NOTE NUMBER 340 84380 viewpoint PUBLIC POLICY FOR THE PRIVATE SECTOR FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY OCTOBER 2013 Deposit Insurance Systems Claire McGuire and What Do Initial Assessments Show? Yejin Carol Lee Deposit insurance is increasingly being recognized as an important part of Claire McGuire (cmcguire@worldbank.org) a country’s financial sector safety net. Deposit insurers are using the Core is a senior financial sector Principles for Effective Deposit Insurance Systems to complete self-assessments to specialist, and Yejin Carol guide them in their strategic planning and ongoing operations. So far there Lee (ylee5@worldbank.org) a research analyst, in the have been 13 guided self-assessments facilitated by the International World Bank’s Financial Association of Deposit Insurers or detailed assessments completed through Architecture and Banking Systems Unit. the World Bank and International Monetary Fund’s Financial Sector Assessment Program. The results of these assessments show areas of particular concern for deposit insurers. The global financial crisis highlighted the Reviewing compliance with the importance of effective schemes for compensating Core Principles depositors when banks fail (see FSB 2012, p. 1). The Core Principles were developed in 2008 by But what makes a deposit insurance scheme the Basel Committee on Banking Supervision effective, and how can a deposit insurance agency (BCBS) and the International Association of improve its operations? One source of guidance Deposit Insurers (IADI) and adopted by the is the Core Principles for Effective Deposit Insurance international community in 2009. A methodology Systems (BCBS and IADI 2009). Deposit insurers for assessing compliance with the Core Principles are increasingly using the Core Principles to was adopted by the BCBS and IADI in December THE WORLD BANK GROUP complete self-assessments to guide their strategic 2010. As stated in the introduction to the Core planning. In addition to self-assessments, three Principles, they are “reflective of, and designed Standards and Codes Assessments utilizing the to be adaptable to, a broad range of country Core Principles have been carried out through the circumstances, settings and structures” (BCBS World Bank and International Monetary Fund’s and IADI 2009, p. 2). For each of the 18 Core Financial Sector Assessment Program (FSAP).1 Principles, systems are marked as compliant, This Note references the guidance developed by largely compliant, materially noncompliant, standard setters on deposit insurance generally noncompliant, or not applicable. and summarizes some of the issues that have Since the development of the methodology, developed around the specific application of IADI and others have organized workshops to the Core Principles. review the compliance of individual deposit DEPOSIT INSURANCE SYSTEMS WHAT DO INITIAL ASSESSMENTS SHOW? insurance systems with the Core Principles and, Issues emerging in application as noted, several deposit insurance systems The 13 assessments of deposit insurance systems have been analyzed in the context of the FSAP. completed so far point to some common issues The results of 13 assessments completed as in the areas covered by the seven Core Principles part of IADI workshops or through the FSAP proving to be most problematic. Some of these show that a number of areas have emerged issues may be the result of weaknesses in the overall that present particular issues for deposit safety-net framework in the relevant jurisdiction insurance systems. Almost a quarter of these rather than weaknesses attributable to the deposit assessments produced ratings of materially insurer. Other areas of concern, however, may 2 noncompliant or noncompliant (figure 1). relate to the institutional framework used in The most problematic areas involve seven establishing deposit insurers (for example, a Core Principles (figure 2): Core Principle 4 governance framework for a deposit insurer’s (Powers), Core Principle 5 (Governance), Core board of directors that provides too little Principle 6 (Relationships with Other Safety- independence and autonomy for the insurer). In Net Participants), Core Principle 11 (Funding), addition to describing some of the shortcomings Core Principles 15 and 16 (Early Detection and identified in the 13 assessments, the following Effective Resolution), and Core Principle 17 sections review relevant guidance developed by (Reimbursing Depositors).2 standard setters on deposit insurance. (For the Another interesting finding is that all systems text of the Core Principles discussed here, see assessed were graded as compliant with Core box 1.) Principle 14 (Dealing with Parties at Fault in a Bank Failure). The reason is that this Core Core Principle 4: Powers Principle is designed not to focus solely on No matter what mandate a deposit insurer has,3 it the role of the deposit insurance system in must have the power to provide depositors access investigating those contributing to the failure to their insured funds if a bank fails. In a November of a bank but to ensure that inappropriate 2012 guidance paper, Enhanced Guidance for actions are investigated by some government Effective Deposit Insurance Systems: Reimbursement agency, including the public prosecutor’s office Systems and Processes, IADI found that many or a professional or disciplinary body. Also deposit insurers faced important constraints in notable is that almost all the deposit insurance making prompt reimbursement. These included systems assessed shared in the proceeds of the lack of access to depositor records in advance recoveries from the estate of the failed bank and of bank failure, inability to aggregate deposit were therefore marked as compliant with Core records of individual depositors because of poor Principle 18 (Recoveries). records or lack of unique identifiers associated with the accounts, difficulty in applying netting requirements,4 and lack of computerized systems Figure Distribution of ratings of the 13 deposit insurance systems on all Core Principles for reimbursement. The main recommendation of the 1 Not applicable 6% Materially noncompliant guidance paper is that impediments to prompt reimbursement should be eliminated, including by streamlining procedures for payment and 18% creating an appropriate legal framework for all aspects of the reimbursement process. It is Noncompliant 4% increasingly clear that in order to make prompt Compliant payout, a deposit insurer must have ongoing 46% access to depositor data at its member institutions and the ability to test the data for accuracy and Largely compliant completeness. 