:
• Additional tools for bank supervisor
and DIS to evaluate individual banks’
health and banking systems as a whole
• Provides basis for accurate and timely
insured deposit determination,
necessary for prompt reimbursement
• Accurate data for risk-adjusted
differential premium systems
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Summary
 Basic preconditions:
• Macroeconomic stability
• Sound, market-based banking system
• Strong prudential regulation and
supervision
• Well-developed, proper legal framework
• Strong accounting and disclosure regime
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Summary
 The advantages of an explicit, limited
deposit insurance scheme can best be
realized if certain conditions are in place
before its introduction.
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Thank you
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