Volume II - PDF - International Association of Deposit Insurers

•BACKGROUND DOCUMENTS•
Part II: Outreach
That action, he said, involved a cost that, under
modern legislation, would be paid for by the
members and users of the financial system. The
supervisor could reduce that cost by taking prompt
action to detect and remedy problems in the
banking system.
Permissive action by the lender of last resort could
harm the deposit insurance fund, said Dr. Jaime. A
troubled bank requesting lender-of-last-resort
assistance would give its best assets as collateral for
this assistance, which would go to benefit the weak
bank’s most restless depositors—those who were
not guaranteed and thus sought to withdraw their
funds. Such action would increase the final cost to
the insurer. Dr. Jaime set out how each of the three
components of the financial safety net should
behave. The lender of last resort should (1) limit
spillover by lending funds that would be quickly
recovered because they were paid only to illiquid
but solvent banks, (2) provide assistance without
expanding the monetary base, and (3) have an
asset base that enabled it to sterilize assistance. He
stated that, despite popular belief, even central
banks in countries with a currency board were able
to act as lenders of last resort if they had the
appropriate assets on their balance sheets.
The speaker observed that the supervisor required
a legal/prudential framework that strengthened
banks’ solvency and liquidity without hindering
the work of markets. Thus, the Basel Committee’s
Core Principles must be followed. In practice, the
supervisor must be preventive and do more than
just monitor ex post compliance with prudential
regulations. The deposit insurer protected insured
depositors when a bank failed so there should be
no excuse for delayed supervisory action. No banker
should benefit from, or be protected during, the
winding up of his bank. Resolutions that in fact
covered all liabilities at a “too-big-to-fail” bank
violated this principle and led to ambiguity that
was in no way constructive. Such resolutions also
raised costs to the surviving banks.
A sound government budget, absence of inflation,
strong supervision, and politicians who did not
meddle were all prerequisites for the establishment
of a system of deposit insurance and for the better
functioning of the financial system. Further, the
safety net needed to function as a virtuous triangle
with its three components acting in harmony.
In its turn, the deposit insurer should resolve
problem banks with a minimum commitment of
funds and a maximum recovery of those expended.
Moreover, the deposit insurer should not act as
payer of last resort to the lender of last resort.
Mr. Carl Tannenbaum of ABN AMRO (a large,
Dutch, international bank holding company)
spoke first for the discussants. In introducing him,
Mr. Evanoff pointed out that Mr. Tannenbaum
was the only practicing banker on the program—his
bank paid deposit insurance premiums and footed
the bill for others’ mistakes. Mr. Tannenbaum said
that, while he was aware that there were alternatives
to deposit insurance, he nevertheless was
supportive of its aims to stabilize markets and
assure the interests of small depositors. From a
banker’s perspective, it reduced volatility, lowered
the cost of capital, and built a stronger currency.
He regretted, however, that private suppliers of
deposit protection had insufficient funds and
credibility to take over the government’s role.
Mr. Tannenbaum doubted the ability of deposit
insurance to achieve the objectives attributed to it
in the paper on public policy objectives. Achieving
financial stability, for example, would require 100
percent coverage, because the flight of large pools
of uninsured money would be destabilizing. There
was a danger that protection would extend beyond
banks—for example, even commercial firms might
be backstopped by the deposit insurance system
under Holland’s universal banking system. One
impediment to deposit insurance’s success was
poor processing of information. Here he stressed
the role that private rating agencies for banks
played in providing information to the markets
and the sophisticated public in the United States.
Mr. Tannenbaum observed that reliance on
supervision, regulation, capital requirements, and
disclosure to thwart moral hazard, as recommended
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Guidance for Developing Effective Deposit Insurance Systems: Volume II