Volume II - PDF - International Association of Deposit Insurers

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•BACKGROUND DOCUMENTS• Part II: Outreach Mr. Hanc’s presentation closely followed the options available for controlling moral hazard that were laid out in the issue paper written by the subgroup composed of officials from Chile, France, Germany, Italy, Japan, the United States and . He stated that, although moral hazard was inherent in deposit insurance, the subgroup was resisting the temptation to give advice because the choices might be “country specific.” He then referred to three general strands of discipline to mitigate moral hazard—internal governance, market discipline and supervision/regulation. He pointed out that none of these strands could be achieved easily. Good corporate governance with strong internal controls and incentive structures for controlling risk, for example, might require supervisory oversight/encouragement. The speaker said that market discipline could be encouraged by a number of measures, including coverage limits, the exclusion of certain instruments from coverage, coinsurance, mandatory subordinated debt requirements, and depositor preference. To be successful, market discipline required good information, adequate disclosure, sophisticated recipients, uniform application of rules, and supervisors and deposit insurers who responded to market signals. Mr. Hanc observed that many countries relied principally on regulation and supervision, despite their intrusive nature, to contain moral hazard but that successful reliance required human and technical resources, legal authorities, incentives, and supervisory cooperation that were often lacking. Risk-based premiums, minimum capital requirements, prompt corrective action, legal action against those responsible for failures, and personal liability for bank officials could provide good incentives for both bankers and supervisors to keep the financial system sound. He noted that unlimited liability facing private banks in Germany restrained moral hazard in that country. Mr. Carlos Isoard’s presentation illustrated an interesting supplement to the discussion in the issue paper on transitioning from blanket to limited coverage with particular reference to the experience of Mexico. The issue paper had been written by a subgroup that consisted of officials from Hungary, Japan, Mexico, and the IMF and which had received written submissions from Finland, Korea, and Sweden. He observed that transition issues were country-specific and involved many tradeoffs. He discussed a number of questions raised by the transition (public policy objectives, the regulatory framework, institutional arrangements, membership, coverage, funding, public awareness, timing, and corporate governance). For example, he said that Mexico explicitly included increasing public confidence as an objective of the new deposit protection system. The regulatory and supervisory framework needed for the transition should be transparent and embodied in law. In making institutional arrangements, he said, policymakers needed to decide whether to retain existing institutions or establish new ones, how institutions would exchange information and cooperate and whether the system should be publicly or privately managed. In Mexico, Mr. Isoard said that IPAB would insure deposits, resolve failed banks, design and implement programs to sell assets, and actively manage its liabilities. It would be one of five components of the Mexican safety net that also includes the Ministry of Finance as the regulator, a supervisor (the National Banking and Securities Commission or CNBV), the central bank, and the National Commission for the Defense of Financial Service Users. Mr. Isoard said that new capital rules would be fully in force in Mexico by the year 2003 and were timed to rise as insurance coverage fell. It was important, he noted, for the deposit insurance system to have mandatory membership at least during the transition—membership was compulsory for commercial banks in Mexico. He recommended that countries in transition reduce coverage gradually to a limit that had been specified earlier. Mexico aimed to reach its limit (which would be the same as that in the United States) by the beginning of 2005. 168 Guidance for Developing Effective Deposit Insurance Systems: Volume II
•BACKGROUND DOCUMENTS• Part II: Outreach Mr. Isoard said that the choice between a system of ex ante and ex post funding would give rise to different transition issues. Mexico had chosen ex ante funding with contributions from banks paying flat fees, funds from the government’s budget, proceeds from asset sales and from issuing debt. He observed that Mexico was conducting a public awareness campaign based on “openness and transparency.” In general, a transition could be put on a fast track or a slow one—a choice that would depend on circumstances. Mexico had chosen a defined but relatively slow track. The country would limit the use of discretionary powers to adjust the declared timing in order to ensure credibility. Finally, Mexico had decided to improve corporate governance by ensuring that four of IPAB’s sevenmember Board of Directors were independent. Dr. Robert Eisenbeis complimented Mr. Hanc on providing a comprehensive list of remedies to combat moral hazard. He also observed that some of the other presenters had provided additional and interesting material in their presentations to supplement the issue papers. He noted that the papers presumed that countries should provide deposit insurance rather than first asking whether there was not a minimal set of preconditions that should be in place before deposit insurance was considered. In particular, he would have preferred to see more emphasis placed on the need for an adequate infrastructure before deposit insurance was initiated. That infrastructure would include capital markets to impose discipline, a sound and certain legal system to reduce uncertainties over claims, a well-defined closure rule, an absence of government-owned banks, and an agency to regulate and insure deposits that is separate from the central bank and the ministry of finance. Mr. Eisenbeis asked what deposit insurance was designed to accomplish. He doubted that it could achieve many of the goals listed by the previous panel. He observed that protecting small depositors had merit but it would not remove the principal causes of financial crises—misguided fiscal policies, runaway inflation, and/or foreign borrowing to stimulate economic growth. Moreover, he thought it unnecessary to offer the public a risk-free asset by guaranteeing certain private-sector liabilities in a developed economy because it damaged the incentive structure. Neither did it make sense, he said, to offer deposit insurance in a developing country that lacked credibility. Instead, deposit insurance put the government on the hook for bad policies and encouraged forbearance. He maintained that the legitimate goals for deposit insurance were to make failures isolated events, to protect taxpayers and eliminate forbearance. Mr. Eisenbeis then turned to the options listed in the moral hazard paper and asked which of them were consistent with the goals that he had identified. He observed that the issue paper offered a menu of deposit insurance features but provided little guidance on which features were substitutes and which were compliments. In this sense, it was like offering a box of parts to someone who wanted to build a car, but leaving out the assembly instructions. He offered the observation that deposit protection, when not properly priced, interferes with the market discipline that is needed to control risk-taking. Important questions, not raised in the issue paper, were what kind of discipline would be effective and how much discipline would be needed He answered these questions by suggesting, first, that supervisors should charge banks for determining the true value of their activities so that they would voluntarily provide more realistic information. Second, he recommended that the deposit insurance agency itself, not the supervisor, be put in charge of risk monitoring and closure. There were few examples where organizations bearing risk delegate monitoring of that risk to someone else. He did not find risk-based premiums to be an effective counter to moral hazard, at least as they were currently constructed in the United States. Third, he argued that a properly implemented system of early intervention and corrective action would contain moral hazard but it would also make deposit protection unnecessary because (except in cases of fraud, measurement error, or forbearance) only equity holders would lose funds. 169 Guidance for Developing Effective Deposit Insurance Systems: Volume II
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III Feedback
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FINANCIAL STABILITY FORUM Guidance
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