Senior ECB figure calls for risk-based deposit insurance

The creation of a cross-border bank deposit insurance scheme in the European Union would not lead to stronger national banking systems subsidising weaker ones, a senior regulator argued in a speech in Brussels on April 11.

Countries opposing moves towards a European deposit insurance scheme, or EDIS, should rethink their beliefs, said Pentti Hakkarainen, a member of the European Central Bank’s (ECB) supervisory board. 

“A few member states” of the EU oppose moves towards an EDIS due to fears of “cross-subsidisation of weaker banking systems using the financial resources of stronger countries”, he said.

The European Commission published proposals for an EDIS in November 2015, but there has been little progress towards making the scheme a reality. Senior economic policymakers in Germany and other northern European countries have publicly expressed doubts over the idea.

“I believe these fears are unfounded,” Hakkarainen argued, saying they “fail to understand how limited the risks are, both in terms of exposure to losses and cross-subsidisation for well-constructed deposit-guarantee schemes”.

He said an occasional paper published by the ECB “demonstrates exactly how limited those cross-subsidisation risks are” for properly designed schemes. It shows risks are low, provided deposit insurance is funded by “appropriately designed, risk-based contributions” from banks.

Completing the banking union with a European Deposit Insurance Scheme: who is afraid of cross-subsidisation? by Jacopo Carmassi et al was published by the ECB on April 11. The authors argue a scheme based on risk-based contributions “can, and should, internalise” the risks of specific banks and banking systems.

I believe these fears are unfounded… [and] fail to understand how limited the risks are, both in terms of exposure to losses and cross-subsidisation for well-constructed deposit-guarantee schemes

Pentti Hakkarainen, European Central Bank

The paper is based on the European Commission’s proposal for a scheme backed by a deposit insurance fund equal to 0.8% of the covered deposits. The authors use data on the current balance sheets of 1,675 eurozone banks, representing about 75% of the currency area’s banking assets and 83% of its covered deposits.

They calculate how much banks would pay into the scheme by using a variant of the European Banking Authority’s guidelines on how national deposit guarantee schemes should levy contributions from domestic banks.

The paper estimates the effects of an EDIS funded by risk-based contributions on several EU-wide banking crises. The biggest simulated crisis would see the riskiest 10% of covered banks failing.

The loss rates needed to produce cross-subsidisation of weaker banking systems by stronger ones would have to be “considerably higher than those experienced in the last banking crisis”. This suggests there would be “no unwarranted cross-subsidisation via EDIS, in the sense of some banking systems systematically contributing less than they would benefit”.

The authors also find no evidence that country-specific banking crises would cause cross-subsidisation.

Mixed scheme “would increase cross-subsidy”

But the authors find cross-subsidisation would increase under a “mixed deposit insurance scheme”.

In the example of a mixed scheme, national funds bear losses on deposits up to a value of 0.4% of total covered deposits, after which a eurozone-wide scheme would pay out an equal amount. This would increase cross-subsidisation because the contributions to the fund would be fixed at 0.4% of covered deposits in each country, rather than based on risk.

The authors also find a fully funded deposit insurance fund would be sufficient to cover all necessary payouts to depositors, “even in a severe banking crisis”.