Deposit Insurance and Bank Failure Resolution. Thorsten Beck World Bank

Transcription

1 Deposit Insurance and Bank Failure Resolution Thorsten Beck World Bank

2 Introduction Deposit insurance (DI) and bank failure resolution (BFR) are part of the overall financial safety net Opposing objectives Minimize risk of contagion and protect small depositors Reduce moral hazard risk

3 Explicit vs. implicit All countries have deposit insurance, as long as not explicitly prohibited by constitution Implicit for gov t owned banks and Too-Big- To-Close banks All countries have bank failure resolution, even if not formal Even the failure to resolve banks constitutes a form of bank failure resolution

4 Main players in financial safety net Bankers Equity as put option; participate more in up-side risk; tend to aggressive risk taking Depositors Care about safety of their savings Large depositors might exert market discipline Safety net managers (regulators) Have official task to avoid aggressive risk-taking Risk of political or regulatory capture Safety net owners (ultimately tax payers) Care about costs Have often no say

5 Overview Introduction Deposit Insurance Theory Cross-Country Evidence Bank Failure Resolution The Interaction of Deposit Insurance and Bank Failure Resolution Example Germany Cross-Country Evidence

6 Deposit insurance - Theory Protect small depositors and prevent bank runs Might reduce market discipline exerted by depositors and put a greater burden on supervision In the absence of market discipline and effective supervision, DI might result in financial fragility

7 Deposit insurance - Evidence Explicit DI increases crisis probability Demirguç-Kunt and Detriagache, 2003 Even more so in economies with de-regulated interest rates and weak institutions U.S. S&L crisis Explicit DI can reduce market discipline exerted by depositors Demirguç-Kunt and Huizinga, 1999 Risk-shifting by banks stronger in weak institutional environments, but can be reduce with incentive-compatible design Hovakimian, Kane and Laeven, 2002

8 Deposit insurance - Design Compulsory membership, to avoid adverse selection Limited coverage, to increase market discipline Coverage limit Co-insurance Exclude interbank and insider deposits Private management and funding, to minimize agency cost Make banks pay for the risks they are taking Reduce gap between managers and owners of DI

9 Deposit insurance - Funding Adequate funding Viability of fund Make banks pay the actuarially fair price for the risk they are taking Ex-ante vs. ex-post funding Sufficient funding might enhance confidence and strengthen incentives to close unviable banks Pots of money might invite abuse and looting Instead of accumulation of liquid resources, provide contingent access to resources

10 Deposit insurance interaction of design features Management and funding Private mgmt. and public funding invites regulatory capture Public mgmt. and private funding invites political abuse Enhance private mgmt. with regulatory powers

11 Overview Introduction Deposit Insurance Theory Cross-Country Evidence Bank Failure Resolution The Interaction of Deposit Insurance and Bank Failure Resolution Example Germany Cross-Country Evidence

12 Bank failure resolution Conceptual ideas Minimize disruption and cost of bank failure Prevent asset decay refrigeration problem Prevent depositor panic and contagion risk hostage problem Preserve payment system Protect banking system, not individual bank Look for better solutions than liquidation

13 Bank failure resolution Conceptual ideas Minimize aggressive risk-taking by banks Shareholders and insiders first to lose Treat all banks equal, to avoid adverse selection no banks that are too-big-to-close Create class of creditors required to take first hit Timely intervention Minimize taxpayers losses Look for better solutions than open bank assistance, nationalization or forbearance

14 Alternative options in bank failure resolution Merge and acquisition Market solution No public funding, but role for supervisors Purchase and assumption Transfer good assets and part of liabilities to other bank Remainder liquidated Gap might be filled with DIS funds Trade-off: how many liabilities to transfer?

15 Not all banks are equal Open bank assistance Legal risk Financial risk Moral hazard risk Who decides? Discretion vs. rules Who pays? DI vs. gov t budget

16 Overview Introduction Deposit Insurance Theory Cross-Country Evidence Bank Failure Resolution The Interaction of Deposit Insurance and Bank Failure Resolution Example Germany Cross-Country Evidence

17 Interactions of DI and BFR with other elements of the financial safety net Lender of last resort: Assistance against unwarranted runs Limit access by unviable banks (pricing, collateral, limits) Regulation and supervision enable early intervention in BFR and compensate for loss of market discipline in the case of DI Rules vs. discretion Private monitoring Financial information Liquid and deep markets

18 DI and BFR institutional arrangement Role of Deposit Insurer DI as pay-box DI as risk-minimiser scheme DI as liquidator Judiciary vs. administrative component Licensing and de-licensing are administrative/regulatory acts Balance might depend on institutional environment

19 Country example Germany Deposit insurance Separate schemes for the three banking groups (commercial, savings, cooperative) Completely industry-based DI for commercial banks: nearly unlimited coverage Interbank deposits excluded No government back-up Voluntary membership DI has regulatory and supervisory functions

20 Country example Germany Bank failure resolution Federal Banking Supervisory Office has wide-ranging powers Private sector solutions, with major creditor banks involved Lender of last resort is private (not Bundesbank)

21 Country example Germany Analysis Financial safety net shows substantial private sector participation Success explained by banking structure Club-like character of banking association Large share of non-profit banking Impedes competition?

22 The Interaction of DIS and BFR Deposit Insurance Macroenvironment Risk-Taking Fragility Bank Failure Resolution Bank Characteristics

23 Institutional set-up of bank failure resolution Legal basis Corporate bankruptcy law Special laws Institutional set-up Extra-judicial process Judicial process We assess two options: Deposit insurer as bank failure resolver Incentives aligned to avoid insurance losses Judicial involvement Fairness Too slow

24 Cross-country analysis Variables and Methodology How to measure fragility Z-score = (ROA + C/A)/SD(ROA) Higher values = lower failure probability How to measure deposit insurance and bank failure resolution? Coverage/GDP Deposit Insurer Role in bank failure resolution Possible Judicial Role in bank failure resolution Mandatory Judicial Role in bank failure resolution Z-score i,k =αbank i +βmacro k +γdis k +δbfr k +e i,k

25 Stability and Bank Failure Resolution Coverage GDP pc ratio *** *** *** *** *** Deposit Insurer role 0.497*** 0.482*** 0.387*** 0.601*** Possible court role *** Mandatory court role -0.32*** Supervisory independence 0.596*** Official supervisory power 0.402*** Countries

26 Stability and Bank Failure Resolution Higher deposit insurance coverage increases fragility Deposit Insurer s involvement in bank failure resolution is positively associated with stability Judicial involvement is positively associated with fragility Results robust to controlling for bank characteristics, macroeconomic conditions, institutional development and supervisory approaches

27 Conclusions Components of financial safety net have to be consistent Optimal design depends on banking structure and institutional development Efficiency of safety net can be enhanced by other financial sector policies: Reduce gov t ownership in banking system Allow foreign banks Avoid banks that are too-big-to-close Involvement of deposit insurer increases, while judicial involvement reduces stability