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Why it exists [ edit ]

Banks are allowed (and usually encouraged) to lend or invest most of the money deposited with them instead of safe-keeping the full amounts (see fractional-reserve banking ). If many of a bank’s borrowers fail to repay their loans when due, the bank’s creditors, including its depositors, risk loss. Because they rely on customer deposits that can be withdrawn on little or no notice, banks in financial trouble are prone to bank runs. where depositors seek to withdraw funds quickly ahead of a possible bank insolvency. Because banking institution failures have the potential to trigger a broad spectrum of harmful events, including economic recessions, policy makers maintain deposit insurance schemes to protect depositors and to give them comfort that their funds are not at risk.

Deposit insurance was formed to protect small unit banks in the United States when branching regulations existed. Banks were restricted by location thus did not reap the benefits coming from economies of scale, namely pooling and netting. To protect local banks in poorer states, the federal government created deposit insurance. [ 1 ] [ 2 ]

Many national deposit insurers are members of the International Association of Deposit Insurers (IADI), an international organization established to contribute to the stability of financial systems by promoting international cooperation and to encourage wide international contact among deposit insurers and other interested parties.

How it works [ edit ]

Deposit insurance institutions are for the most part government run or established, and may or may not be a part of a country’s central bank. while some are private entities with government backing or completely private entities.

There are a number of countries with more than one deposit insurance system in operation including Austria. Canada (Ontario & Quebec ), Germany. Italy. and the United States .

On the other hand, one deposit insurance system can cover more than one country: for example, many banks in the Marshall Islands. the Federated States of Micronesia. and Puerto Rico are insured by the US Federal Deposit Insurance Corporation .

Overview by country [ edit ]

According to the AIDI, [ 3 ] as of 31 January 2014, 113 countries have instituted some form of explicit deposit insurance up from 12 in 1974. Another 41 countries are considering the implementation of an explicit deposit insurance system.

North America [ edit ]

In the antebellum period and the 1920s, various deposit insurance schemes were tried out. Those based on self-regulation via mutual liability were successful; compulsory state versions based were not. [ 4 ] A look at Texas in the years 1919–26 shows that the deposit insurance for state-chartered banks increased the likelihood of bank failure during the period. [ 5 ] The United States was the second country (after Czechoslovakia ) [ 6 ] to establish a national deposit insurance scheme, the Federal Deposit Insurance Corporation. during a Great Depression banking crisis in 1933.

In Massachusetts, the Depositors Insurance Fund (DIF) insures deposits in excess of the FDIC limits at state-chartered savings banks. [ 7 ] In 1981, the General Law of Credit Institutions and Auxiliary Organizations provided for the creation of a fund to protect credit obligations assumed by banks.

www.cdic.ca. Insurance is restricted to registered member institutions, and covers only the first C$ 100,000 in very specific categories of accounts. Credit unions and Quebec’s caisse populaire system are not insured Federally, because they are created under Provincial charters and backed by Provincial insurance plans, which generally follow the Federal model. Funds in a foreign currency, not Canadian dollars, are not insured, such as a US dollar accounts even when held in a registered CDIC financial institutions. Guaranteed Investment Contracts with a longer term than 5 years are also not insured. Funds in foreign banks operating in Canada may or may not be covered depending on whether they are members of CDIC. [ 8 ] Some funds in the Registered Retirement Savings Plan or Registered Retirement Income Fund at their bank may not be covered if they are invested in mutual funds or held in specific instruments like debentures issued by government or corporations. The general principle is to cover reasonable deposits and savings, but not deposits deliberately positioned to take risks for gain, such as mutual funds or stocks.

The roots of this reform can be traced back to the 19th century, such as the Upper Canada’s financial problems of 1866, the North American panic of 1872 and the 1923 failure of Toronto’s Home Bank, symbolized today by Casa Loma. Historically, in Canada, regional risk has always been spread nationally within each large bank, unlike the uneven geography of US unit banking, layered with savings & loans of regional or national size, which in turn disperse their risk through investors. Generally speaking, the Canadian banking system is well regulated, in part by the Office of the Superintendent of Financial Institutions (Canada). which can in an extreme case close a financial institution. That and Canada’s tight mortgage rules mean the risk of bank failures similar to the US are much less likely.

Caribbean and South America [ edit ]

In Brazil, the creation of deposit insurance was authorized by Resolution 2197 of 1995, the National Monetary Council. This standard mandated the creation of a protection mechanism for credit holders against financial institutions, called Credit Guarantee Fund (FGC). Currently, the FGC is regulated by Resolution 4222 of 2013. The Fiscal Responsibility Act prohibits the use of public funds to finance the losses, so it is formed exclusively by compulsory contributions from the participating institutions. The warranty is limited to R$ 250,000 per depositor. More recently, the Guarantor Credit Union Fund (FGCoop) was created, in order to protect depositors of credit unions and cooperative banks. As the FGC, the FGCoop guarantees up to R$ 250,000 and consists of compulsory contributions of cooperatives and cooperative banks.

European Union [ edit ]

Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guarantee schemes [ 9 ] requires all member states to have a deposit guarantee scheme for at least 90% of the deposited amount, up to at least 20,000 euro per person. On October 7, 2008, the Ecofin meeting of EU’s ministers of finance agreed to increase the minimum amount to 50,000. [ 10 ] Timelines and details on procedures for the implementation, which is likely to be a national matter for the member states, was not immediately available. The increased amount followed on Ireland ‘s move, in September 2008, to increase its deposit insurance to an unlimited amount. Many other EU countries, starting with the United Kingdom. reacted by increasing its limit to avoid that people transfer savings to Irish banks.

In November 2007 a comprehensive report was published by EU, with a description and comparison of each Insurance Guarantee Scheme in place for all EU member states. The report concluded, that many of the schemes (but not all) had restricted the appliance of guarantees to retail consumers, usually private individuals, although Small or Medium-sized (SME) businesses sometimes also were placed into the retail category. Common for all schemes are, that they do not apply for big wholesale customers. The argument behind this decision is, that the big wholesale customers often are in a better position than retail customers to assess the financial risks of particular firms with whom they engage, or even able on their own hand to reduce their risk by using several financial banks/institutes. The report recommend this practice to continue, as the limiting of the scheme’s to retail customers (excl./incl. SME businesses) help reduce the cost of the scheme while also helping to increase its available funds towards those who really depend on the guarantee – when being activated for protection of claimants in a certain case. [ 11 ]

As from October 2008, many EU countries were in the process of increasing the amounts covered by their deposit insurance schemes. Since these amounts are typically encoded in legislation, there was a certain delay before the new amounts were formally valid. Countries have varied in their approach; some have permanently increased the amount, while others have implemented temporary measures. [6]