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Banks make loans that cannot be sold quickly at a high price. Banks issue demand deposits that
allow depositors to withdraw at any time. This mismatch of liquidity, in which a bank’s
liabilities are more liquid than its assets, has caused problems for banks when too many
depositors attempt to withdraw at once (a situation referred to as a bank run). Banks have
followed policies to stop runs, and governments have instituted deposit insurance to prevent
runs. Before discussing the methods by which banks might create liquidity, it is important to
understand why there is a demand for liquidity by consumers or producers. I begin with the
consumer demand for liquidity. Investors demand liquidity because they are uncertain about
when they need to consume and, thus, how long they wish to hold assets. As a result, they care
about the value of liquidating their assets on several possible dates, rather than on a single date.
Creating deposits that are more liquid than the assets held by banks can be viewed as an
insurance arrangement in which depositors share the risk of liquidating an asset early at a loss.
This model explains an important function of banks. It also shows that offering these demand
deposits subjects the banks to bank runs if too many depositors withdraw. Creating liquid
deposits is one important function of financial intermediaries like banks. Another function is
monitoring borrowers and enforcing loan covenants.
I will analyze some important reasons for the demand for more liquid assets by investors who are
consumers, then provides an alternative motivation for a demand for liquid assets by
entrepreneurs. When the assets that investors can hold directly are illiquid, there is a demand for
creating more liquid assets. An illiquid asset is one in which the proceeds available from physical
liquidation or a sale on some date are less than the present value of its payoff on some future
date. In the extreme, a totally illiquid asset is worthless (cannot be sold or physically liquidated
for a positive amount) on some date but has a positive value on a later date. The lower the
fraction of the present value of the future cash flow that can be obtained today, the less liquid is
the asset.
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Consider the following asset on three dates, T = 0, T = 1, and T = 2. If one invests one unit at
date 0, it will be worth r2 at date 2, but only r1<r2 at date 1. The lower r1/ r2 is (holding constant
market discount rates), the less liquid is the asset.
Banks can create liquidity by offering deposits that are more liquid than their assets. If only the
proper depositors withdraw, it works very well. However, creating this liquidity subjects the
bank to bank runs. The bank may have liquidity problems. If a depositor’s need for liquidity (the
depositor’s type) were a verifiable characteristic that could be written into contracts, the contract
could specify that a type 1 be given r1 at date 1, and a type 2 be given r2 at date 2. However, on
date 1 when each depositor learns his type, this is unverifiable private information. If a bank
offers liquid deposits that offer each depositor the opportunity to withdraw r1 on date 1 or r2 on
date 2, the depositors may select the appropriate withdrawal date for their type. That is, the type
1s take r1 and the type 2s take r2 , and if all are expected to do this, each will choose the option
that is best for him. It turns out, however, that there are multiple equilibria. That is, there is more
than one self-fulfilling prophecy about who withdraws at date 1. There is a good equilibrium in
which only the type 1 depositors withdraw and a bad equilibrium (a bank run) in which all
withdraw at date 1 because they all expect each other to do the same.
To see why there are multiple equilibria, consider how much is left to pay depositors whowait
until date 2 to withdraw if a fraction f of initial depositors withdraw at date 1. Because each asset
is worth 1 at date 1, a fraction f r1 of the total assets must be liquidated at date 1. This leaves
for each of the fraction 1 − f who wait until date 2. In any equilibrium, at least a fraction t of
deposits will be withdrawn, or f ≥ t , because type 1s always withdraw at date 1. The type 2
depositors will choose to withdraw at date 1 as well if r2 (f) < r1. In the example with 100
depositors, t = 1 /4, or 25 are of type 1. If just the type 1 depositors withdraw, or f = t = 1 /4 , and
r1= 1.28, then r2 = 1.813 > r1, and the type 2 depositors will choose to wait until date 2 to
withdraw. Depositors must choose simultaneously, before they know the actions of others. Each
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needs a forecast of f , denoted by fˆ. Given a borrower’s forecast, he chooses whether to withdraw
at date 1. A Nash equilibrium is a self-fulfilling prophecy of fˆ= f, and in the good equilibrium,
f = fˆ= t = 1/4.
However, suppose all depositors forecast that everybody else will withdraw (i.e., 99 depositors,
so fˆ≥ 0.99). Then the bank will fail before T = 2. If 79 depositors or more are expected to
withdraw, then the bank will be worthless at date 2: the bank can be liquidated for at most 100 at
T = 1, and if 79 depositors were to each receive 1.28, at T = 1, the bank would not have sufficient
assets, because 79 × 1.28 = 101.12 > 100. Note that a prophecy of fˆ = 0.99 is not self-fulfilling,
because if it is believed by all, then every depositor will withdraw. The self-fulfilling prophecy
of a bank run is f = fˆ= 1, where all rush to withdraw. Providing liquidity subjects the bank to
runs. If a run is feared, it becomes a self-fulfilling prophecy.
The first paragraph of Diamond and Dybvig (1983) follows: “Bank runs are a common feature of
the extreme crises that have played a prominent role in monetary history. During a bank run,
depositors rush to withdraw their deposits because they expect the bank to fail. In fact, the
sudden withdrawals can force the bank to liquidate many of its assets at a loss and to fail. In a
panic with many bank failures, there is a disruption of the monetary system and a reduction in
production.”
Bank runs disrupt production because they force banks to call in loans early. This forces the
borrowers to disrupt their production. The model does not have an explicit model of loans from
the banks; it simply models the bank loans as illiquid.
These two possible equilibrium beliefs (self-fulfilling forecasts of f ) are locally stable. That is, if
t = 1 /4 , a type 2 depositor will not run given that a forecast fˆis just above 1 /4 , for example fˆ=
0.27. Similarly, a type 2 depositor would run given a forecast fˆjust below1, for example, fˆ= 0.97.
The tipping point for a run is a forecast implying that
ˆ
r1≥ r2 or r1 > r2 ( f ) = {1−[fˆ×r1]}R 1−fˆ ,
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fˆ> (R−r1) r1(R−1) = 2−1.28 1.28(2−1) = 0.5625.
Because moving away from a good equilibrium requires a large change in beliefs, the initiation
of a run when none was expected requires something that all (or nearly all) depositors see (and
believe that others see). For example, a newspaper story that the bank is performing poorly could
cause a run even if many knew that it was inaccurate, because those who know it is inaccurate
can believe that the others will decide to withdraw based on the story. Even sunspots could cause
runs if everyone believed that they did.
Using diversified funding sources can help insulate a bank from runs if diversified means that
there is no commonly observed information source that is seen by a large number of the diverse
depositors. An older example is also useful. It would make sense for a bank to have a large lobby
(or fast bank tellers), because if a line to withdraw extended out to the street, passersby may
conclude that a run is in progress. Conversely, once a run is in progress, it will be important to be
able to convince all depositors that it will stop and to ensure all the depositors know that all
others have been so convinced.
When all depositors do not observe the same news or other information sources, then the
depositors will not have a way to tell if others are choosing to panic and run (they will have
“incomplete common knowledge”). There are some very interesting analyses of runs in this
context. In addition, there are some important, but somewhat difficult, analyses of bank policies
when there is an unavoidable positive probability of a run.
SUSPENSION OF CONVERTIBILITY
In this simple model, a bank can suspend convertibility of deposits to cash in order to stop a run.
That is, suppose the bank does not allow more than a fraction t of deposits to be withdrawn (does
not allow f > t, or in the example, allows only 25 to withdraw). Then no matter how many
depositors attempt to withdraw at date 1, a type 2 will get
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In the example, the type 2 would get 1.813 at date 2. As a result, the depositors would never
panic and a run would never start. In this case, the suspension is a threat that need not actually be
carried out. The problem lies in convincing potential participants in a run that convertibility will
be suspended at the proper time. In the days before deposit insurance, banks regularly suspended
convertibility to stop runs ( Friedman and Schwartz 1963). In a more general model, in which the
fraction of type 1 depositors fluctuates sufficiently (and the realized fraction cannot be written
into contracts), suspension cannot be used only as a threat. Some suspension would actually
occur and would be unpopular. If suspension occurred regularly, depositors would desire another
way of stopping runs caused by panics. In practice, government-provided deposit insurance has
been instituted following many financial crises. Its effects are described in the next section.
An alternative way to stop and prevent runs is deposit insurance, a promise to pay the amount
promised by the bank no matter how many depositors withdraw, without suspension of
convertibility. In the example, this is a promise of 1.28 to those who withdraw at T = 1 and
1.813 to those who withdraw at T = 2. How can this be accomplished if everyone withdraws?
Unless there are outside resources that we did not account for in the model, the only way is to
take some resources away from those who run and withdraw. Governments have taxation
authority, which is the ability to take resources without prior contracts. This gives government
deposit insurance an advantage over private deposit insurers who might themselves fail in a run,
or who would need to hold sufficient liquid assets to prevent the financial system from creating
liquidity.
In our example with t = 1 /4, where exactly 25 people ought to withdraw, suspension of
convertibility works as well. However, if there is aggregate uncertainty about t , then suspension
may prevent some type 1 depositors from withdrawing. In this case, suspension is costly. Deposit
insurance can stop runs and avoid suspension of convertibility.
A bank with deposit insurance can credibly promise not to have runs. Government
deposit insurance works because the government has taxation authority and, unlike
most insurance companies, can provide a guarantee against large losses that are
usually off the equilibrium path without holding reserves to back up their promise.
