General Guidance for Developing Differential Premium Systems

October 31, 2011
factor used is capital adequacy and an examination data rating composite
score which incorporates the CAMEL(S) framework. 10
An important consideration in systems which combine both quantitative and
qualitative factors is the relative weighting between these factors. In some
systems quantitative criteria receive an equal weight to more subjective
criteria such as examination ratings. In other countries, such as Canada,
qualitative criteria are weighted less than quantitative criteria. In fact, the
tendency among the systems studied seems to be to weight more heavily
quantitative elements than qualitative factors. This may reflect less comfort
on the part of many banks with subjective assessments – even in situations
where a subjective or qualitative assessment such as the quality of
management may be one of the more effective leading indicators of risk.
The advantage of combining both quantitative and qualitative indicators is
that it can be a highly effective and comprehensive way to assess the risk
profile of banks. Of all the general approaches discussed, this takes into
account the widest range of information to help assess a bank’s risk profile.
The main drawback is that it may impose a higher level of information
requirements on banks and could be more open to challenges compared to
approaches using mostly quantitative criteria.
Consideration should also be given to the state of the economy when setting
the thresholds for each category as more institutions should find themselves
in the better categories in good times with more in the worse categories in
bad times (i.e. a differential premium system is inherently pro-cyclical).
However, the deposit insurer has the opportunity to strike a balance among
criteria chosen, or in the weights assigned to the measures chosen, that
could mitigate the effects of procyclicality within the system, if any.
Nonetheless, there is a need to balance the desire to address procyclicality
with the primary goal to effect differentiation of banks on the basis of risk
and provide incentives to control risk.
In summary, although there are a wide variety of approaches to differentiate
risk among banks and assign premiums, the approach chosen should: (1) be
effective at differentiating banks into appropriate risk categories; (2) utilize a
10 Another deposit insurer - the Institutional Protection Scheme of German Cooperative Banks -
has implemented a two-step approach. The first step classifies all member banks using a quantitative
approach (the member contributions are based on this step). Depending on an institution’s ranking,
the second step analyzes in more detail using qualitative elements those institutions that have been
identified as being riskier under the first step.
13