core principles for effective deposit insurance systems
TRANSCRIPT
David C. Parker
International Monetary Fund Monetary and Capital Markets Department
Core Principles for Effective Deposit Insurance Systems
-Overview and Methodology-
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Mandates & Missions
Protect (small) depositors
Contribute to financial stability
Preserve confidence in the banking system
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Mandates & Missions (cont…)
Also:• Promote competition• Promote economic development• Limit moral hazard• Promote market discipline
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Key Assumptions or Prerequisites
Coordination, communication, cooperation, and information sharing among all safety-net players.
Ministry of Finance
Central Bank
Deposit Insurance Organization
Bank Supervisor/ Regulator
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Preconditions
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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Preconditions for Deposit Insurance
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 governance, accounting and
disclosure regimes
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Preconditions
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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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 StabilityThese 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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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, it’s 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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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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Accounting and Disclosure
Should include comprehensive, well-defined 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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Preconditions 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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Background
The International Association of Deposit Insurers (IADI) developed a set of Core Principles for Effective Deposit Insurance Systems in February 2008.
Sources: FSF (2001), IADI research and guidance (2002-2009), APEC policy dialogue (2005) and consultation with BCBS and EFDI.
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Background
In July 2008 a working group comprised of Basel Committee on Bank Supervision (BCBS) and the Guidance Group of IADI representatives was formed to develop a set of joint Core Principles.
Were released by BCBS and IADI in June 2009
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Background
Core Principles objectives :• Enhance effectiveness of deposit insurance
systems worldwide• Be reflective of and adaptable to a broad
range of country circumstances, settings, and structures
• Utilize the practical experience of deposit insurers
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Background
The Principles were designed to be neutral with regard to different approaches to deposit insurance, so long as the overriding goals are achieved
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Core Principles Preconditions
Effective deposit insurance preconditions: An ongoing assessment of the economy and
banking system Sound governance of agencies comprising the
financial safety net Strong prudential regulation and supervision A well developed legal framework, governance,
accounting and disclosure regime
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Core Principles Preconditions
Preconditions may not be ideal and if this is the case, it is important to identify them. If actions are necessary, they can be taken
before, or in concert with, the adoption or reform of a DIS. Assessment of preconditions should rely as
much as possible on official IMF and World Bank documents (e.g. FSAPs)
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Core Principles
There are 18 Core Principles regarding:Policy issuesDesign featuresLegal issuesEffective bank resolution
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Assessment Methodology Framework
Compliant
All essential criteria are met without any deficiencies. Largely Compliant
Only minor shortcomings—authorities can achieve full compliance within a prescribed time frame. Materially Non-Compliant
Severe shortcomings which cannot be easily rectified. Non-Compliant
No substantive implementation of the principle. Not Applicable
Not relevant to the circumstance of the insurer.
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Principle 1 – Public-policy objectives
The two fundamental public-policy objectives are to:1. Protect small depositors2. Contribute to financial stability
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Principle #2 – Mitigating Moral Hazard
Moral hazard is inherent in insurance, and especially deposit insurance The deposit insurance system should contain
appropriate design features to help mitigate moral hazard
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Principle #3 - Mandate
A deposit insurer’s mandate must be clear and formally specified There must be consistency between public-policy
objectives and the powers and responsibilities given to the deposit insurer.
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Principle #4 - Powers
A deposit insurer should have all powers necessary to fulfill its mandate. Some of these powers include the ability to: Finance prompt insured depositor repaymentsEnter into contractsSet internal operating budgets and procedures,
andAccess timely and accurate information to ensure
that they can meet their obligations to depositors.
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Assessment Criteria Example: CP#4
Essential criteria 1. The powers(legal authority) and responsibilities of
the deposit insurance system are clearly defined and formally specified in the law or regulation (including approved self-regulation in the context of private or public deposit insurance systems).
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Assessment Criteria Example: CP#4
Essential criteria 2. Deposit insurer has all powers necessary to fulfil its
mandate. In particular, the deposit insurer can:(a) compel member banks to comply with their
obligations to the deposit insurer; (b) have the means to reimburse depositors(c) enter into contracts (i.e. agreements or
transactions to obtain goods, services, or insurance)
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Assessment Criteria Example: CP#4
2 (cont.)(d) set internal operating budgets and internal
procedures (e.g., human resources)(e) access timely and accurate information to meet
their obligations to depositors (f) share information with other safety-net
participants (g)engage in information sharing and coordination
agreements with deposit insurers in other jurisdictions
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Principle #5 - Governance
The deposit insurer should be operationally independent, transparent, accountable and insulated from undue political and industry influence.
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Principle #6 – Relationships
The deposit insurer and other financial system safety-net participants must have a framework for close coordination and information sharing on a routine basis. In particular the deposit insurer must have accurate
and timely information regarding problem banks. Information-sharing and coordination
arrangements should be formalized.
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Principle #7 – Cross-border issues
All relevant information should be exchanged between deposit insurers in different jurisdictions and between deposit insurers and other foreign safety-net participants when appropriate (with proper confidentiality arrangements, of course).