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In addition, a deposit insurance law commits the government to insure banks, which
is an advantage over discretionary policies if self-fulfilling prophecies of runs need
to be eliminated. Suspension of convertibility is usually a discretionary policy. Another
discretionary policy to prevent banks from liquidating illiquid assets and avoiding self-fulfilling
runs is central-bank lending, financed by implicit taxation or money creation authority. The
extent of the Great Depression in the United States in the 1930s has been blamed on the lack of
Federal Reserve discount window lending by Friedman and Schwartz (1963). Deposit insurance
will solve this problem of discretionary lending, but its guaranteed bailout of depositors may
cause incentive problems if bank regulation is poorly structured.
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CHAPTER II
The recent financial crisis has put financial sector regulation on top of the policy agenda. There
is little consensus about the proper direction to go, however. One direction is to strengthen direct
regulation and supervision and, thereby, to limit the ability of financial institutions to participate
in particular types of risky activities. Another direction is to focus on measures that enhance
market discipline. By market discipline we mean that stakeholders in financial institutions
demand compensation for being subject to default risk and managers respond to such increased
costs of funding by reducing default risk.
The coverage of explicit deposit insurance affects risk-taking directly, as well as indirectly
through its impact on implicit insurance of depositors and other creditors. Implicit insurance is
caused by lack of credibility of non-insurance of those creditors, who are not covered by explicit
insurance as noted by Gropp and Vesala (2004). The evidence also indicates that risk taking
incentives can be influenced by institutional factors affecting the credibility of noninsurance.
One example is rule-based procedures for bank distress resolution.
Implicit protection is usually not stated and sometimes denied by governments but it exists if
there are widespread expectations that the government will not allow some or all stakeholders to
lose their stakes fully or partially for political reasons or for fear that stakeholders’ losses will
threaten confidence in the financial system more generally. There is ample evidence that few
governments allow banks of importance in the financial system to simply fail and enter
bankruptcy proceedings.
Explicit deposit insurance is one aspect of the so-called safety net for the banking system.
The other aspects are the central banks’ role as Lender of Last Resort (LOLR), capital
requirements, regulation of asset composition, and supervision. The most important role of
deposit insurance is to prevent bank runs that can threaten the whole banking system. Diamond
and Dybvig (1983) show how limited information among depositors about the risk and value of
bank assets can lead to “contagion” of bank runs from one bank to another. Contagion effects
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could also be caused by interbank claims on a distressed bank (Allen and Gale, 2000). The
potential for contagion implies that the banking system is subject to “systemic risk” to a greater
extent than the non-bank financial system.
The downside to deposit insurance from a systemic risk perspective is that it creates incentives
for risk shifting from banks’ shareholders to deposit insurance funds and tax-payers to the extent
insurance premiums do not fully reflect the default risks of the banks. There is widespread
consensus among economists that explicit and implicit guarantees of depositors, other creditors
and shareholders of banks induce banks to take on excessive risk. A strong indication of this so-
called moral hazard behavior, or lack of market discipline on risk-taking, is the prevalence of
banking crises across the globe as documented in Caprio and Klingebiel (2003). Neither
developed nor developing countries have been spared, and countries with weak, as well as
countries with seemingly strong and able banking supervisors have experienced crises.
Supervisors and policy makers also seem to consider excessive risk-taking a real problem as
demonstrated by the international efforts since 1988 to create global standards for bank capital
within the Basel Capital Adequacy framework.
Policy makers and regulators, in particular, sometimes argue that if guarantees are not explicit
there is “constructive ambiguity” about the degree to which different creditors of banks will be
bailed out in times of crisis, and that this “constructive ambiguity” contributes to market
discipline. It is possible, however, that absence of explicit guarantees leads to strong expectations
that governments and regulators in times of crises will respond by issuing blanket guarantees of
all creditors of banks or by bailing them out in other ways. If so, there is little or no ambiguity
and the lack of insurance is not credible.
Banking crises tend to occur without much warning and, as a result, policy makers must react
very quickly to stave off any threat to the financial system as a whole and to the payment system
in particular. The government and supervisors cannot wait to see whether a large bank is truly
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insolvent or only has a liquidity problem and, in case of insolvency, they cannot allow normal
corporate insolvency procedures to work themselves out before creditors’ claims are honored
fully or partially.3 An important function of the banking system is to supply liquidity and lack of
trust in the banking system as a whole can rapidly become very costly. Central banks can provide
liquidity assistance to banks in distress but the difficulty of distinguishing between liquidity- and
insolvency crises in combination with the fear of contagion tends to compel governments to
secure a distressed bank’s survival if they fear systemic repercussions one way or another.
Different ways of securing a bank’s survival have different implications for shareholders, in
particular. The issuance of a blanket guarantee of creditors tend to benefit shareholders as well,
while nationalization and temporary public administration can cause
shareholders to lose their entire stake.5 In case the distressed bank is
merged with another bank, shareholders would typically obtain some stake
in the merged entity.
The empirical evidence in Angkinand (2008) indicating that costs of crises are relatively high in
countries with low explicit deposit insurance coverage implies that the incentive to intervene
quickly to protect banks from the risk of runs is particularly strong in these countries. Keefer
(2001) analyze the political forces and costs associated with banking crises. Assuming that
market participants understand these costs, the credibility of non-insurance is weakened further.
Many countries including the US and members of the EU have introduced partial deposit
guarantee schemes in order to reduce the risk of runs of such magnitude that banks must be
closed while retaining an element of market discipline. The magnitude of explicit coverage, as
well as the types of deposits covered by insurance, varies considerably from country to country.
The question policy-makers face is what coverage is needed to reduce the risk of runs to an
acceptable level while also providing market discipline. If the risk of severe runs remains high at
a partial level of coverage, non-insurance of relatively large deposits is not credible.
The discussion so far implies that the effect of explicit insurance schemes on banks risk taking
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incentives depends on three factors: the coverage of explicit deposit insurance schemes, the
credibility of non-insurance of those not covered by explicit schemes, and the relation between
the coverage of explicit insurance and the credibility of non-insurance. Figure 1 illustrates our
argument and the hypothesis that there is a partial level of explicit coverage that minimizes
banks’ risk-taking in a country. On the horizontal axis we have the extent of explicit insurance
coverage (EC) of deposits and other claims on banks. On the vertical axis we have the
incentives of banks to take risk (RT) given macroeconomic conditions, capital requirements,
efficiency of supervision and other institutional characteristics of the country. We interpret risk-
taking (RT) as the probability of a bank’s capital buffer being exhausted within a certain
timeframe.
In the Figure1, the line denoted “Explicit DI” shows how market discipline
declines and risk-taking (RT) increases as explicit insurance coverage (EC)
expands at a constant level of implicit insurance. As EC increases depositor
monitoring declines and the ability of banks to shift risk to a deposit
insurance fund or tax payer’s increases. We postulate the following partial
relationship:
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“diminishing returns” in terms of effects on risk-taking from reducing explicit
coverage starting from full coverage and a minimum of market discipline. In
other words, a relatively small group of uninsured creditors can contribute
substantially to market discipline.
The sufficient conditions for the line Implicit DI to be downward sloping in EC,
as well as in CNI(1-EC), are that the conditions in above equation hold and
that the effect on risk-taking incentives of an increase in EC are dominated
by the increase in CNI relative to the decline in the share of non- insured
deposits ((1-EC). These sufficient conditions for diminishing effects on RT of
an increase in EC are expressed formally in Appendix 1.
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Vertical summation of the lines Explicit DI and Implicit DI gives us the U-
shaped curve RT describing the relationship between risk-taking and explicit
deposit insurance coverage. Although the U-shaped relationship described in
Figure 1 constitutes the main hypothesis to be tested below, it is clear that
the U-shape is not a mathematical necessity. For example, if the derivatives
for both RTExpl and RTImpl had the opposite signs, the RT-curve would have a
maximum instead of a minimum. In this case the risk-minimizing deposit
insurance system would be either no explicit insurance or full coverage.
Another scenario is that an increase in EC has little effect on the credibility of
non-insurance while the direct effects of changes in EC on risk-taking
incentives are strong. If so, the risk minimizing coverage would be zero.
One scenario not considered so far is that the credibility of the explicit
coverage depends negatively on the extent of this coverage. In this case, the
line Explicit DI would be nearly flat and the costs in terms of risk-taking of
increasing EC would be small. Under the same circumstances CNI would
most likely be insensitive to changes in EC. Under these conditions the RT-
line would be close to a straight line and the explicit coverage would not
matter much for risk-taking. Thus, a prerequisite for the analysis to be
meaningful is that explicit coverage has reasonable credibility.
This hypothesis will be tested below using alternative proxies for risk-taking.
Although risk-taking in the sense analyzed here depends on the risk of the
asset portfolio as well
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as the equity capital ratio, most countries have implemented capital
requirements. If these requirements are binding, they affect banks’ risk-
taking incentives according to the following
hypothesis:
Hypothesis 2: Incentives for risk-taking increase as equity capital declines.
If capital requirements are not binding, the capital ratio and risk-taking on
the asset side are simultaneously determined. Both aspects of risk-taking
would depend on the incentives to shift risk to creditors, a deposit insurance
fund or tax-payers.
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rule of law but not prudential regulation and supervision contribute to lower
risk-taking.
Using provisions for non-performing loans and the volatility of stock returns
as risk measures
Gropp and Vesala (2004) and Nier and Baumann (2006) find that explicit
deposit insurance reduces banks’ risk-taking incentives. Nier and Baumann
(2006) using data for 729 banks in 32 countries also find that implicit
guarantees associated with banks being “Too-Big- to-Fail” induce risk-taking
in the sense that relatively large banks hold less capital. Gropp and Vesala
emphasizing that credibility of non-insurance increases when partial deposit
insurance is introduced find support for this hypothesis in a sample of
European banks.
