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Deposit Insurance

This paper has been prepared by Mohammed Al-Ja’fari of Jordan Deposit Insurance Corporation (JODIC) and David Walker of Canada Deposit Insurance Corporation (CDIC) to assist the World Bank (WB) in the preparation of its flagship study on the resilience of financial systems in the Middle East and North Africa (MENA) region. This paper was prepared on a request from the World Bank and the views expressed in the paper are those of the authors and strictly for the World Bank purposes, they do not necessarily represent the views of the JODIC, CDIC or the International Association of Deposit Insurers (IADI). The analysis covers MENA countries according to the WB geographical classifications. It evaluates existing explicit deposit insurance systems in the region by benchmarking them to the Basel Committee on Banking Supervision (BCBS)/ the International Association of Deposit Insurers (IADI) Core Principles for Effective Deposit Insurance Systems (Core Principles). The MENA countries reviewed in this paper were benchmarked against the BCBS/IADI Core Principles at a high level.  A detailed Core Principles Assessment Methodology has been prepared by IADI, BCBS, IMF, WB, the European Forum of Deposit Insurers (EFDI) and the European Commission (UC) and is currently being considered by the Financial Stability Board for adoption.  It also examines and evaluates the views supporting the persistence of blanket government guarantees (both explicit and implicit) in place in a number of MENA countries. See BCBS/IADI (June 2009).

The number of explicit limited deposit insurance systems in the MENA region has increased rapidly over the last ten years. Countries that still rely on blanket guarantees are mainly the oil exporting countries and those with clear state control of the banking system. Policymakers in these countries believe that the political, economic and financial conditions do not currently support transitioning away from blanket guarantees.  In particular, those countries that provided explicit deposit guarantees in certain MENA countries during the latest global financial crisis are proceeding cautiously in ending such guarantees given the continued fragility of financial systems worldwide.

Properly designed explicit (rules-based) limited coverage deposit insurance systems can support market discipline and help improve competitiveness. They limit regulatory forbearance and accordingly can reduce the direct financial cost of bank resolutions. However, the adoption of an explicit limited system requires the removal of blanket guarantees which may create market instability or outright panic if certain political, economical and financial prerequisites are not met.

Policy resistance to transitioning away from blanket guarantees stems from fears of market panic during the transitioning process and the limitation of policy choices in such circumstances.  For those MENA financial systems adopting publicly-announced prompt-corrective action regimes the latter consideration is particularly relevant.

However, evidence from countries around the world that have successfully transitioned shows the importance of creating an environment characterized beforehand by healthy banking systems and stable economic and financial conditions. The focus in the MENA region should, in turn, be directed to building these necessary preconditions and transitioning to limited coverage systems as soon as the circumstances permit.

Existing explicit deposit insurance systems in the region provide varying levels of coverage reflecting fundamental economic and financial differences. Key design feature of those systems are largely in line with the IADI Core Principles.  They are either pure “paybox” systems managed directly by the Central Bank or administratively independent organizations governed by a board of directors and chaired by the Central Bank governor.  The mandate of the administratively independent organizations is wider than pure paybox systems and typically includes receivership and liquidation responsibilities.

The following analysis emphasizes the importance of establishing properly designed deposit insurance systems in the MENA region that avoid either explicit or implicit blanket guarantees. It also highlights the need to improve many of the existing limited coverage systems in the MENA countries.  This can help encourage banks to better manage their risks, cut down on the cost of bank failures and thereby save public funds, contain the contagion effect of financial crises, provide formal mechanisms for resolving failed banks, and enhance confidence in the financial system. The current explicit or implicit blanket guarantees in the MENA region, if continued for long periods, will increase negative incentives such as moral hazard.

The following sections (II, III, IV and V) identify the scope of analysis for the paper, highlight the role of deposit insurance in contributing to financial stability and provide an analysis of the existing explicit deposit insurance systems in the MENA region and their design features. Section VI evaluates blanket government guarantees in the region and evaluates their implications. Deposit Insurance in countries with a large presence of state-owned banks is discussed in section VII.

The withdrawal of the blanket guarantees along with the conditions for effective transition to limited coverage system are discussed in sections VIII. Section IX discusses the insurability of Shariah-based deposits followed by a summary of the main challenges and the envisaged way forward in section X.

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