April 11, 2018

ECB published an occasional paper that investigates the potential impact and appropriateness of several features of the European Deposit Insurance Scheme (EDIS) in the steady state. The paper summarizes the rationale, objectives, and challenges related to deposit insurance and illustrates the key features of EDIS, while setting the stage for empirical analysis. It then presents the model for estimation of default probabilities of banks, describes the loss-absorbing mechanism and assumptions, and reports the findings on EDIS exposure. Next, the report discusses the rationale, methodology, and findings of the contributions and cross-subsidization analysis under a full-fledged EDIS. Finally, the paper illustrates the results on contributions and cross-subsidization under a mixed deposit insurance scheme, before setting out conclusions.

The following are the key findings of the investigation:

  • A fully funded Deposit Insurance Fund would be sufficient to cover payouts, even in a severe banking crisis.
  • Risk-based contributions can, and should internalize, specificities of banks and banking systems. This would tackle the moral hazard and facilitate moving forward with risk-sharing measures toward the completion of the Banking Union in parallel with risk reduction measures; this approach would also be preferable to lowering the target level of the Deposit Insurance Fund to take into account banking system specificities.
  • Smaller and larger banks would not excessively contribute to EDIS relative to the amount of covered deposits in their balance sheet.
  • There would be no unwarranted systematic cross-subsidization within EDIS in the sense of some banking systems systematically contributing less than they would benefit from the Deposit Insurance Fund. This result holds also when country-specific shocks are simulated.
  • Under a mixed deposit insurance scheme that is composed of national deposit insurance funds bearing the first burden and a European deposit insurance fund intervening only afterward, cross-subsidization would increase relative to a fully fledged EDIS.

The key drivers behind these results are a significant risk-reduction in the banking system, increase in loss-absorbing capacity of banks in the aftermath of the global financial crisis, a super priority for covered deposits, and an appropriate design of risk-based contributions that are benchmarked at the euro area level, following a "polluter-pays" approach.

 

Related Link: Occasional Paper (PDF)

Keywords: Europe, EU, Banking, EDIS, Risk-based Contributions, Cross Subsidization, ECB

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