The use of country data allows us to use a relatively broad range of proxies
that we obtain from different sources. The following proxies for risk-taking
within a country’s banking system are used:
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i) The Occurrence of a Banking Crisis (BC) in a country during a particular
year
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situation when much or all of bank capital is exhausted; a borderline banking
crisis is identified when there is evidence of significant banking problems
such as government intervention in banks and financial institutions. These
data have been used in much of the literature on banking crisis.
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Therefore, we do not include STDNPL/CAP as a separate independent
variable.
The fifth proxy is the Implicit Insurance Premium (IPP) calculated as the
mean implicit insurance premium for listed banks in each country. These
values have been taken from Hovakimian et al (2008), who calculated bank-
specific premiums and country means for the period 1999-2007. The IPP has
theory foundation in Merton (1977), who modelled deposit insurance as a put
option on a bank’s assets. Option values depend on stock market volatility
and leverage of the banks. The implied option premiums can be used as a
measure of the bank’s risk-taking if volatility and leverage reflect the
probability that a bank will become insolvent and the option to sell the
bank’s assets is expected to be exercised in insolvency. This model has
subsequently been implemented in a number of studies of over and under
pricing of deposit insurance in various countries. The articles differ in terms
of pricing model, assumptions about government forbearance and
assumptions about the term of option contracts.
Table III (a) shows correlations between different proxies for risk-
taking used in panel and cross-section analysis. The negative
correlation between Z-scores and other proxies is explained by the
fact that a higher Z-score corresponds to a lower probability of
default. In general the correlations are quite low. The exception is
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the noted high correlation of 0.74 between NPL/CAP and
STDNPL/CAP.
The third variable, called covgdpint, is constructed in the same way as covdepint but it is
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based on data for the ratio of the coverage limit per GDP relative to GDP per capita (covgdp).
Since the correlations among these three proxies range from 0.94-0.98 (Table II (b)), we report
empirical results mainly using covdepint.
Since there are important features of deposit insurance systems besides coverage, we construct a
fourth variable based on features of the explicit deposit insurance systems. This index, called
Comprehensive Deposit Insurance or CompDI, is aggregated from four dummy variables:
The value of the CompDI variable, therefore, varies from 0 to 4, where the highest value
indicates an explicit system that is designed to comprehensively protect depositors and creditors.
The correlations among the first three variables lies around 0.90, while the correlation between
each of these three variables and CompDI are lower, mostly around 0.80 in the full sample.
Table II (d) reports Logit regression results for both linear and quadratic relationships between
the occurrence of banking crises (BC) and (lagged) explicit deposit insurance coverage (EC). In
column (1) in Table IV for All Countries there is a simple dummy variable for the existence of
an explicit deposit insurance scheme. Columns (2) and (4) report results for linear formulations
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with respect to different proxies for deposit insurance coverage, in order to compare results with
formulations including the square of the EC proxy in columns (3) and (5) for All Countries. The
remaining columns in Table IV report results including the squared EC-term in order to test
Hypothesis 1 for Industrial plus Emerging Markets, Industrial Countries, Emerging Markets, and
Developing Countries separately.
The deposit insurance dummy in column (1) is negative but not significant at the 95 percent
level. The linear models in columns (2) and (4) reveal no effect of deposit insurance coverage
whether covdepint or Comp DI is used as proxy. These results are different from those in
Demirgüç Kunt and Detragiache (2002), Hutchison and McDill (1999), and Barth et al. (2004),
who report increased risk-taking as a result of the existence of an explicit deposit insurance
system and as a result of increased coverage. These authors use similar linear specifications but
their estimation period begins in 1973 instead of 1985 and the dummy for a banking crisis year is
slightly different. I included only the first year of a crisis as a crisis year for reasons discussed
above.
Among the lagged control variables real GDP per capita and GDP growth have statistically
significantly negative relationships with the probability of banking crises. The ratios of money
supply to reserves and domestic credit to GDP, as well as the pre-crisis inflation rate are
statistically significant and increasing the likelihood of banking crises. The results for these
variables are consistent across different formulations and will not be discussed further.
Introducing the squared explicit coverage variables we obtain strong support in Table II (d) for
Hypothesis 1 proposing a U-shaped relationship between the probability of banking crisis and
explicit deposit insurance coverage. In columns (3), (6), and (10) the coefficient for covdepint
becomes negative and significant while the coefficient for the squared covdepint is positive and
significant at the 1% level. In columns (8) for industrialized countries alone and column (12) for
developing countries alone the signs are as hypothesized but the coefficients are not significant.
Using the Comp DI proxy the negative linear coefficient and the positive coefficient for the
squared term are significant for All Countries, Industrial and Emerging Markets, and Industrial
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Countries alone. Coefficients with the same signs are weakly significant (denoted # to represent
the 65 percent level) for Emerging Markets alone and Developing countries alone.
The relatively weak results for developing countries may be explained by the relatively small
number of crisis episodes among these countries when a deposit insurance system was in place at
the onset of the crises. It is also possible that both explicit deposit insurance ands noninsurance
are not strongly credible in these countries. Table I shows when deposit insurance schemes were
introduced and whether a crisis was ongoing at the time of introduction. In the following we
focus on analyses of All Countries and Industrial plus Emerging Markets in order to avoid
problems with insufficient observations.
Table II (e) presents results for regressions with three alternative proxies
for risk-taking. The proxies are:
(i) Non-performing Loans relative to Equity Capital (NPL/CAP),
(ii) the Z-score representing “distance to default”, and
(iii)IPP representing the implicit insurance premium
These are obtained from Hovakimian et al. NPL/CAP is introduced in a panel
regression as well as in a cross section regression. Note that Hypothesis 1
implies an inverted U-shape for the Z-score, since this variable should be
inversely related to default risk. The hypothesized signs of the coefficients
for the linear deposit insurance term, as well as for the quadratic term, are
obtained for all risk-taking proxies for All Countries as well as for Industrial
plus Emerging Markets. They are significant in the panel regression for
NPL/CAP for both country groups. The squared term is significant on the 65
percent level in the Z-score regressions. The cross-section regressions
obviously include fewer observations. The coefficients in the IPP regressions
have the expected signs but they are not significant. As discussed, the
explanation could be that IPP measures across countries are biased because
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IPP is likely to depend on country specific implicit protection of depositors in
an unpredictable way.
Hypothesis 2 with respect to the capital ratio is also tested in Table II (e).
The hypothesized negative coefficient for CAP/TA is significant in the both
the panel and cross-section NPL/CAP regressions but insignificant in
regressions for the Z-score. These results indicate that moral hazard
incentives strengthen as capital declines as theory predicts. There is a
potential simultaneity problem between risk-taking and the capital ratio in
spite of the one year lag for the capital ratio. For this reason the cross-
section regressions in Table V are estimated using instrumental variables
(2STLS).
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expected pattern with more than one sign shift for the dummies representing
the intermediate levels of covdep. However, high coverage seems to be
associated with the largest risk-taking, while low partial coverage seems to
be associated with the lowest risk-taking (covdepdummy 2) as expected.
Table II (g) shows in column (1) the coefficients for linear and squared
covdepint when only systemic banking crises are included in the dependent
variable. Clearly, the U-shape remains strongly significant in this case.
The other columns show results for two other proxies for explicit deposit
insurance coverage. lncovdep is the log of (1+covdep) and covgdpint is the
maximum coverage relative to deposits divided by GDP per capita.
The coefficients shown in the table are significant and indicate the U-shape.
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CHAPTER III
Recently, many countries have implemented deposit insurance schemes and many more countries
are planning to do so. The design of this part of the financial safety net differs across countries,
especially in account coverage. Countries that introduce explicit deposit insurance make many
decisions: which classes of deposits to insure and up to what amount, which banks should
participate, who should manage and own the deposit insurance fund, and at what levels
premiums should be set. When countries elect not to introduce explicit deposit insurance,
insurance is implicit. In either case, the benefits banks gain depend on how effective the
government is at managing bank risk-shifting.
Throughout the discussion I will refer to the funding of deposit insurance as the actual
contributions by banks to cover deposits and to the pricing of deposit insurance as the actuarially
fair price of deposit insurance. Actual contributions can be made on an ex-ante basis, in which
case contributions are typically accumulated towards a deposit insurance fund or reserve, or on
an ex-post basis, in which case banks pay deposit insurance premiums or levies only after
bank failures occur. Actual contributions by banks can differ substantially from estimates of the
actuarially fair price of deposit insurance for several reasons. First, deposit insurance can be over-
or underpriced. Second, the estimate of the fair price of deposit insurance may be biased.
Third, the government may contribute funds or issue guarantees on certain bank liabilities.
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And fourth, actual contributions are not always smoothed over time, unlike fair premiums that are
typically calculated as annual annuities. For instance, many countries establish target fund levels.
Once the fund achieves its target level, contributions may be (close to) zero. Also, countries
may decide to set contributions high initially in order to quickly reach a certain minimum fund
size.
The academic foundations for measuring the value of deposit insurance lie in Merton
(1977), who models deposit insurance as a put option on the value of the bank's assets. Most of
the empirical literature on deposit insurance has either focused on the issue of over- or
underpricing of deposit insurance or on how different design features affect the effectiveness of
deposit insurance. No study thus far has systematically investigated how the different design
features affect the value of deposit insurance, and therefore its pricing.
Another approach of pricing deposit insurance is known as "expected loss pricing". This
approach is centered on the expected default probability of a bank, which can be estimated using
fundamental analysis and/or market analysis. Fundamental analysis is typically based on
CAMEL-type ratings, and thus on accounting values. Market analysis is typically based on
interest rates or yields of uninsured bank debt, such as certificates of deposits (CDs), inter-
bank deposits, subordinated debt, and/or debentures.
