The Deposit Guarantee Scheme (DGS) contributes to financial stability by protecting accountholders' deposits up to €100,000 if a bank becomes unable to meet its obligations. The knowledge that savings accounts are guaranteed helps to prevent a bank run by depositors. This is important because a bank run may trigger large-scale panic among savers and thus lead to contagion across the banking industry, even if doubts about the safety of other banks are unfounded.
Participation in the DGS, which is managed by DNB, is mandatory for all banks holding a Dutch banking authorization. Under the current arrangement, DNB pays compensation to deposit holders, after which the total reimbursement is apportioned to participating banks. The compensation paid under the DGS after the collapse of Icesave (2008) and DSB Bank (2009) was financed in this way.
Reinforcement and harmonization of deposit guarantee schemes
The effectiveness of the DGS depends crucially on the confidence it enjoys among savers, as is taught by the experience of the credit crisis. In September 2008, shortly after the collapse of Lehman Brothers, the Irish government decided to offer unlimited guarantee to deposit holders of Irish banks. This fuelled unrest within the European banking sector because it gave savers an incentive to move deposits to those European banks that offered the highest cover. Just a few weeks later, the European Finance Ministers therefore declared that the deposit guarantee in all Member States was to be raised to at least €50,000. In the Netherlands, the maximum compensation under the DGS was increased to €100,000. This helped to calm down the Dutch savings market.
In the period that followed, national schemes within the EU were further harmonized. Since late 2010, the protection across the EU is fixed at €100,000. In addition, payout to depositors has to be achieved within 20 working days instead of 3 months, reassuring savers that should their bank fail, they will soon have their savings back. The extended protection and swifter payout have contributed to the confidence in the banks and thus helped to prevent bank runs.
However, both adjustments have the disadvantage that they weaken the incentive for savers to look critically at the solidity of a bank before entrusting their savings to it. Many depositors go mainly for the interest rate a bank offers – witness the rapid growth of Icesave in 2008. Such absence of surveillance by savers creates a moral hazard that tends to erode banks' market discipline.
Benefits of a pre-funded Deposit Guarantee Scheme
The Order in Council (in Dutch: Algemene Maatregel van Bestuur ex ante financiering depositogarantiestelsel) for a pre-funded DGS based on risk-weighted contributions will come into effect on 1 July 2013. The fund is to grow to a target size of 1% of all deposits guaranteed under the Scheme, at present some €4 billion. The target size has to be reached in 15 years. With the introduction of ex ante funding, The Netherlands anticipates a proposal by the European Commission to make such funding mandatory throughout the EU. In many European countries, pre-funded schemes have been standing practice.
Ex ante funding based on risk-weighted contributions has several important benefits compared to the current funding model. First, risk weighting relates a bank's contribution to its risk profile, thus eliminating at least part of the moral hazard. It gives banks an incentive to take less risk. Under the new regime, levies for risk-seeking banks may be twice as high as for conservative banks. Furthermore, fund-building means that a bank contributes to the compensation paid after its own failure, in line with the 'polluter pays' principle.
Finally, fund-building helps to spread out the burden of the DGS over time, reducing the probability that the sector will be forced to make large one-off contributions to the Scheme after a bank has failed. This will also weaken the procyclical effect of the DGS.
Towards a European deposit guarantee scheme
Europe has taken important steps to overcome the crisis and to reinforce the Economic and Monetary Union. As part of this effort, European heads of government made a historic step towards the creation of a Banking Union. This should consist of effective banking supervision at the European level, supplemented by a European resolution mechanism providing for the uniform dissolution of problem banks. Ultimately, a European deposit guarantee scheme should also be part of the banking union.