There is no compelling case for a Deposit Guarantee Scheme for the Eurozone
The European Commission has put forward on Tuesday proposals for a Deposit Guarantee Scheme for the Eurozone, as third pillar of the Banking Union. According to economic theory, a Eurozone Deposit Guarantee Scheme (DGS), by comparison with (sub)national deposit guarantee schemes, may increase the pool of insured risks and show a comparative benefit because of better risk-spreading, higher efficiency and more robustness than existing (sub)national deposit guarantee schemes.
However, this only holds true where the following prerequisites are met:
1. The specific national risks of bank failures must be accurately priced. This presupposes different financial target levels for the participating national deposit guarantee schemes or for each and every participating bank. Alternatively or in addition thereto, national deposit guarantee schemes may take out commercial excess of loss insurance.
2. Banks must be obliged to back sovereign risk with own funds. Sovereign exposure plays an important role in banks’ balance sheets but is generally not backed with own funds. Without this, a Eurozone DGS may increase the linkage between sovereign solvency and that of the banks which runs counter to the very idea of the Banking Union.
3. Affected Member States must contribute financially to the compensation of depositors. This is necessary as Member States influence the size and risks of their domestic banking sector. Their financial participation in the compensation of depositors may avoid moral hazard.
4. Moral hazard on the side of banks must be contained. By contrast with (sub)national systems, a Eurozone DGS provides more incentives for banks to take risks and to externalise the costs of such behaviour to other members of the Eurozone DGS. National compartments within a Eurozone DGS, and limits on the mutual use of the financial means of those compartments, may alleviate this problem.
5. Financial stability risks must be contained. By comparison with existing (sub)national systems, a Eurozone DGS may considerably increase the risk of contagion. Depositors in uninvolved Member States may question the credibility of the DGS when its means are used to compensate depositors elsewhere. National compartments within a Eurozone DGS, and limits on the mutual use of the financial means of those compartments, may alleviate this problem.
6. Distortions of competition must be avoided. A Eurozone DGS must not distort competition, given the considerable differences in the financial endowments of existing (sub)national deposit guarantee schemes. National compartments within a Eurozone DGS, and a gradual mutualisation of means over time, may alleviate this problem. A full mutualisation should not occur before 2024.
Based on prerequisites 4 – 6, any Eurozone DGS must consist of “national compartments” or must otherwise entail a gradual mutualisation of means over time which is at the same time limited in amount. Such national compartments, however, reduce the comparative benefit of a Euro-zone DGS vis-à-vis existing (sub)national deposit guarantee schemes. There is therefore no compelling case for a Eurozone DGS.
Dr. Bert Van Roosebeke, Head of Financial Markets Division, email@example.com