25 | P a g e
If markets are efficient, market prices reflect their true value, meaning that all relevant and
ascertainable information is reflected in asset prices.4 Therefore, in countries with well-developed
capital markets, market-based models are to be preferred over accounting-based models of deposit
insurance. However, the application of market-based models of deposit insurance is limited.
First, market-based models may give poor estimates of asset risk in countries with
underdeveloped (illiquid) capital markets. Second, market-based information is not available
for all banks. For example, market value of equity is only available for listed banks, and
debenture yields are available only for banks that have issued debentures. For these reasons,
practical models of pricing deposit insurance typically embed both market-based and accounting-
based information.
The principle of expected loss pricing is simple, and can be represented by the following
equation:
In the above equation, the "Expected loss" equals the size of the loss to the deposit
insurer as a percentage of insured deposits, and thus measures the cost of deposit insurance.
In order to breakeven in expectation, the deposit insurer should set a premium per insured
26 | P a g e
deposit equal to the expected loss price. The "Expected default probability" can be estimated
using fundamental analysis, market analysis, or rating analysis. Fundamental analysis typically
involves the use of CAMEL- like ratings. Market analysis, on the other hand, uses interest rates or
yields on uninsured bank debt, such as interbank deposits, subordinated debt, and debentures.
Rating analysis indicates the use of credit ratings of rating agencies, such as Moody's and
Standard and Poor's. In principle, credit ratings can be based on both fundamental and market
analysis, although they also tend to be affected by political considerations. The "Exposure" is
usually equal to the amount of insured deposits, but can be set equal to total deposits (uninsured
plus insured deposits) in "too big too fail" cases. "Loss given default" indicates the size of the loss
to the deposit insurance fund as a percentage of the total defaulted exposure to all insured
deposits, and thus indicates the severity of the loss. Good indicators for the loss given default
may include the business mix of bank, its loan concentration, and the structure of bank
liabilities. Estimates of losses given default are typically also based on historical experience.
Although all three components to the expected loss pricing formula (expected default
probability, exposure, loss given default) are equally important in terms of estimating the
expected of loss of a bank to the deposit insurance fund, the focus is typically on
estimating the default probability of the bank, given that the other two components
(exposure and loss given default) are relatively easy to measure given the availability of
bank-specific information on the amount of uninsured deposits and historical information
on the losses incurred by the deposit insurance fund given default.
In the following section we present how analysis of credit ratings and interest rates on
uninsured debt can be used to estimate the expected default probabilities. We focus on the
analysis of credit ratings and interest rates rather than on fundamental analysis, because
fundamental analysis is more ad hoc and is not based on market principles. Nevertheless, in
practice one may use fundamental analysis of expected default probabilities, either as a
complement to the other two types of analyses to check for robustness, or in case the other types
of analyses cannot be carried out due to the lack of data on either market rates or credit ratings.
27 | P a g e
extensive time series on historical default rates for each of their rating categories. In the case
of Moody's, these time series go back to the year 1920. For example, one can translate credit
ratings on long-term bank deposits by using historical default rates on corporate bonds in the
same rating category, and use these default rates as an estimate of the expected default
probability of the bank. To reduce measurement error, it is advisable to estimate one-year default
probabilities by taking the average cumulative default rate over several years. The optimal
number of years depends on the specific situation. It should be large enough to reduce
measurement error, but short enough in order not to use outdated information.
In other words, 1+ r f equals (1- p)(l+r). This implies that the expected default
probability can be calculated as
p = l - l l l= L Z l fL r > rf .
1+r 1+ r
In case of deposits, one can apply this methodology to estimate bank default probabilities
by setting r equal to the interest rate on uninsured deposits, and r f equal to the yield on zero-
coupon Treasury securities rate. Uninsured deposits can include such deposits as interbank
deposits. r - rf is the risk premium on uninsured deposits.
The above methodology to estimate bank default probabilities is only suitable for
application to deposit premiums on uninsured deposits, not to deposit premiums on insured
deposits. The reason is that risk premiums on insured deposits not only reflect the risk of the
individual deposit-issuing bank (as do risk premiums on uninsured deposits), but are also
28 | P a g e
affected by the credibility of deposit insurance, i.e., the guarantor risk, which is difficult to
estimate. Guarantor risk comprises both the risk of repudiation of the guarantee and the
restitution costs borne by depositor when seeking restitution of his insured deposit losses.
Because of the protection provided by deposit insurance, risk premiums on insured deposits tend
to be lower than risk premiums on uninsured deposits. If deposit insurance were fully credible,
depositors do not bear losses in case of bank failure, inducing a low risk premium on insured
deposits. With imperfect credibility of deposit insurance, the risk premium on insured deposits
is higher. By using data on uninsured deposits one avoids the problem of estimating the
guarantor risk.
Since the above methodology to estimate bank default probabilities requires the availability
of data on deposit rates on uninsured deposits, it can not be applied to countries that insure all
deposits. A more general problem with using deposit premiums to estimate default probabilities
is that they are influenced by monetary policy and may therefore not only reflect default
probabilities.
I apply the methodology of expected loss pricing of deposit insurance to bank credit ratings and
yields on subordinated bank debt. Table 4 shows the results for different scenarios. Panel A in
Table 4 highlights the expected loss pricing method using Moody's credit ratings. Panel B in
Table 4 highlights the expect loss pricing method using yield rates on subordinated debt. In
principle, one can apply the methodology to any type of uninsured bank debenture, not just
subordinated debt.
Column 1 in panel A of Table III (a) reports the broad classification of Moody's credit ratings.
Moody's credit ratings range from Aaa to C, where Aaa indicates high credit rating and C
indicates low credit rating. Column 1 in Panel B reports the yield on a one-year, zero-coupon
Treasury bond. We set this yield equal to 3 percent for each scenario. Column 2 in Panel A
transforms the credit ratings into five-year average cumulative default rates. The average
cumulative default rate over five years are calculated using historical default rates for the period
29 | P a g e
1920-99 and are taken from Exhibit 31 of Moody's Historical Default Rates of Corporate Bond
Issuers, 1920-1999 (Moody's, 2000). Note that we use historical default rates on corporate
rather than banks as estimate for the default rates of banks. Column 2 in Panel B reports the
spread of a one-year, zero-coupon subordinated bank debt over the one-year, zero-coupon
Treasury bond. Column 3 in Panel A reports the one-year default rate for each corresponding
credit rating. The one-year default rate is calculated by dividing the average cumulative default
rate over five years reported in column 1 by five. Column 3 in Panel B reports the average one-
year likelihood of default, which is calculated using risk-neutral pricing. This means that the
average one-year likelihood of default p equals (y -r / )/(l+ y), where y-rf is the spread of the
one-year, zero-coupon subordinated bank debt over the one-year, zero-coupon Treasury bond
and y is the yield on the one-year, zero-coupon subordinated bank debt, which in this case can be
calculated as the yield on a one-year, zero-coupon Treasury bond r f plus the spread of the
one-year, zero-coupon subordinated bank debt y-rf . Column 4 in panels A and B reports
the loss rate on assets.
The loss rate is set equal to 8 percent of bank assets, which corresponds to the FDIC's historical
loss rates on bank assets for banks with assets exceeding 5 billion US dollars. Column 5 in
panels A and B reports the expected one-year loss rate as a percentage of assets, which
corresponds to the product of the one-year default rate and the loss rate on assets. Column 6 in
panels A and B reports the share of deposits in total bank assets, and therefore indicates the loss
exposure in terms of total assets. Column 7 in panels A and B reports the expected loss as a
percentage of deposits, which corresponds to the quotient of the figures in column 4 and column
5. Column 8 in panels A and B reports the expected loss in basis points (bp) of deposits, and
equals the product of 10,000 times the figure in column 6. The expected loss in basis points (bp)
of deposits is an estimate of the assessment rate for deposit insurance.
30 | P a g e
TABLE III (a) EXPECTED LOSS PRICING
Panel A in TABLE III (a) highlights the expected loss pricing method using Moody's credit
ratings. Panel B in Table 4 highlights the expect loss pricing method using yield rates on
subordinated debt. We set the yield on a one-year, zero-coupon Treasury bond equal to 3% for
each scenario. The average cumulative default rate over five years are calculated using historical
default rates for the period 1930-08 and are taken from Exhibit 31 of Moody's Historical Default
Rates of Corporate Bond Issuers, 1930-2008 (Moody's, 2008). The loss rate is set equal to 8%
of bank assets, which corresponds to the FDIC's historical loss rates on bank assets for banks
with assets exceeding US$ 5 billion.
31 | P a g e
Caa-C 43.37% 8.67% 0.69% 75% 0.93% 92.52
32 | P a g e
DESIGN FEATURES AND PRICING OF DEPOSIT INSURANCE
Deposit insurance premiums differ widely across countries, depending on the design features of
the deposit insurance scheme of the respective countries and their institutional environment,
among others. Table III (b) presents country averages of actuarially fair deposit insurance
premium estimates. These figures are taken from Hovakimian, Kane, and Laeven (2002), and
are calculated by applying the RV (1986) method to a large sample of banks in different countries
for the period 1999-08. The premiums are expressed as a percentage of deposits, and are
estimated either under the assumption of no regulatory forbearance (p =1), or under the
assumption of a regulatory forbearance parameter of p =0.97, as in the original RV (1986)
model. The estimates are based on calculations for listed banks and as such for a better-than-
average sample of the banks in each country.
Without forbearance the country averages range from less than 0.001 percent of deposits
in Australia, Austria, Germany, and Luxembourg to 1.93 percent of deposits in Russia, and
average 0.18 percent of deposits. The premiums tend to be lower for developed countries.