26% Core Principle 5: Governance In its Thematic Review the FSB defined operational Source: World Bank calculations. independence to mean that “the deposit insurer is able Figure The 13 deposit insurance systems by compliance status with each Core Principle 2 CP 1: Public Policy Objectives 0 20 Share of systems (%) 40 60 80 100 CP 2: Mitigating Moral Hazard CP 3: Mandate CP 4: Powers CP 5: Governance CP 6: Relationships with Other Safety-Net Participants CP 7: Cross-Border Issues CP 8: Compulsory Membership CP 9: Coverage CP 10: Transitioninga CP 11: Funding CP 12: Public Awareness CP 13: Legal Protection CP 14: Dealing with Parties at Fault in a Bank Failure CP 15: Early Detection CP 16: Effective Resolution CP 17: Reimbursing Depositors CP 18: Recoveries Materially noncompliant Noncompliant Largely compliant Compliant Not applicable Note: CP = Core Principle. a. Core Principle 10 addresses transitioning from a blanket guarantee to a limited coverage deposit insurance system. Source: World Bank calculations. to use the powers and means assigned to it without on their own. Some deposit insurers have found undue influence from external parties and . . . there that having an advisory committee made up of is no significant evidence of undue government, stakeholders can assist them in getting the benefit supervisory or industry interference” (2012, p. 17, of the views of bankers and consumers without note 36). This has proved to be a difficult area for creating the confidentiality issues that can arise the deposit insurers that have been assessed. A from having private sector board members. number have board structures that represent too much influence either by the industry (for example, Core Principle 6: Relationships with Other with too many bankers on the board of directors) Safety-Net Participants or by the government (with a majority of board The strengthening of information sharing and members being from government agencies or the coordination among safety-net participants has central bank acting as board chair). been an important reform driven by the financial The better practice is to have a board with a crisis. But as the sample of assessments indicates, majority of independent board members (not this area can still present difficulties, with deposit active bankers), with the board chair being insurers in some jurisdictions not being part of designated from that group. The ministry of the information flow for bank-level data until a finance and central bank or banking supervisor bank is in serious financial difficulty. could also be represented on the board, but In a recent guidance paper IADI (2013) noted without being able to control board decisions that deposit insurers with different institutional mandates (for example, a paybox mandate in robust early detection regimen in place will almost contrast with a risk-minimizer mandate) have always lead to a suboptimal resolution process. different needs for information but that in all Assessing compliance with Core Principle 15 cases there is a need for close coordination and requires assessing the intervention process. In information sharing. There should be clear some jurisdictions a bank is given a long period guidelines requiring supervisory authorities to (even up to a year) after intervention to attempt share relevant information on a timely basis to recapitalize or correct shortcomings in its with the deposit insurer. In addition, the deposit operations. During this time the deposit insurer insurer should be part of the country’s apex crisis is not making payments to insured depositors 4 management committee. Only then can the or attempting to find a lesser-cost solution, deposit insurer be adequately prepared to meet its such as a purchase and assumption or insured obligations to insured depositors with the liquidity deposits transfer. Such long delays in resolving an and other resources needed to make a payout. institution would result in a grade of materially noncompliant or even noncompliant on this Core Principle 11: Funding Core Principle. In other jurisdictions there might Resolution of a failed financial institution be forbearance, permitting insolvent banks to should be done in an orderly manner, without stay open and continue operations and thereby severe systemic disruption and without taxpayer potentially increasing the cost to the deposit support (FSB 2011). Key to meeting this objective insurer for a future resolution. Such systems is to identify industry financing in advance of would also be rated as materially noncompliant resolution, either deposit insurance funds or some or noncompliant. form of industry-funded resolution financing. But even a fully funded deposit insurance scheme Core Principle 16: Effective Resolution may find itself in need of liquidity support during Core Principle 16 has proved to be problematic for times of stress, and a newly established scheme some deposit insurers because the responsibility might