Deposit insurance

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Experiences from bank runs during the Great Depression led to the introduction of deposit insurance in the US.

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Explicit deposit insurance is a measure implemented in many countries to protect bank depositors, in full or in part, from losses caused by a bank's inability to pay its debts when due. Deposit insurance systems are one component of a financial system safety net that promotes financial stability.

Why it exists

Banks are allowed (and in most places, encouraged) to lend or invest most of the money deposited with them instead of safe-keeping the full amounts (see fractional-reserve banking). If many of a bank's borrowers fail to repay their loans when due, the bank's creditors, including its depositors, risk loss. Because banks rely on customer deposits that can be withdrawn on little or no notice, banks are prone to a Bank run, where depositors seek to withdraw funds quickly ahead of a possible bank insolvency. Because banking institution failures have the potential to trigger a broad spectrum of harmful events, including economic recessions, policy makers maintain deposit insurance schemes to protect depositors and to give them comfort that their funds are not at risk.

Deposit insurance was formed to protect small unit banks in the United States when branching regulations existed. Banks were restricted by location thus did not reap the benefits coming from economies of scale, namely pooling and netting. To protect local banks in poorer states, the Federal government created deposit insurance.

Many national deposit insurers are members of the International Association of Deposit Insurers (IADI), an international organization established to contribute to the stability of financial systems by promoting international cooperation and to encourage wide international contact among deposit insurers and other interested parties, in particular, IADI.

Detractors of deposit insurance claim the schemes introduce a moral hazard issue, encouraging both depositors and banks to take on excessive risks. Without deposit insurance, banks would compete for deposits because depositors would prefer safe banks over risky banks to guard their money. With deposit insurance, banks can take excessive risks because depositors do not fear for their deposits safety and thus do not move their money to safer banks. The risks are shared by all banks, be they safe or risky.

How it works

Deposit insurance institutions are for the most part government run or established, and may or may not be a part of a country’s central bank, while some are private entities with government backing or completely private entities.

There are a number of countries with more than one deposit insurance system in operation including Austria, Canada (Ontario & Quebec), Germany, Italy, and the United States.

On the other hand, one deposit insurance system can cover more than one country: the Marshall Islands, the Federated States of Micronesia, and Puerto Rico are insured by the US Federal Deposit Insurance Corporation.

Cameroon, the Central African Republic, Chad, Congo, Equatorial Guinea, and Gabon will also be covered by a single system.

Overview by country

According to IADI, as of June 2008, there are currently 119 countries with a deposit insurance system in operation, pending, planned or under serious study (i.e. 99 in operation, 8 pending, 12 planned or under serious study).

North America

United States

Further information: Bank regulation in the United States

The United States was the first country to establish an official deposit insurance scheme, the Federal Deposit Insurance Corporation, during a Great Depression banking crisis in 1933.

A separate fund, the National Credit Union Share Insurance Fund (NCUSIF) administered by the National Credit Union Administration (NCUA), was created in 1970 to insure deposits at credit unions.

In Massachusetts, the Depositors Insurance Fund (DIF) insures deposits in excess of the FDIC limits at state-chartered savings banks.

Canada

Canada created its own Deposit Insurance Corporation in 1967. It is similar to the Federal Deposit Insurance Corporation in the United States. Since 1967, 43 financial institutions have failed in Canada and all were members of CDIC. There have been no failures since 1996. Information on the Canadian system is found at http://www.cdic.ca. Insurance is restricted to registered member institutions, and covers only the first C$100,000 in very specific categories of accounts. Credit unions and Quebec’s caisse populaire system are not insured Federally, because they are created under Provincial charters and backed by Provincial insurance plans, which generally follow the Federal model. Funds in a foreign currency, not Canadian dollars, are not insured, such as a US dollar accounts even when held in a registered CDIC financial institutions. GICs with a longer term than 5 years are also not insured. Funds in foreign banks operating in Canada may or may nor be covered depending on whether they are members of CDIC . Some funds in the RRSP or RRIF at their bank may not covered if they are invested in mutual funds or held in specific instruments like debentures issued by government or corporations. The general principle is to cover reasonable deposits and savings, but not deposits deliberately positioned to take risks for gain, such as mutual funds or stocks.