They average 0.04 percent for developed countries, but 0.32 percent for developing countries.
These figures are under-estimates of the actuarially fair price of deposit insurance, mainly because
they ignore regulatory forbearance.
from 0.01 percent of deposits in Australia, Switzerland and the US to 2.94 percent of deposits
in Russia, and average 0.41 percent of deposits. The premiums under forbearance also tend
to be lower for developed countries. They average 0.15 percent for developed countries, but 0.64
percent for developing countries. It is, however, difficult to choose the level of regulatory
forbearance a priori, particularly across countries.
This section investigates how several design features affect the price of deposit insurance, and
vice versa. In particular, we focus on the relation between deposit insurance coverage and the
33 | P a g e
price of deposit insurance, and how risk diversification and risk differentiation within a deposit
insurance system can reduce the price of deposit insurance.
Ronn and Verma (1986) deposit insurance premiums by country Premiums are expressed as a
percentage of deposits. Sample period is 1999-08. Premiums are estimated both under the
assumption of no regulatory forbearance (?=1.00) and under the assumption of a regulatory
forbearance parameter of ?=0.97 (as in RV, 1986). Time to maturity (T) equals 1. It is assumed
that all bank debt is insured. The implied premium estimates are taken from Hovakimian,
Kane, and Laeven (2002). The developing versus developed country classification follows the
country classification of the World Bank.
34 | P a g e
Thailand 0.780 1.189
Zimbabwe 0.536 1.157
Average Average
Developing 0.322 0.641 Developed countries 0.042 0.153
Grand average 0.188 0.407 Grand average 0.188 0.407
Column 2 presents the premium assessment base. Column 3 presents annual premiums for flat
rate deposit insurance schemes as a percentage of the assessment base. Column 4 shows the
value of deposit insurance coverage as a percentage of total deposits. Column 5 presents annual
premiums as a percentage of insured deposits.
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Trinidad & Total deposits 0.20 34.1 0.59
Turkey Insured 1.00-1.20 100.0 1.00-1.20
Uganda Total deposits 0.20 26.0 0.77
Ukraine Total deposits 0.50 19.0 2.63
United Insured <0.30 n.a. <0.30
United States Insured 0.00-0.27 65.2 0.00-0.27
Venezuela Insured 2.00 n.a. 2.00
deposits
Deposit insurance coverage differs substantially across countries. Coverage limits average
20,660 US dollars per deposit for all countries, but range from as low as 120 US dollars in the
Ukraine to as high as 243,520 US dollars in Norway. Insurance coverage tends to increase with
the level of economic development of the country. Naturally, coverage levels are expected to be
higher in countries with higher levels of economic development. When controlling for
differences in the level of per capita GDP, there is less variation in coverage across countries.
The coverage limit-to-per capita GDP ratio averages 3.19 for all countries, 1.98 for developed
countries, and 3.78 for developing countries.
The higher coverage in developed countries would suggest that the price of deposit
insurance is higher in these countries, unless these countries are more effective in controlling the
moral hazard arising from a high level of coverage. For example, these countries may be more
inclined to install risk-adjusted insurance premiums, co-insurance, and/or private funding and
administration. In what follows we analyze in more detail whether countries with high insurance
coverage tend to be countries with high income levels, and whether these countries are more
inclined to implement design features of deposit insurance systems that tend to limit moral
hazard, such as risk-adjusted insurance premiums, co- insurance, and/or private funding and
administration.
First, we regress the insurance coverage limit on per capita GDP and several design
features. The design features are the age of the deposit insurance scheme, a variable that
indicates whether the scheme involves co-insurance or not, a variable that indicates whether
premiums are risk-adjusted or not, a variable that indicates whether the source of funding is
private or not, and a variable that indicates whether the fund administration is private or not.
We include per capita GDP to control for the level of economic development. The sample
includes all countries with explicit deposit insurance schemes as of end-2000. The results are
36 | P a g e
presented in column (1) of Table III (d). The table also presents the correlation matrix of the
design features.
The findings confirm that coverage limit tends to increase with per capita GDP. We also find
that coverage tends to higher in countries where deposit insurance has been introduced a long
time ago. However, the age of the deposit insurance fund is also strongly correlated with per
capita GDP, suggesting that deposit insurance has been around for longer on average in rich
countries than in poor countries. Next, we find that coverage tend to be higher in countries that
have installed risk-adjusted premiums. Given the difficulty of implementing risk-adjusted
premiums, one would expect that they tend to be more common in developed countries that in
developing countries. However, the correlation matrix does not suggest such a relation. Private
funding and administration are not significantly related to insurance coverage in the regression
results, although the correlation between coverage limit and private fund administration is
positive and significant.
Next, we use the deposit insurance coverage-to-per capita GDP ratio as dependent
variable. Interestingly, we find that the coverage ratio is negatively associated with per capita
GDP, suggesting that although coverage increases with per capita GDP, the rate of increase in
coverage is lower than the rate of increase in per capita GDP. In other words, once we control
for the level of economic development, we actually find that the insurance coverage is less
generous in rich countries than in poor countries. We also find that countries with high coverage
ratios tend to implement risk-adjusted premiums, suggesting that these countries try to curb the
moral hazard arising from the generous level of insurance coverage. The other design features do
not appear to be significantly associated with the coverage ratio.
37 | P a g e
TABLE III (d)
Panel A presents the regression results of coverage limit as a function of design features.
Panel B presents the correlation matrix of several design features for countries with explicit
deposit insurance as of end-year 2000. Dependent variable in column 1 is the coverage limit
expressed in thousands of US dollars. Dependent variable in column 2 is the coverage limit
divided by per capita GDP, also referred to as the coverage ratio. Per capita GDP is expressed
in thousands of US dollars. Age of the scheme refers to the age of the deposit insurance
scheme and is calculated as 2000 minus the year when deposit insurance was enacted. Co-
insurance takes value of one if there is co-insurance, and zero if not. Risk-adjusted premiums
takes value of one if premiums are risk-adjusted, and zero if not. Private funding takes value of
one if the source of funding is private, and zero if not. Private administration takes value
one if the fund administration is private, and zero otherwise. Source of the data is Garcia
(2000) and Demirgüç-Kunt and Sobaci (2001). The data are presented in the Annex to this
paper. The number of country observations is 67. Six countries are deleted from the sample
due to lack of data on any of the regression variables. The remaining sample is 61 countries.
The correlation matrix is based on the total sample of 67 countries. A constant term was
included, but is not reported. Heteroskedasticity-constistent standard errors between brackets.
38 | P a g e
* indicates significance at a 10% level. ** indicates significance at a 5% level. *** indicates
significance at a 1% level.
(0.466) (0.028)
Age of the scheme 0.594*** 0.004
(0.293) (0.027)
Co-insurance -1.079 -0.668
(7.657) (0.663)
Risk-adjusted premium 13.366** 2.200**
(5.813) (0.988)
Private funding -23.668 0.179
(14.960) (0.650)
Private expenditure 15.135 0.214
(12.661) (0.735 )
R2 0.482 0.202
No. of observations 61 61
39 | P a g e
PANEL CORRELATION
Coverage Coverage Per capita Age of Co- Risk- Private
limit ratio GDP scheme insurance adjusted funding
Coverage 1.00 admin.
It is well known from investment portfolio theory that non-systemic risk can be diversified
away by pooling different assets into one portfolio (see, for example, Markowitz 1952). The
risk diversification value of an additional asset relates linearly to the covariance between the
returns on the additional asset and the asset returns of the portfolio. The deposit insurance
analogue to portfolio diversification is that, unless bank equity returns are perfectly correlated,
the price of deposit insurance of a group of banks is lower than the sum of the price of deposit
insurance for each individual bank. The risk diversification potential of a particular bank is greater
if the correlation between its equity returns and the equity returns of the other banks in the group
is lower.
40 | P a g e
More generally, the actuarial cost of insurance decreases with the pool of underlying
assets. If default probabilities are not perfectly correlated, it is cheaper to insure a large pool of
assets than a small pool of assets. A larger pool of assets is also more likely to be insurable,
because losses occur with a higher degree of randomness and more frequently, and the average
loss amount upon loss occurrence is smaller (see Berliner, 1982).
The issue of potential diversification of non-systemic risk is often overlooked when discussing
appropriate pricing levels for deposit insurance in a country. Typically, the actuarially fair price
of deposit insurance for a country is estimated by averaging estimated actuarially fair deposit
insurance premiums of individual banks in the country. From the above, it follows that the cost
of insuring the deposits of a banking system is lower than the sum of the cost of insuring each
bank individually. The difference between the cost of insuring the system and the sum of the
individual parts is greater if there is greater risk diversification potential in the country.
Naturally, the potential for risk diversification is larger in larger countries, in countries with many
banks, and in countries with different types of banks (other things being equal). Therefore, the
deposit insurance premium should be higher (or the insurance coverage smaller) in small
countries, in countries with few banks, and in countries without substantial differentiation
between banks (and their risk-characteristics).
A more direct way to limit the risk of deposit insurance, and therefore its price, is to exclude
risky banks from the insurance contract. Unless some of these banks have great
diversification potential because of their covariance matrix structure, and exclusion of the risky
banks from insurance can reduce the cost of deposit insurance significantly. Of course, the
success of this risk differentiation approach depends on the technical ability and political will
to differentiate between risky banks and not so risky banks.
