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Financial uncertainty
inevitably leads to the revival of proposals for safety
schemes. A popular one is deposit insurance, such as the
comprehensive one introduced last week by Ireland’s six
banks with government backing.
At the weekend, Germany also guaranteed all deposits to
prevent a panic caused by the failure of a rescue plan for a
leading mortgage lender, Hypo Real Estate.
Deposit insurance is popular with voters and New Zealand,
with Australia, is unusual in not having a scheme.
A recent OECD report, Financial Turbulence: Some lessons
regarding deposit insurance, covers some of the latest
research. It cites a study of banking crises from the 1980s
to the mid-1990s that found the presence of an explicit
deposit insurance scheme “tends to increase the probability
of such events.”
Another showed that in institutionally weak environments,
such schemes “increase the probability of systemic banking
problems.”
They are also not required under the 1997 Core Principles of
Effective Banking Supervision prepared by the Basel
Committee on Banking Supervision, which supervises central
banks.
Deposit insurance has the advantages of creating financial
stability and ensuring problems in one bank do not spread to
another.
The downside comes from the increased risk of imprudent
behaviour, as depositors are unlikely to withdraw funds that
are not at risk, though this can be limited by caps or co-insurance
in which the amount covered is less than 100%, and
depositors are required to bear part of the costs of a
banking failure. |