The roots of all of this well organized reform can be traced back to the 19th century, such as the Upper Canada’s financial problems of 1866, the North American panic of 1872 and the 1923 failure of Toronto’s Home Bank, symbolized today by Casa Loma. Historically in Canada regional risk has always been spread nationally within each large bank, unlike the uneven geography of US unit banking. layered with savings & loans of regional or national size, who in turn disperse their risk through investors. Generally speaking, the Canadian banking system is well regulated, in part by the little known Office_of_the_Superintendent_of_Financial_Institutions_(Canada), who can in an extreme case close a financial institution. That, plus Canada’s tight mortgage rules, mean the risk of bank failures similar to the US are slim, but not impossible.

Mexico

Mexico’s Banking Act of 1897 established the legal possibility of failure of a credit institution, but set up some mechanisms in the banking law itself to prevent bank failures -- but the law itself did not create a formal insurance scheme. In 1981 the General Law of Credit Institutions and Auxiliary Organizations provided for the creation of a fund to protect credit obligations assumed by banks.

Caribbean & South America

European Union

Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guarantee schemes requires all member states to have a deposit guarantee scheme for at least 90% of the deposited amount, up to at least 20,000 euro per person. On October 7, 2008, the Ecofin meeting of EU's ministers of finance agreed to increase the minimum amount to 50,000. Timelines and details on procedures for the implementation, which is likely to be a national matter for the member states, was not immediately available.

The increased amount followed on Ireland's move, in September 2008, to increase its deposit insurance to an unlimited amount. Many other EU countries, starting with the United Kingdom, reacted by increasing its limit to avoid that people transfer savings to Irish banks.

By EU country

As from October 2008, many EU countries were in the process of increasing the amounts covered by their despoit insurance schemes. Since these amounts are typically encoded in legislation, there was a certain delay before the new amounts were formally valid. Countries have varied in their approach; some have permanently increased the amount, while other have implemented temporary measures.

Footnote: (*) Those countries which have a deposit insurance of less than EUR 50,000 are expected to increase the amount following an October 7, 2008 meeting of the Ecofin.

Rest of Europe

Turkey

Deposit insurance in Turkey is handled by Savings Deposit Fund Insurance (Tasarruf Mevduatı Sigorta Fonu) and covers a maximum of 50,000 TL.

Iceland

Deposit insurance in Iceland is handled by Depositors' and Investors' Guarantee Fund (Tryggingarsjóður) and covers a minimum of 20 887 euros.

Norway

Deposit insurance in Norway is handled by the Norwegian Banks' Guarantee Fund (Bankenes sikringsfond) and covers deposits up to 2 million NOK.

Russia

Russia enacted deposit insurance law in December 2003 and established the national deposit insurance agency (DIA) in 2004. Until 2004, Russian banking system was divided: obligations of state-owned Sberbank were guaranteed by law, while other banks were not insured in any way, creating an unfair advantage for Sberbank. The law addresses only individuals' deposits. Maximum compensation is limited to 700,000 roubles (equivalent to 23 thousand US dollars or 17 thousand Euro at February 2009 exchange rate). As at January 2008, DIA funds exceeded 68 billion roubles (2.8 billion US dollars). There were 15 "insured events" (bankruptcy cases involving DIA intervention) in 2007 with resulting payout reaching 350 million roubles.

The agency is set up as a state-owned corporation, managed jointly by Central Bank and the government of Russia. DIA membership is mandatory requirement for any bank operating with private investors' money. Central Bank of Russia used admission of banks into DIA system to weed out unsound banks and money launderers. The murder of Andrey Kozlov, the Central Bank executive in charge of DIA admission, was directly linked to his non-compromising attitude to money launderers.

Switzerland

Switzerland has a privately operated deposit insurance system called Deposit Protection of Swiss Banks and Securities Dealers . It guarantees up to CHF 100 000 per bank customer per bank. Membership is compulsory for all banks and securities dealers that are regulated by the Swiss Financial Market Supervisory Authority (FINMA) . See the list of members of the Deposit Protection of Swiss Banks and Securities dealers at http://www.einlagensicherung.ch/en/bankkunden-link/bankkunden-unterzeichner.htm

It had covered depositors in 1993 in the case of the failure of Spar- und Leihkasse Thun SLT, Thun. The next cases happened in 2007 with the liquidation of AB FIN SA (a securities dealer) in Lugano and with Kauphting (Luxembourg) SA, Geneva branch which was closed on October 9, 2008. Clients of this bank received the payments (at the time up to CHF 30'000 per customer) within 3 weeks.