certainly lack adequate funds to meet its for resolution often resides with another safety-net payout obligation. For that reason Core Principle member. Whatever safety-net member has that 11 is designed to assess whether adequate back-up responsibility should also have a comprehensive funding is available to the deposit insurer. tool kit for bank resolution. Only with such tools This is an area that has presented real can there be a possibility that the deposit insurer difficulties. The absence of formal mechanisms will have lesser-cost options for meeting its payout for accessing back-up funding has resulted in obligations, such as the transfer of deposits to systems being marked materially noncompliant another institution. with this Core Principle even where the governing statute provides for government back-up funding Core Principle 17: Reimbursing Depositors for the deposit insurer.5 Another difficult issue For many of the same reasons that Core Principles relates to how the industry would be made to 15 and 16 have proved to be difficult for deposit pay back the government for any funds it might insurers, systems did not often receive a rating of make available. compliant with Core Principle 17. Many issues can adversely affect a deposit insurer’s ability to effect Core Principle 15: Early Detection prompt reimbursement of insured depositors. Core Principles 15 and 16 have proved to be These include problematic legal frameworks difficult to apply in practice because of their that require suspending a bank’s operations overlapping subject matter. As stated in version for some period before depositors are entitled 5.0 of the Handbook for the Assessment of Compliance, to reimbursement, a deposit insurer’s inability Core Principle 15 is designed to assess the early to access account records in advance of a bank detection of financial distress and the timely failure so as to check them for completeness and decision to intervene, while Core Principle 16 is accuracy, and lack of procedures for the efficient focused on the process of failure resolution once payment of depositors (such as the use of paying the decision to intervene is made (IADI 2011, agent banks or the ability to transfer insured pp. 42–45). In reality, however, it is difficult to deposits to another bank). For a fuller discussion separate the two because the failure to have a of obstacles to prompt payout, see IADI (2012). Box Core Principles presenting issues for deposit insurers 1 Core Principle 4: Powers A deposit insurer should have all powers necessary to fulfill its mandate and these powers should be formally specified. All deposit insurers require the power to finance reimbursements, enter into contracts, set internal operating budgets and procedures, and access timely and accurate information to ensure that they can meet their obligations to depositors promptly. Core Principle 5: Governance The deposit insurer should be operationally independent, transparent, accountable and insulated from undue political and industry influence. 5 Core Principle 6: Relationships with Other Safety-Net Participants A framework should be in place for the close coordination and information sharing, on a routine basis as well as in relation to particular banks, among the deposit insurer and other financial system safety-net participants. Such information should be accurate and timely (subject to confidentiality when required). Information-sharing and coordination arrangements should be formalised. Core Principle 11: Funding A deposit insurance system should have available all funding mechanisms necessary to ensure the prompt reimbursement of depositors’ claims including a means of obtaining supplementary back-up funding for liquidity purposes when required. Primary responsibility for paying the cost of deposit insurance should be borne by banks since they and their clients directly benefit from having an effective deposit insurance system. For deposit insurance systems (whether ex-ante, ex-post or hybrid) utilising risk-adjusted differential premium systems, the criteria used in the risk-adjusted differential premium system should be transparent to all participants. As well, all necessary resources should be in place to administer the risk-adjusted differential premium system appropriately. Core Principle 15: Early Detection and Timely Intervention and Resolution The deposit insurer should be part of a framework within the financial system safety net that provides for the early detection and timely intervention and resolution of troubled banks. The determination and recognition of when a bank is or is expected to be in serious financial difficulty should be made early and on the basis of well defined criteria by safety-net participants with the operational independence and power to act. Core Principle 16: Effective Resolution Processes Effective failure-resolution processes should: facilitate the ability of the deposit insurer to meet its obligations including reimbursement of depositors promptly and accurately and on an equitable basis; minimise resolution costs and disruption of markets; maximise recoveries on assets; and, reinforce discipline through legal actions in cases of negligence or other wrongdoings. In addition, the deposit insurer or other relevant financial system safety-net participant should have the authority to establish a flexible mechanism to help preserve critical banking functions by facilitating the acquisition by an appropriate body of the assets and the assumption of the liabilities of a failed bank (e.g., providing depositors with continuous access to their funds and maintaining clearing and settlement activities). Core Principle 17: Reimbursing Depositors The deposit insurance system should give depositors prompt access to their insured funds. Therefore, the