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    FSI Paper Examines Role of Deposit Insurance in Bank Resolution

    August 23, 2019

    The Financial Stability Institute, or FSI, of BIS published a paper that examines the role of deposit insurance schemes in the bank resolution framework. The paper takes stock of the types of alternative measures that the deposit insurance schemes may fund. These measures include purchase and assumption transactions; the transfer of deposits—and, possibly, other business—to a bridge bank; and the provision of capital and liquidity support, either to prevent the failure of a stressed bank or in the context of a resolution or insolvency procedure. The paper discusses how deposit insurance scheme support for such measures can complement bank insolvency and resolution frameworks and expand the toolbox for bank failure management.

    Deposit insurance schemes play an important role in the framework for managing bank failures. The core use of the deposit insurance scheme resources is the payout of insured deposits in the context of a bank closure and insolvency proceeding. The deposit insurance schemes may also fulfill their mandate by funding measures that, at a minimum, preserve access to insured deposits as an alternative to payout. The use of the deposit insurance scheme resources for purposes other than payout is reflected in international standards such as the International Association of Deposit Insurers (IADI) Core Principles for Effective Deposit Insurance Systems and the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions. On the basis of responses to a survey of 32 members of IADI, the paper takes stock of the types of alternative measures that deposit insurance schemes may fund.

    The survey reveals a wide range of approaches, based on variables that include the tools available under the applicable framework for bank failure management; the mandate of the deposit insurance schemes; the safeguards to protect deposit insurance scheme resources such as the operation of any financial cap on the amount that can be used for alternative measures for a single bank; and the availability of backup funding arrangements for the deposit insurance schemes. These differences in part reflect policy priorities and national institutional arrangements with the safety net. The ability to use deposit insurance scheme resources for alternative measures can complement bank insolvency and resolution frameworks and expand the options for bank failure management. However, a number of policy considerations frame choices about the use of deposit insurance scheme resources. Although these options can be helpful, they may require capacity on the part of the deposit insurance authority to assess and implement more sophisticated funding arrangements; the availability of appropriate backup funding arrangements if there is a risk that measures other than payout may involve material amounts that could exhaust the available resources of the scheme; and arrangements to deal with any moral hazard incentives for banks. Safeguards in the form of financial caps, including a “least cost” principle, and, where relevant, collateral requirements can help to counterbalance these issues at the cost of lower flexibility.

    The funding options for individual deposit insurance schemes will depend on the measures available under the legal framework for bank failure management and the role of the deposit insurance scheme in that framework. The availability of deposit insurance scheme resources to fund alternative measures is subject to conditions and safeguards. The amount the deposit insurance scheme may contribute to specific measures is generally also subject to constraints aimed at safeguarding its resources although backup funding arrangements may increase the capacity for deposit insurance scheme resources. Within these constraints, the availability of deposit insurance scheme resources to fund alternative measures can increase options for authorities in managing bank failures. This may be especially relevant when dealing with medium-size or non-systemic banks, in which deposits may be the main form of loss absorbency.

     

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    Keywords: International, Banking, Deposit Guarantee Scheme, Deposit Insurance, Resolution Framework, Systemic Risk, BIS, FSI

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