Now, I investigate the potential of risk diversification and risk differentiation of banks in the
Republic of Korea. We compare RV (1986) estimates of actuarially fair deposit insurance
premiums for individual banks with their equivalent for a group of listed banks in Korea. The
reasons for focusing on Korea are threefold. First, to apply the RV (1986) methodology, we
need data on bank equity returns. Most commercial banks in Korea are listed and data on
their equity returns are readily available. Second, and most importantly, the majority of the
Korean commercial banking system consists of listed banks, so that the portfolio of listed banks
41 | P a g e
is a good proxy for the overall commercial banking system. Ideally, one would want to look at
all banks in the country when assessing the potential of risk diversification in the country.
Unfortunately, there is no country where all banks are listed. Korea is one of the best case studies
from this perspective.
We collect daily market data and annual balance sheet data on all listed commercial banks
in Korea for the year 2008 from CapitalLine and Datastream. Data on the total commercial
banking system come from the Korean Central Bank. A summary of the data is presented in Table
III (e). We estimate annual equity volatility from weekly equity returns expressed in US dollars,
and follow Fama's (1965) suggestion to delete days when the Korean stock exchange is
closed. We also delete observations for days on which large jumps in share prices occur. Such
observations may be due to restructuring or merger announcements. Inclusion of such
observations would overestimate the volatility of equity returns.
Table III (e) confirms that the group of listed banks comprises a large part of the total commercial
banking system in Korea. In terms of total assets, the thirteen listed commercial banks in
Korea account for 81.8 percent of total commercial banking system assets. The share of listed
banks in total commercial bank deposits is even slightly higher with 82.5 percent. This means
that the group of listed banks in Korea is a reasonable proxy for the entire commercial banking
system in Korea, so that the risk diversification potential embedded in the group of listed banks
(and the corresponding saving in the cost of deposit insurance) approximates the risk
diversification potential of the country.
The average equity volatility weighted by equity market values is 80.1 percent, which is
substantially larger than the equity volatility of the portfolio of stocks of the thirteen listed
banks reported in Table III (e) of 56.2 percent. The total equity volatility is lower than the
average equity volatility due to imperfect correlation of the equity returns of the sampled banks.
Table III (f) presents the correlation matrix between the equity returns. The table shows that
there is a large variation in the equity return correlations of different banks. Some equity return
42 | P a g e
correlations are close to zero. These correlations suggest that the potential for risk diversification
among Korea banks is substantial.
Next, we investigate the potential for risk reduction achieved by excluding the three riskiest banks
in terms of equity volatility from the insurance contract. These three banks are highlighted in
italics in Table III (e) and include Hanvit Bank (with an equity return volatility of 90
percent), Korea First Bank (with an equity return volatility of 120 percent) and Seoul Bank
(with an equity return volatility of 124 percent). The share of the remaining ten banks in the assets
of the total Korean commercial banking system drops to 58 percent. Note that one of these
banks, Korea First Bank, is a bank with large risk diversification potential, as reflected by
the low correlation of its equity returns with some of the other Korean banks. Nevertheless,
we find that exclusion of these banks of above-average risk further reduces the risk of the
portfolio and therefore the actuarially fair deposit insurance premium. The estimate of the
actuarially fair deposit insurance premium for the portfolio of ten remaining banks is 1.28
percent of deposits.
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The above mentioned actuarially fair deposit insurance premiums have been estimated under
the assumption that all debt is insured. Next, we carry out an extreme debt-structure experiment
where we assume that all non-deposit debt is subordinated to deposits.21 Although in reality it is
quite likely that all bank creditors in Korea were implicitly guaranteed by the government during
the year 2008, so that insured bank debt equals total bank debt, this experiment highlights the
potential reduction in costs if insurance and bailouts were to be strictly limited to bank
deposits, and non-deposit creditors hold junior debt.
With non-deposit debt subordinated, the estimated actuarially fair deposit insurance premiums
reduce further. Under this setup, insuring the deposits of the thirteen banks carries a price of
only 0.39 percent of deposits (see column 4 in Table III (g)). When the three "risky" banks are
excluded, the estimated actuarially fair premium further reduces to 0.33 percent of deposits. The
latter is dramatically lower than the original weighted average of 2.81 percent of deposits.
This section has shown that the potential for risk diversification should be taken into account
when considering an appropriate level for the deposit insurance premium of a country.
Countries with little diversification of risk should charge higher deposit insurance premiums.
We have also shown that premiums can be set substantially lower if countries (have the option to)
exclude risky banks from the deposit insurance system.
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The following table shows bank-specific data for listed banks in the Republic of Korea as of
end-2008. Values are in millions of US dollars, unless otherwise noted. Equity volatility is
annualized volatility, based on weekly equity returns (i.e., weekly equity volatility times the
square root of 52). In italics are the banks the three riskiest banks according to equity volatility.
Individual bank data come from Capital line and Datastream. Total commercial banking
system data from the Korean Central Bank. Column (1) presents total banks assets. Column (2)
presents bank deposits. Column (3) presents total bank debt. Column (4) presents the market
value of equity. Column (5) presents the volatility of equity. Column (6) shows the dividend
paid. Column (7) presents the debt-to-equity ratio. Column (8) presents the ratio of deposits to
(equity plus non-deposit debt), also equal to the ratio of deposits to (assets minus deposits).
Total (10)
banks 268,69 201,437 255,45 15,08 55.2 119.1 16. 2.9
Percentage 58.1 56.5
of total
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Table III (f)
Correlation matrix of weekly equity returns in US dollars for the year 2008
Table III (g) presents estimates of the expected loss rates for different categories of
Moody's credit ratings using loss rates on assets of 8 percent or 50 percent. The 8 percent loss
rate represents the US historical average. The expected losses loss rates presented in Table 11 are
generated using the same framework and under the same assumptions as those presented earlier
in Panel A of Table III (a) in Section 1. Column (3) in Table III (g) presents the expected loss
rates under the assumption of loss rates on assets of 8 percent, while column (4) presents the
expected loss rates under the assumption of loss rates on assets of 50 percent. The estimates in
column (3) serve as a conservative estimate of the actuarially fair premium of deposit insurance.
The estimates in column (4) are less conservative. The estimates in column (3) and (4) differ
only in the assumed loss rate on assets. Since expected loss rates are proportional to the loss rates
on assets (other things equal), the expected loss rates calculated under the assumption of 50
percent loss rates on assets are 50-over-8 times higher than the expected losses calculated under
the assumption of 8 percent loss rates on assets.
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The expected loss rates per deposit derived under the assumption of the US historical average
loss rate on assets of 8 percent and presented in Table III (g) show a similar range of values as
the actual assessment rates of FDIC-insured deposit-taking institutions in the US. Table 12
presents the assessment rates for such institutions for the year 2001 by supervisory group and
capital group. Supervisory group A denotes better quality than supervisory group B, and group B
denotes better quality than group C.
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While the FDIC premiums range from zero to 0.27 percent of insured deposits, the Moody's
ratings implied premiums (under the assumption of 8 percent loss rates) range from zero to 0.93
percent of insured deposits. Considering that the Moody's ratings of large banks in the US range
from Aa to Ba, the Moody's ratings implied premiums for a significant part of the US banking
system range from 0.1 percent to 0.27 percent of insured deposits, very similar to the actual
FDIC pricing schedule of 0.0 percent to 0.27 percent of insured deposits. These results do not
MOODY’S AVERAGE DEPOSIT/ASSE EXPECTE EXPECTED
CREDIT CUMMULATIVE TS D LOSS LOSS 50%
RATINGS DEFAULT RATE 8% LOSS LOSS
FOR 5 YEARS RATE ON RATE ON
Aaa 0.20% 75.00% ASSET
0.00% ASSETS
0.03%
48 | P a g e
indicate that deposit insurance is priced correctly in the US, but merely seem to suggest that the
expected loss pricing method gives reasonable estimates of the price of deposit insurance.
This table presents the assessment rate schedule of the U.S. FDIC risk-based assessment system
as of end-2001. Assessment rates are by supervisory group and capital group. Rates are annual
and are expressed in percentage points per insured deposits
A B C
Well-capitalized 0.00 0.03 0.17
o
dn
Capital
Under-capitalized
Next, we compare the conservative estimates of the actuarially fair price of deposit
insurance with the actually charged premiums in countries around the world. If the
conservative estimate of the true cost of deposit insurance is higher than the officially charged
premium, we argue that deposit insurance is underpriced. Table III (i) presents both the official
premiums and the conservative estimates of actuarially fair premiums based on credit ratings
and option prices. We use both country and bank credit ratings from Moody's to estimate
expected loss rates. The country credit rating acts as a ceiling of the rating for (most) banks in
the country. In several countries, country risk is so dominant that bank ratings equal the
country rating. Since we focus on expected loss rates on bank deposits we use the Moody's
ratings for long-term bank deposits. For countries, we use Moody's ratings on foreign-
currency denominated long-term bank deposits. For individual banks, we use Moody's
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ratings on long-term bank deposits (including both local-currency and foreign-currency
denominated deposits).
Column (1) in Table III (i) presents the country rating on foreign-currency
denominated, long-term bank deposits. Column (2) presents the median of the ratings on long-
term bank deposits for individual banks. The median is taken across Moody's universe of
rated banks in the country (see Moody's, 2001). Column (3) reports the actually charged
deposit insurance premiums in the country. These official premiums are expressed as a
percentage of insured deposits, and are taken from Table III (c).
The next four columns in Table III (i) present the credit rating implied estimates of the
price of deposit insurance. Column (4) presents the country credit rating implied premium under
the assumption of a 8 percent loss rate on assets. The country credit rating is also expressed as a
percentage of insured deposits. For consistency with the actual premiums, all implied premiums
are expressed as a percentage of insured deposits. The country rating implied premiums in
column (4) are our most conservative estimates of the actuarially fair price of deposit insurance,
because they assume a low loss rate on assets of 8 percent and because they use the credit rating
of the country which is at least as good as the (median) credit rating of banks in the country.