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Principle #8 - Membership
In order to avoid adverse selection, membership in the deposit insurance system must be compulsory for all financial institutions accepting deposits.
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Principle #9 - Coverage
Coverage has two components:1. Scope2. Level
Insurable deposit must be clearly defined in law, prudential regulations, or by-laws. The level of coverage should be limited but
credible and capable of being quickly determined.
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Principle #9 - Coverage
Coverage has two components:1. Scope2. Level
Insurable deposit must be clearly defined in law, prudential regulations, or by-laws. The level of coverage should be limited but
credible and capable of being quickly determined.
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Principle #10 –Blanket Guarantee Transition
Countries with blanket guarantees are encouraged to transition to a limited coverage deposit insurance system as rapidly as possible. Blanket guarantees can have a number of adverse
effects if retained too long (most notably, moral hazard). Policymakers should pay particular attention to
public attitudes and expectations during the transition period.
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Principle #11 - Funding
A deposit insurance system should have all necessary funding available to ensure the prompt reimbursement of depositors’ claims (including emergency back-up funding). Member banks must pay for deposit insurance (i.e.,
entrance fees, premiums), since they and their clients directly benefit from having an effective deposit insurance system.
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Principle #11 – Funding (cont.)
The criteria used in any risk-based premium system should be transparent to all participants. In addition, all necessary resources should be in place to administer the risk-adjusted differential premium system appropriately.
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Principle #12 – Public Awareness
An effective deposit insurance system will keep the public informed about all aspects (e.g., benefits and limitations) of the deposit insurance system.
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Principle #13 – Legal Protection
The deposit insurer’s board members and employees should be protected against lawsuits for their decisions and actions taken in “good faith” and in the normal course of their duties. In turn, board members and employees must abide by
proper codes of conduct (e.g., conflict-of-interest). Legal protection should be defined in legislation and
administrative procedures, and include coverage of legal costs for those indemnified.
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Principle #14 – Parties at fault
A deposit insurer, or other relevant authority, should have the power to seek legal redress—criminal and civil--against those parties at fault in a bank failure.
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Principle #15 – Early detection, timely intervention, and
resolution The deposit insurer should be part of a framework within
the financial safety net that provides for early detection, timely intervention, and resolution of troubled banks.
Problem banks should be so designated on the basis of well defined and transparent criteria by operationally independent supervisory authority which has the power to act.
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Principle #16 – Effective Resolution Processes
Effective failure-resolution processes should:• Facilitate the deposit insurer’s ability to meet
it’s primary obligation: prompt reimbursement to insured depositors.
• Minimize resolution costs and disruption of markets
• Maximize recoveries on assets• Reinforce discipline through legal actions in
cases of negligence or other wrongdoings
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Principle #16 – Effective Resolution Processes
There must be a flexible mechanism to help preserve critical banking functions (i.e., maintaining clearing and settlement activities)by facilitating transfer of a failed bank’s assets and liabilities (at a minimum, insured deposits). Specifically, a deposit insurer must be able to
use its funds to facilitate a P&A transaction.
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Principle #17 –Reimbursing depositors
When an insured event occurs, depositors should have a legal right to prompt reimbursement up to the coverage limit. The deposit insurer should inform the public of applicable coverage limits, along with when, where, and how payment will be made.
The deposit insurer must be involved early in the problem bank process and provided depositor information in advance in order to adequately prepare for prompt reimbursement.
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Principle #18 - Recoveries
The deposit insurer, as subrogee to insured deposits payment, should share the proceeds of recoveries from the estate of the failed bank. Failed bank asset management and disposition
should be guided by net present value principles.
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Assessment Methodology
Collaborative process to develop an agreed upon “Assessment Methodology” with:
• Basel Committee on Bank Supervision• International Association of Deposit
Insurers• International Monetary Fund• European Forum of Deposit Insurers• World Bank and European Commission
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Assessment Methodology
Drafting completed August, 2010 Following approval from the Executive Boards
of IADI, EFDI and the BCBS, the Methodology will undergo:• Full public consultation (September -
November) Field tests (September – October): Czech
Republic, India and Mexico
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Assessment Methodology
Methodology to be approved by IADI, EFDI and BCBS and presented to the Financial Stability Board (FSB) – November/December 2010.
Expectation: Eventual incorporation into Financial Stability Board (FSB) Compendium of Key International Standards
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Objectives of Methodology
Identification of the nature and extent of any weaknesses in the deposit insurance system in compliance with the Principles
Benchmark systems against the Core Principles to judge how well the system meets its mandates.
Aid the deposit insurer and policymakers in making improvements to the deposit insurance system and financial safety net
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Use of Methodology
Methodology can be used in multiple contexts: i) IMF/World Bank assessments in the context of
the FSAPii) Peer reviews conducted, for example, by IADI
regional committeesiii) Self-assessment performed by the deposit
insureriv) Reviews conducted by private third parties
such as consulting firms
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Use of Methodology
Assessments will be conducted by suitably qualified persons
Assessments require cooperation of all relevant authorities