For further information see the FAQ at http://www.einlagensicherung.ch/en/bankkunden-link/bankkunden-faq.htm

British Isles Offshore

Although many offshore subsidiaries of mostly British-based banks and building societies in the Isle of Man, Jersey and Guernsey offer a parental guarantee for all sums deposited with them, the Crown Dependencies fall outside the jurisdiction of both the United Kingdom's Financial Services Authority guarantee to underwrite the first £50,000 per depositor per bank and the European Economic Area 'passport scheme' that pays a minimum of £16,000 per depositor per bank in the case of a default. In 1991, the Isle of Man introduced a bank depositors' insurance scheme to cover 75 percent of the first £15,000 per depositor per bank, but it was the October 2008 crisis-stricken Icelandic government's seizure of Kaupthing Bank hf in Iceland after the United Kingdom suspended the trading licence of Kaupthing's British subsidiary that compelled a radical revision of deposit insurance in the Isle of Man. Unable to secure reserves held by Kaupthing hf in Iceland or Kaupthing's British subsidiary to facilitate customer withdrawals, Kaupthing Singer and Friedlander (Isle of Man) Ltd. saw its Isle of Man banking licence suspended after operating less than a year, compelling the firm to request to be wound up. The Isle of Man government called an emergency session of the Tynwald parliament which voted unanimously to bring the Isle of Man depositors' compensation scheme into line with the newly-enlarged scheme in the United Kingdom, guaranteeing with immediate effect 100 percent of the first £50,000 per depositor per bank, and studying amendments for the subsequent inclusion within the scheme of corporate and charitable accounts. The Isle of Man government also pressed the Icelandic government to honour Kaupthing hf's irrevocable and binding guarantee of all depositors' funds held by Kaupthing, Singer and Friedlander (Isle of Man) Ltd. In Jersey and Guernsey, deposit insurance schemes for non-residents have yet to be enacted.

Australia & New Zealand

The Australian Prime Minister announced on October 12, 2008 that, in response to the Economic crisis of 2008, 100% of all deposits would be protected over the subsequent three year period. This measure comes on top of existing mandates of APRA and ASIC to monitor Australian banks and deposit taking authorities to ensure that their risks do not compromise the safety of depositors funds.

New Zealand has announced on October 12, 2008, that an opt-in scheme for retail deposits will be introduced. 100% cover. Banks and other institutions. First NZ$5billion free, excess amounts charged at 10 basis point pa.

Asia

India

India was the second country in the world to introduce Deposit Insurance in 1962. The Deposit Insurance Corporation commenced functioning on January 1, 1962 under the aegis of the Reserve Bank of India (RBI). 1971 witnessed the establishment of another institution, the Credit Guarantee Corporation of India Ltd. (CGCI). In 1978, the DIC and the CGCI were merged to form the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Hong Kong

Deposit Protection Scheme

Hong Kong Deposit Protection Board, which is an independent and statutory institution formed to manage and supervise the operation of Deposit Protection Scheme. The maximum protection amount of deposit is HKD$100,000.

Malaysia

Malaysia introduced its Deposit Insurance in 2005. Malaysia Deposit Insurance Corporation (MDIC) or locally known as Perbadanan Insurans Deposit Malaysia (PIDM), is a statutory body formed under the Akta Perbadanan Insurans Deposit Malaysia 2005. Until December 2010, all deposit in Malaysia is fully guaranteed under the Government Deposit Guarantee Scheme.

Economic impact

When a nation state has a deposit insurance scheme, foreign investors (aka non-resident bank depositors) are more likely to passively deposit larger amounts of money in the banks of said nation state (that has a bank deposit insurance scheme).

Having a bank deposit insurance scheme (for all practical purposes) guarantees that a nation state will more likely have a higher rate of passive foreign investment (within the margin of insurable amount).

Passive foreign investment in a nation state’s finance system allows for more lending to be made when global finance system conditions constrict the amount of lendable money. There has been substantial research done over the years on the impact on foreign investment of bank deposit insurance schemes.