National Treasury is mulling Deposit Insurance with an explicit charge on the banks.
This is not a new idea, and has historically been resisted by the major banks since they feel, generally rightly, that they are less likely to have a problem of confidence and therefore less likely to benefit from deposit insurance. Smaller banks, on the other hand, are certainly more at risk of a run on the bank arising due to perceptions thus causing a liquidity problem when a solvency problem doesn’t exist.
Determining the appropriate mechanism to charge for deposit insurance is not straightforward. Clearly the charge can’t be the same fixed amount for all banks as the exposure will be very different between banks. The large banks would lobby hard to pay a lower rate (even if a higher overall amount) for the insurance given that they should be less subject to those confidence issues.
But how to determine that difference? One could take cue from the market by looking at credit ratings and, even more market-oriented, the spreads on debt issued by the banks. Three immediate problems come to mind:
- Credit quality of long-term debt isn’t the same as protection for depositors
- Probability of default is an input into confidence issues but certainly isn’t the entire story
- Does anybody seriously still believe in the Efficient Market Hypothesis and trust that we can believe what the market offers as an impartial, objective and balanced view of reality?
So there are some fascinating technical problems to solve when implementing deposit insurance, not least of which is deciding how much gets protected.
What caught my eye was Moneyweb columnist, Phakamisa Ndzamela, demonstrating his disbelief at how deposit insurance could create a moral hazard and ultimately increase risk within the banking system.
some senior bank executives have cautioned that this could push the cost of banking higher and somehow encourage risky lending. [emphasis added]
Obviously Ndzamela hasn’t heard of the Savings and Loan crisis in the US in the 1980s, or, I don’t know, the Global Financial Crisis that we are still in, which was massively exacerbated (if perhaps not quite caused) through risk being accepted without due care because it was being passed off immediately to someone else.