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Deposit Insurance Scheme IW News 25. November 2015

Mutualisation of Losses Will Not Improve Bank Soundness

The EU-Commission launched its proposal for a European deposit insurance scheme with the intention of a full mutualisation of deposit insurance. The system is backed by savers from countries with a sound banking system who will now cover the losses of others.

So far the European Banking Union rested on the three pillars single bank supervision, single bank restructuring and single standards for national deposit insurance schemes. The Commissions most recent plans intend to mutualize the national deposit insurance schemes step by step. It should be funded by the contribution of all Eurozone banks according to the Commission’s plan.

The structural differences in the national banking systems are, however, too large for a project of this type. A mutualisation of deposit insurance will lead to a redistribution from countries with a sound banking system to countries with a less sound banking system. These structural differences can be inferred from data on non-performing loans, i.e. loans which are doubtful to be fully paid back, in relation to all granted loans. The numbers go from 0.8 percent in Finland to 44.4 percent in Cyprus. It is just a question of time until the deposit insurance schemes from countries with a low fraction of non-performing loans, e.g. Germany (1.8 percent), the Netherlands (2.8 percent) or Austria (4.1 percent) will cover losses from banks in Greece (24.6 percent), Ireland (22.8 percent) or Cyprus.

In addition to that, it is problematic that the Commission’s proposal considers all banks as operating on a cross-border basis. Most banks are small and locally oriented instead. These banks are less exposed to the risks from financial markets, like a sovereign default, compared to the cross-border operating larger banks. Instead they are using their local expertise to finance the local economy. Moreover, these banks have less problems with non-performing loans (2.7 percent compared to 5.3 percent for large Eurozone banks).

The diversity of bank business models is advantageous for financial stability as well as for the financing of the economy – it should not be destroyed by a mutual deposit insurance. The route towards to a more stable financial system is not leading over a mutualisation of losses. Politicians should focus on the problem of non-performing loans instead. It can be tackled by European minimum standards for insolvency procedures. These are especially necessary in countries in which banks have the highest rate of non-performing loans. Losses due to the default of a lender could be minimized through a better collaboration of banks with insolvency practitioners. Through better insolvency procedures banks will have a greater chance to recover their invested capital.

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