Column (5) presents the bank credit rating implied estimates of the actuarially fair deposit
insurance premium under the assumption of a 8 percent loss rate on assets. This country-level
estimate is a weighted average of the bank credit rating implied estimates for individual banks
in Moody's universe of rated banks in the country. These estimates correspond therefore to
the default probabilities implied by the median bank credit ratings presented in column (2).
Column (6) presents the country credit rating implied premium under the assumption of a 50
percent loss rate on assets. These estimates differ from the estimates in column (4) only in the
assumed loss rate, and are therefore a factor 50-over-8 larger than the implied premiums in
column (4). Column (7) presents the bank credit rating implied estimates of the
actuarially fair deposit insurance premium under the assumption of a 50 percent loss rate on
assets. Similarly, these estimates are a factor 50-over-8 larger than the premiums in column (5).
The implied premiums in columns (6) and (7) use higher loss rates on assets and are therefore
less conservative than the estimates in columns (4) and (5), but possibly more realistic in the case
of some countries.
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The last two columns in Table III (i) present the option-pricing implied estimates of actuarially
fair deposit insurance premiums. Column (8) presents the RV (1986) estimates under the
assumption of no forbearance (i.e., using a forbearance parameter of ?=1.00). Column (9)
presents the RV (1986) estimates under the assumption of substantial forbearance (equivalent
to a forbearance parameter of ?=0.97 in their model). The RV (1986) implied deposit insurance
premiums are from Hovakimian, Kane and Laeven (2002). These estimates are based on stock
market and balance sheet data on a sample of listed banks in each of the reported countries, and
are averages for the period 1999-08. We do not have estimates for a number of countries due to
lack of data.
Despite the fact that we calculate rather conservative estimates of the price of deposit
insurance, we find that these estimates are still higher than the officially charged premiums in a
number of countries. In the case of Bulgaria, India and Jamaica, the actually charged
premiums are even lower than the country credit rating implied premiums reported in column
(4) - our most conservative estimates of the cost of deposit insurance. In Korea and Romania,
the actual premiums levied are lower than the premiums implied by median bank credit in the
country reported in column (5). Based on less conservative estimates of the cost of deposit
insurance that assume a loss rate on assets of 50 percent (reported in columns (6) and (7)), one
would conclude that deposit insurance is underpriced in a large number of countries, most of
which are developing countries.
The actuarially fair deposit insurance premiums implied by the RV (1986) option-pricing
model also suggest underpricing in several countries. When allowing for forbearance (to the
equivalent?=0.97 in the RV model), the implied premiums are higher than the actual
premiums in the following countries: Bangladesh, Brazil, Germany, Hungary, India, Japan,
Kenya, and Korea. More conservative estimates based on the assumption of no forbearance still
suggest underpricing of deposit insurance in Bangladesh, Brazil, India, Japan and Korea.
In sum, we find using two different methods of pricing deposit insurance that the actual
premiums levied on banks are lower than the premiums implied by these theoretical models
in many countries. Given that we have used different models and have set model parameters
such that these models produce conservative estimates of the true cost of deposit insurance (in
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many countries, forbearance may well exceed the level implied by?=0.97, and loss rates on
assets may well exceed 50 percent), one could argue that deposit insurance is underpriced in
many countries around the world. In particular in most developing countries, where the
ability to control bank risk tends to be weak, under-pricing of deposit insurance is likely to be
greater than estimated here.
For many countries, we find such high levels of actuarially fair premiums as 5 percent or
more of deposits. Few banks would be able to afford such high deposit insurance premiums.
Our estimates thus suggest that many of these countries cannot afford deposit insurance, in
particular countries with weak banks and institutions. This is another way of saying that
countries with weak institutions should not adopt explicit deposit insurance.
Column (1) presents the country rating on foreign-currency denominated, long-term bank
deposits as of end-year 2001. Column (2) presents the median of the ratings on long-term bank
deposits for individual banks as of end-year 2001. The source of the credit ratings is Moody's
Investors Service (2001). Column (3) reports the actually charged deposit insurance premiums in
the country as a percentage of insured deposits. The source of these figures is Table 6. Column
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(4) presents the country credit rating implied premium as a percentage of insured deposits
under the assumption of a 8 percent loss rate on assets. Column (5) presents the bank credit
rating implied estimates of the actuarially fair deposit insurance premium as a percentage of
insured deposits under the assumption of a 8 percent loss rate on assets. Column (6) presents the
country credit rating implied premium as a percentage of insured deposits under the
assumption of a 50 percent loss rate on assets. Column (7) presents the bank credit rating
implied estimates of the actuarially fair deposit insurance premium as a percentage of insured
deposits under the assumption of a 50 percent loss rate on assets. Column (8) presents the RV
(1986) (RV) implied estimates of deposit insurance premiums as a percentage of insured
deposits under the assumption of no forbearance. Column (9) presents the RV implied estimates
of deposit insurance premiums as a percentage of insured deposits under the assumption of
substantial forbearance (equivalent to a forbearance parameter of? =0.97). The source of RV
(1986) implied deposit insurance premiums is Hovakimian, Kane and Laeven (2002). These are
averages for the period 1999-08.
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Kenya n.a. n.a. 0.94 n.a. n.a. n.a. n.a. 0.71 1.02
Korea Baa3 Ba1 0.05 0.04 0.20 0.26 1.27 0.28 0.85
Latvia Baa3 Ba1 0.30 0.04 0.16 0.26 0.99 n.a. n.a.
Lithuania Ba2 n.a. 1.00 0.27 n.a. 1.72 n.a. n.a. n.a.
Macedoni n.a. n.a. 0.01- n.a. n.a. n.a. n.a. n.a. n.a.
Mexico
a Ba1 Ba1 0.40-
0.03 0.27 0.27 1.72 1.72 n.a. n.a.
Nigeria n.a. n.a. 4.46
0.80 n.a. n.a. n.a. n.a. n.a. n.a.
Peru B1 B1 >0.65 0.64 0.64 4.02 4.02 0.35 0.67
Portugal Aaa A1 0.08 to 0.00 0.01 0.03 0.10 0.01 0.06
Romania Caa1 Caa1 0.30
0.12 to 0.93 0.93 5.78 5.78 n.a. n.a.
Slovak Ba1 Ba1 0.10
0.60 to 0.27 0.27 1.72 1.72 n.a. n.a.
Spain
Rep. Aaa A1 0.10
0.30 0.00 0.01 0.03 0.07 0.05 0.07
Sweden Aa1 Aa3 Max. 0.01 0.01 0.05 0.05 0.02 0.21
Taiwan Aa3 A3 0.05-
0.50 0.01 0.02 0.05 0.14 0.02 0.06
Tanzania n.a. n.a. 0.83
0.06 n.a. n.a. n.a. n.a. n.a. n.a.
Trinidad Ba1 n.a. 0.59 0.27 n.a. 1.72 n.a. n.a. n.a.
Turkey
& Tobago B3 B3 1.00- 0.64 0.64 4.02 4.02 n.a. n.a.
Uganda n.a. n.a. 0.77
1.20 n.a. n.a. n.a. n.a. n.a. n.a.
Ukraine Caa1 Caa1 2.63 0.93 0.93 5.78 5.78 n.a. n.a.
United Aaa A1 <0.30 0.00 0.01 0.03 0.11 0.01 0.09
United
Kingdom Aaa Aa3 0.00- 0.00 0.01 0.03 0.20 0.00 0.01
Venezuel
States B3 B3 2.00
0.27 0.64 0.64 4.02 4.02 n.a. n.a.
a
CHAPTER IV
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next only to the Federal Deposit Insurance Corporation (FDIC) of USA. The DICGC is a wholly-
owned subsidiary of the RBI. Its capital, which initially stood at Rs.1 crore, has been increased
from time to time and currently stands at Rs.50 crore (since May 1, 1984). The DICGC has been
given the mandate to operate as a Pay Box Deposit Insurance System.
Deposit Insurance in India is governed by the Deposit Insurance and Credit Guarantee
Corporation Act, 1961 and the Deposit Insurance and Credit Guarantee Corporation General
Regulations 1961 framed there under. The broad features of the current scheme include bulk
insurance of deposits on a mandatory basis, with its implementation and operation being closely
linked with the regulatory functions of the Reserve Bank of India to safeguard the interest of
depositors.
The statutory arrangement aims at the protection of small depositors of banks. The Act and the
Regulations clearly lay down the guidelines for the management of the DICGC, registration of
insured banks, liability to depositors, management of funds of the Corporation and their accounts
and audit, sharing of information with the bank supervisors, manner of settlement of claims of
depositors of failed banks and subsequent appropriation of recoveries, if any, out of distressed
assets etc. Amendments have been carried out on a few occasions; a few more are under
consideration.
The DICGC charges premium at a flat rate to all insured banks, though there is an enabling
provision in Section 15 (1) of the Deposit Insurance & Credit Guarantee Corporation Act, 1961,
which empowers the Corporation to charge different rates for different categories of insured
banks. Moving to a risk based premium system in India was recommended by the Narasimham
Committee on Banking Sector Reforms (1998) and later reiterated by the Advisory Group
(Capoor Committee) on Reforms in Deposit Insurance in India, 1999. DICGC had set up a
Committee under the Chairmanship of Prof. D.M.Nachane, Senior Professor, IGIDR, who is a
Director on the Board of the Corporation, to examine the issue and formulate a suitable credit
risk model for the Corporation. The Committee recommended a model based on capital
adequacy and supervisory rating used by RBI. Looking, however, to the heterogeneity amongst
insured banks, strengthening the co-operative banking sector having just commenced and the
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recent developments in the international financial markets, there is a need to carefully assess the
determinants of risk based premier, trade-off, if any, between minimizing moral hazard and
placing additional burden on banks that are already weak, before going ahead with adoption of
risk based premium. However, the issue will be kept under constant review.