deposit insurer should be notified or informed sufficiently in advance of the conditions under which a reimbursement may be required and be provided with access to depositor information in advance. Depositors should have a legal right to reimbursement up to the coverage limit and should know when and under what conditions the deposit insurer will start the payment process, the time frame over which payments will take place, [and] whether any advance or interim payments will be made as well as the applicable coverage limits. Source: Excerpted from BCBS and IADI (2009, pp. 2–5). Conclusion areas are proving to be more problematic than The Core Principles have proved to be a useful others for deposit insurers, including funding, tool for deposit insurers in assessing their information sharing, and effective resolution and readiness to compensate insured depositors and payout processes. As bank resolution frameworks complete any other bank resolution functions evolve to take account of ongoing guidance by that are part of their mandate. A review of the international standard setters,6 the Core Principles assessments completed so far shows that certain may themselves have to evolve along with the DEPOSIT INSURANCE SYSTEMS WHAT DO INITIAL ASSESSMENTS SHOW? deposit insurance systems whose operations they funding agreement was in place with the minister of are designed to guide. finance (see IMF and World Bank 2013). 6. For example, the Key Attributes of Effective Resolution Regimes for Financial Institutions (FSB 2011). Notes References viewpoint 1. These three assessments were completed in Malaysia, BCBS (Basel Committee on Banking Supervision) Poland, and Uruguay. Malaysia’s assessment has been and IADI (International Association of Deposit is an open forum to published as IMF and World Bank (2013). Insurers). 2009. Core Principles for Effective Deposit encourage dissemination of 2. In addition, Core Principle 10 (Transitioning from Insurance Systems. http://www.bis.org/. public policy innovations a Blanket Guarantee to a Limited Coverage Deposit ———. 2010. Core Principles for Effective Deposit Insurance for private sector–led and Insurance System) has proved to be inapplicable to Systems: A Methodology for Compliance Assessment. market-based solutions for most deposit insurance systems. http://www.bis.org/. development. The views 3. As stated in the Thematic Review (FSB 2012, p. EC (European Commission). 2010. “Proposal for a published are those of the 4), deposit insurers can broadly be characterized as Directive of the European Parliament and of the authors and should not be having one of four mandates: a “paybox” mandate, Council on Deposit Guarantee Schemes [Recast].” attributed to the World in which the deposit insurer is responsible only for Brussels. Bank or any other affiliated reimbursement of insured deposits; a “paybox plus” FDIC (Federal Deposit Insurance Corporation). n.d. organizations. Nor do any mandate, in which the deposit insurer has additional Depositor Priority and Rights of Set-Off (Netting). http:// of the conclusions represent responsibilities, such as acting as the resolution www.fdic.gov/. official policy of the World authority; a “loss minimizer” mandate, in which the FSB (Financial Stability Board). 2011. Key Attributes of Bank or of its Executive insurer actively engages in the choice of the most Effective Resolution Regimes for Financial Institutions. Directors or the countries appropriate least-cost resolution strategy; and a “risk http://www.financialstabilityboard.org/. they represent. minimizer” mandate, in which the insurer not only ———. 2012. Thematic Review on Deposit Insurance has resolution powers but also acts as a prudential Systems: Peer Review Report. http://www. To order additional copies supervision authority. financialstabilityboard.org/. contact Naoki Ogiwara, 4. The term netting, or set-off, refers “to the situation IADI (International Association of Deposit Insurers). managing editor, where the claim of a creditor against an insolvent entity 2011. Handbook for the Assessment of Compliance with Room F 4P-256B, is to be deducted from a claim of that entity against the Core Principles for Effective Deposit Insurance Systems. The World Bank, the creditor” (FDIC, n.d., p. 3). The use of netting can Version 5.0. Available at http://www.sedesa.com.ar/. 1818 H Street, NW, Washington, DC 20433. slow the payout process for a deposit insurer because ———. 2012. Enhanced Guidance for Effective Deposit the insurer will need to match up the deposit and Insurance Systems: Reimbursement Systems and Processes. Telephone: loan records for each depositor and then make the Guidance Paper. http://www.iadi.org/. 001 202 473 1871 necessary adjustments before making payment. For ———. 2013. General Guidance on Early Detection and Email: that reason the draft EU directive on deposit insurance Timely Intervention for Deposit Insurance Systems. nogiwara@worldbank.org recommends ending the practice of setting off http://www.iadi.org/. depositors’ liabilities against their claims (EC 2010; see IMF (International Monetary Fund) and World Bank. Produced by Carol Siegel FSB 2012, p. 4). The use of set-off may also diminish the 2013. Malaysia: Core Principles for Effective Deposit value of a portfolio of performing loans and thus affect Insurance Systems—Detailed Assessment of Observance. Printed on recycled paper the ability to complete a transfer of performing assets http://www.imf.org/external/pubs/ft/scr/2013/ to a new institution in the context of a bank resolution CR1360.pdf. (FDIC, n.d., p. 7). 5. This was the case in Malaysia, for example, where the deposit insurance system was marked as materially noncompliant with Core Principle 11 because no This Note is available online: http://www.worldbank.org/fpd/publicpolicyjournal