Volume II - PDF - International Association of Deposit Insurers

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•BACKGROUND DOCUMENTS• Part II: Outreach in the issue paper on moral hazard, raised banks’ cost of capital, especially where there were multiple regulators, as in the United States. Moreover, supervisors needed information, skills, and salaries commensurate with that paid by the banks they supervised. He would have preferred to see greater reliance placed in the paper on risk-adjusted premiums. Where banks faced flat-rate premiums they dangerously choose risky assets that earned enough to cover the premiums. He considered that having supervisors require banks to hold subordinated debt instruments, another possibility raised in the paper, was an unwarranted intrusion on banks’ ability to determine their own capital structure. Mr. Tannenbaum spoke in opposition to capping the amount of money that could be held in a deposit insurance fund, especially where zero premiums were charged once the fund had hit its target. Professor Kroszner spoke as the next discussant. He noted that the papers contained good ideas, but that they were very general and would not provide sufficient guidance to countries wishing to institute or revise a system of deposit protection. Recommending that staff revising the papers should make them more specific and concrete, he developed four topics that he thought could enhance the papers. The first topic examined the interrelationship between a deposit insurance system and financial stability. The second topic concerned the avoidance, in the first place, of bank failures that required the deposit insurer to intervene. The third emphasized the importance of liquidity while the fourth examined constraints on deposit insurance design and implementation that derived from political economy. Professor Kroszner observed that more private market discipline was the answer to the first two questions. Private insurers, for example, typically work toward reducing risk ex ante. For example, customers who installed sprinklers paid a reduced rate for fire insurance. He said that the two issue papers in Panel I discussed supervision and regulation extensively, but needed to pay more attention to discipline from the private markets. In this context, his research on corporate governance and liability structures was relevant, showing how market discipline could be encouraged. Boards of Directors of banks in the United States had more outside members than the Boards of other firms, which encouraged input from the markets. He called for an incentive structure that would make Board members more responsible for their bank’s performance. The Boards of large banks in Japan, and particularly in Germany, had more members than those in the United States and they had fewer inside directors, which also fostered greater market discipline. He noted that, with regard to closing failed banks, the banking system needed to continue to provide liquidity and transmit payments despite closures. History in the United States had demonstrated that closure policies must not impair market liquidity. The financial crisis in the United States in 1907, for example, was less serious than that in 1933 because the bank holiday in 1907 was only partial—bank customers could continue to conduct some transactions and checks cleared. In 1933, however, in some states the entire banking system, including both good and bad banks, was completely shut down. For depositors and the state of the economy, however, prompt recovery of depositors’ funds was always a key issue. Professor Kroszner also recommended that any revision of the papers pay more attention to issues of political economy. Political pressures from favored groups could impair the design of a deposit insurance system and thwart the implementation of even a well-designed system. Above all, the papers needed to be more concrete and specific. Mr. Robert Bliss delivered Professor Gordon Robert’s presentation because the latter was trapped in Toronto by the blizzard. He began with a medical analogy—deposit insurance, like medical treatment, could have unintended consequences. But at least the deposit insurer (the doctor in the analogy) should do no harm. He likened explicit deposit 166 Guidance for Developing Effective Deposit Insurance Systems: Volume II
•BACKGROUND DOCUMENTS• Part II: Outreach insurance to mainstream medicine, implicit guarantees to alternative medicine, market discipline to natural healing, and forbearance to faith healing. Mr. Bliss noted that the first issue paper laid out public policy objectives very well. The two papers’ stated mandate to provide guidance on deposit insurance immediately raised a question as to whether implicit insurance might sometimes be optimal and referred to Professor Edward Kane’s suggestion that the ambiguity associated with implicit coverage increased market discipline. He also pointed to The World Bank’s research on implicit coverage and the success of Canada’s implicit guarantees during the Great Depression. He asked whether introducing deposit insurance in some circumstances—for example, where legal, regulatory and accounting systems were underdeveloped—could do more harm than good. He raised the issue of minimum necessary standards for the legal, accounting and supervisory framework before deposit insurance could be effective. He pointed to ‘s empirical findings that lower coverage limits, coinsurance, private involvement in funding and management, and covering foreign deposits, appeared to improve market discipline. Lastly, he suggested that subsequent versions of the papers pay more attention to market discipline and to implicit guarantees. In their responses to the discussants’ comments, Mr. Cowper observed that the Working Group’s mandate confined it to studying explicit systems of deposit protection and Dr. Jaime referred to his country, Argentina, as a long-term “laboratory” for deposit insurance experiments. In the question and answer period, Professor Thomas Mondschean of De Paul University observed that the papers neglected questions relating to insuring state-owned banks and pointed to difficulties experienced by Poland in resolving this issue. Mr. Sabourin responded that issues relating to state-owned banks would be covered in a later paper. Another questioner pointed to the difficulties experienced by Hong Kong, Malaysia and Thailand when Japan withdrew the funds it had lent to these and other countries and on which they relied. In response, Mr. Sabourin stated that the issue of insuring foreign banks was, in fact, dealt with in the situational analysis paper. Mr. Tannenbaum pointed to a lack of enthusiasm by the Federal Reserve for his branch bank’s contingency plans to support its Dutch parent during the recent period of market instability. Mr. Eisenbeis called for an examination of the key elements that would lead a country to chose one path for deposit protection rather than another. He expressed some frustration with the statement that the Working Group’s mandate confined it to giving guidance only on explicit systems of deposit protection and prevented it from examining the alternatives. He said that this was like advising someone, who had declared his intention to commit suicide, how best to hold the gun. At this, the moderator said it was time for the coffee break! Panel II: Issues in Implementing Deposit Insurance Systems Mr. John Raymond LaBrosse, moderator of Panel II and Director of International Affairs at CDIC, provided the context for the next two papers that were discussed. He observed that the Working Group looked forward to receiving input from the academic community on the day’s papers, which were important because they addressed the four main policy issues facing deposit insurers. He complimented the next speaker—Mr. George Hanc, Associate Director at the U.S. Federal Deposit Insurance Corporation (FDIC)—on leading the Working Group’s research effort. He also introduced Carlos Isoard, Member of the Board of Directors of Mexico’s Instituto para la Proteccion al Ahorro Bancario (IPAB); and the three discussants— Dr. Robert Eisenbeis, Director of Research at the Federal Reserve Bank of Atlanta; Professor George Kaufman of Loyola University Chicago; and Professor George Pennacchi of the University of Illinois at Urbana-Champaign. 167 Guidance for Developing Effective Deposit Insurance Systems: Volume II
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FINANCIAL STABILITY FORUM Guidance
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