Whenever a crisis hits, interest in guarantee arrangements rises. The current financial crisis is no exception in that respect. It puts the spotlight on the operation of the financial safety net and provides policy makers with a timely opportunity to monitor its performance, with a view to identifying its strengths and weaknesses. The present note focuses on the way parts of the financial safety net are combined, putting special emphasis on deposit insurance and its interaction with other safety net elements. While it also includes a discussion of recent policy actions in that context, the note centres on structural rather than practical crisis resolution issues.
At its meeting in March 2008, the OECD Committee on Financial Markets (CMF) discussed selected financial safety net issues within the Tour d’Horizon on Financial Markets based on a background note prepared by the Secretariat. The note highlighted the importance of various aspects of the design of financial safety nets and in particular of explicit deposit insurance systems. It argued that it was too early to draw any strong policy lessons from recent developments regarding the effects of the turbulence and the adequacy of the financial safety net, but that some preliminary lessons were emerging concerning selected aspects of the design of deposit insurance systems. These included that, as regards coverage, deposit insurance systems with low levels of coverage and/or partial insurance may not be effective in preventing bank runs.
The Committee endorsed this and other preliminary proposals and decided to conduct further work in this area. In particular, it was suggested that future work could further explore some of the issues related to financial safety net interrelationships, focusing among other things in particular on the area of overlap between the deposit insurance and the lender-of-last-resort functions. Pursuant to this suggestion, the present article includes an intitial discussion of the interaction between these two safety net elements (in its third section).
Against the background of recent developments, the present article also provides a discussion of policy measures implemented in the fall 2008 (in its fourth section). In the context of recent events, and these measures, the relevance of the suggestion by the Committee to continue work in the area of deposit insurance is undeniable. Indeed, while aspects of the design of deposit insurance schemes undergo rather infrequent but more or less gradual changes, the accelerated loss of confidence in financial markets - as evidenced by several financial market indicators following the Lehman Brothers Holdings failure - triggered a number of financial safety net emergency policy actions. Deposit insurance is one of several elements of the financial safety net and, as regards the strengths of these nets, there appears to be a growing consensus that they are determined by their weakest elements. Thus, to avoid having the deposit insurance function turn out to be that weakest element in the response to the financial turbulence, a number of policy actions were related either directly or indirectly to deposit insurance.
These measures were consistent with the basic thrust of the arguments developed by the CMF at its meeting in March 2008 (see Schich, 2008), although at least some of the changes may have gone beyond levels that, at that time, might have been considered adequate. The measures included the following ones:
- In those jurisdictions of CMF members where explicit deposit insurance arrangements had not existed, such schemes were introduced.
- In many of the jurisdictions where such arrangements had already existed, some design aspects were changed. Perhaps most notably among such changes, the levels of maximum deposit insurance coverage have been increased, at least on a temporary basis, and co-insurance arrangements were abolished in at least some instances where they had existed.
- Policy makers in some countries made statements that suggested (either explicitly or implicitly) that deposit insurance coverage would be unlimited. Coverage of guarantee arrangements was also extended in some cases to wholesale bank liabilities that were not traditionally covered by such arrangements.
These and other related actions were aimed at restoring confidence among both financial intermediaries and the wider public. They tend to reduce the threat of bank failures by raising the likelihood that depositors and creditors continue to provide a stable source of refinancing for banks. Thus, they buy time.
There are nonetheless potential costs associated with these measures, which are discussed in the fifth section. Before that, the second section develops a framework of the financial safety net that places deposit insurance issues within the wider financial safety net context. Subsequently, the third section addresses selected aspects of the interactions between the lender of last resort and the deposit insurance functions. The sixth section concludes.
Download
PDF Ebook Financial Crisis: Deposit Insurance and Related Financial Safety Net Aspects