An appropriate mix of tools should be used to reach the maximum number of people within the
target audience cutting across different backgrounds and levels of society. Factors that must be
taken into consideration in determining an effective mix of tools are the levels of literacy, size of
population, demographic characteristics of the specific target audiences, as well as budgetary
constraints. Some deposit insurers circulate deposit insurance information through publications,
such as annual reports, brochures, guideline handbooks and answers to Frequently Asked
Questions, distributed through the branches of member institutions, seminars and workshops, or
provided to the public on request. Given the increasing reach and accessibility of the Internet, a
website to directly communicate with the public is an important tool for an effective public
awareness campaign. Deposit insurance signs or logos are common tools used by deposit
insurers to enhance public awareness. The deposit insurance logo and sign symbolize a “seal of
trust” that may be placed in printed and electronic media and bank premises to assure the public
that they have the protection of the deposit insurance system. Some deposit insurers have also
established call centers to enhance communication and provide multilingual services facilitating
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public access to deposit insurers and deposit insurance information. In the event of a member
institution’s failure, depositors need to be informed about reimbursement procedures, and
information related to how and when they can receive their deposits.
In India, as part of public awareness program the Corporation disseminates information about
deposit insurance scheme to the public through insured banks, its own website, and booklet on
guidelines on deposit insurance etc. The Corporation’s web-site furnishes detailed information
on deposit insurance system in India, answers to ‘Frequently Asked Questions’ (FAQs), manner
of settlement of claims, list of insured banks, details of claims settled, circulars issued to insured
banks etc. For the convenience of insured banks, the Corporation has posted forms of periodic
returns required to be submitted by them and is also in the process of uploading a Premium
calculator on its website.
DICGC has forwarded a booklet on FAQs on deposit insurance together with a copy of the
poster containing basic information on deposit insurance to all banks, to be printed according to
their requirement in the language generally read and understood by their account holders. The
booklet on deposit insurance is to be made available to the depositors and the poster is to be
displayed prominently in the premises of every branch. The Corporation disseminates policy
changes/ information / data through circulars to all insured banks, press release in newspaper/
RBI web site, annual report of the Corporation, DICGC’s web-site, etc. For the convenience of
the depositors, the Corporation releases information/ data on claims settled with name of the
bank along with the amount on the DICGC web-site.
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During the year 2007-08, 8 Co-operative Banks and 2 Regional Rural Banks were registered and
3 Commercial Banks, 37Co operative Banks and 6 Regional Rural Banks were de-registered.
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The Deposit Insurance Fund is sourced out of the premium paid by the insured banks and the
coupon income received from (and reinvested in) the Central Government Securities. There is
also an inflow of small amounts into this fund out of the recoveries made by the
liquidator/administrator/ transferee banks. Thus the Corporation builds up its Deposit Insurance
Fund (DIF) through transfer of excess of income over expenditure each year. This fund is used
for settlement of claims of depositors of banks taken into liquidation / reconstruction /
amalgamation etc. The size of the DIF (including surplus) is Rs. 13362.40 crore as on March 31,
2008 implying a Reserve Ratio (Fund/Insured deposits) of 0.74 per cent.
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1.5 SETTLEMENT OF DEPOSIT INSURANCE CLAIMS DURING 2007-08
During the year 2007-08, the Corporation settled aggregate claims for Rs.161.03 crore in respect
of 22 original claims and 18 additional claims of co-operative banks as detailed in Table 3.
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A provision of Rs.487.60 crore was held towards the estimated claim liabilities in respect of
depositors of 160 banks which are under amalgamation/ liquidation and whose licence /
application for licence to carry on banking business has been cancelled / rejected by Reserve
Bank of India.
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TOTAL CLAIMS SETTLED/REPAYMENTS RECEIVED
As on 31st March, 2008, the aggregate amount (cumulative) of claims paid and provided for
since the inception of the Scheme, in respect of 27 commercial banks was Rs. 295.83 crore.
Repayment received from liquidators/amalgamated banks up to 31st March 2008 aggregated
Rs.110.20 crore (including Rs. 25.11 crore received during the year under review). The total
amount of claims paid/provided for in respect of 199 co-operative banks, since the inception of
the Scheme till 31st March, 2008 (including Rs.161.03 crore paid during the year under review)
was Rs. 2459.53 crore. Repayments received from the liquidators/ amalgamated banks up to 31st
March, 2008 aggregated Rs.121.50 crore (including Rs.73.61 crore received during the year).
The particulars of banks in respect of which claims have been paid, written off, provided for and
repayments received till 31st March, 2008.
It may be observed from Figure 1 that spurt in claim payment during the period 2004-05 to 2006-
07 has normalized during the year 2007-08.
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RECENT POLICY INITIATIVES
(i) Expeditious Settlement of Claims
The basic objective of deposit insurance is to ensure prompt reimbursement to the depositors,
particularly small depositors, to the extent permitted under the law, for the losses suffered in the
event of an insured bank’s closure, so as to minimise the loss of public confidence and restrict a
run on other banks. As per the DICGC Act, the Corporation is required to settle the claim of
depositors within two months from the date of receipt of the claim list from the liquidator. The
liquidator is required to submit the claim list of depositors within 3 months of taking charge as
liquidator. However, it is observed that liquidators
generally fail to submit the claim within the statutory time frame of 3 months, with the result that
depositors’ claims are not settled within the statutorily prescribed time limit. Payment by DICGC
to depositors towards their insured deposits and recovery of dues from the failed banks is routed
through liquidators of banks. In case of banking companies, the liquidators are appointed by the
High Court on the application of RBI under the provisions of the Banking Regulation Act, 1949.
In case of co-operative banks, the Registrar of Co-operative Societies directly appoints the
liquidators. However, experience shows that in several cases there is considerable delay in
appointment of liquidators as also in submission of claims to the DICGC by the liquidators,
particularly those of co-operative banks, resulting in delay in payment and inconvenience to the
depositors. Of late, the Corporation has taken certain initiatives to eliminate delay in settlement
of claims of the depositors. The Corporation has formulated policy guidelines to mitigate
hardship to the depositors of insured banks due to delay on account of liquidation order having
been challenged in court of law. Further, in extraordinary situations where the DICGC does not
receive the claim list from liquidators even after considerable delay and prolonged
correspondence, it issues an advertisement in local newspapers informing the depositors about
the non-receipt of claims at its end and requesting them to make a claim with the liquidators
under intimation to DICGC. Before issuing such advertisement, however, DICGC gives one
month’s time to the concerned Registrar of Co-operative Societies for arranging submission of
claims list by the liquidator. However, it has been observed that though this has yielded the
desired results in some cases, in many other cases the response has been poor. An onsite pilot
study was conducted by the Corporation in respect of four such banks in one of the States.
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Findings of the study reveal the following:
(i) The main reason for non-submission of claim list is pendency of audit of the books of
accounts of the banks as on the cut off date and that for the earlier periods. Inadequate and
improper maintenance of records, unauthenticated entries in the books of the banks etc. are
causing delay in the audit by the Government Auditors.
(ii) Some of the liquidators were having liquid funds, sufficient to make payment to depositors,
in accordance with the provisions of the DICGC Act, 1961, but they had utilized the funds for
payment of deposits which were not eligible for settlement of claims, e.g. deposits of the banks /
Government and those exceeding Rs.1.00 lakh.
(iii) The liquidators also resorted to adjustment of deposits against the loan amounts of third
parties. On the basis of observations made in the study report it has been decided that if a bank
under liquidation is having liquid funds which are adequate to make payment to depositors, the
liquidator may approach Deposit Insurance & Credit Guarantee Corporation for its in-principle
approval to pay the small depositors upto Rs.1 lakh as per the provisions of DICGC Act 1961.
The Corporation will consider such requests for payment to depositors subject to the condition
that the liquidator would not submit any claim to the Corporation, or if the payment is made in
part to eligible depositors, submit the claim for net amount after adjustment of such payment. In
a special situation where claim list has not been submitted by the liquidator even after a long
period because of delay in audit of accounts, the Corporation has suggested for appointment of
Chartered Accountant firm by the Registrar of Cooperative Societies to assist the liquidator in
completing the audit and/or preparation of the claim list. On being satisfied about the
authenticity of claims, the Corporation may waive, as a special case, the submission of audited
balance sheet as on the cut off date. It has been suggested by the Corporation that C.A. for the
above purpose may be appointed by the RCS on the recommendation of the sub-committee of
the TAFCUB and they should carry out audit as per the terms approved by the Sub-Committee.
The Corporation will also consider request in other genuine circumstances on a case-to-case
basis. The cumulative impact of the above policies relating to settlement of claims during the
pendency of court cases, issue of advertisement by the Corporation regarding non receipt of
claim list and decisions taken in the light of the findings of the pilot study, has been encouraging
and the Corporation has settled such claims of 14 banks for a total amount of Rs.132 crore in
respect of 1,93,873 depositors.
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(ii) Liberalized Interpretation in case of Joint Holding
Further, the Corporation had revised the policy on joint deposit accounts such that joint deposits
held in the names of A & B and B & A have been treated as two separate accounts, eligible for
maximum claim of Rs.1 lakh each. In response to this policy change additional claims in respect
of 9 banks amounting to Rs. 216 lakh were settled. Though the above steps have brought about
some relief to the depositors of failed banks, the corporation is concerned about the delay in
receipt of claim list from liquidators of Co-operative Banks
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