7 September 2001

**GUIDANCE FOR DEVELOPING** **EFFECTIVE DEPOSIT INSURANCE SYSTEMS**

**Preface**

At its March 2000 meeting in Singapore, the FSF endorsed the report of a
study group and concurred that, in light of the fact that many countries
were considering implementing some form of deposit insurance, it would
be desirable to set out some form of international guidance. Forum
members underscored that the development of such guidance should be
undertaken through a consultative process that would include all the
parties that are interested in deposit insurance issues, so as to ensure
that the guidelines are reflective of, and adaptable to, the broadest
set of circumstances, settings and structures.

The Forum asked Jean-Pierre Sabourin, President and Chief Executive
Officer of the Canada Deposit Insurance Corporation, to chair a working
group that would carry out the task of setting out guidance for
effective deposit insurance systems. The final report of the Working
Group on Deposit Insurance was discussed and endorsed by the Forum in
London, on September 7, 2001.

The FSF report on deposit insurance is built on three general findings.
First, explicit and limited deposit insurance is preferable to implicit
coverage if it clarifies obligations to depositors and creditors and
limits the scope for discretionary decisions. Second, deposit insurance
systems must be properly designed, well implemented and understood to be
credible and avoid moral hazard. Third, to be effective, the deposit
insurance function needs to be part of a well-designed financial safety
net, supported by strong prudential regulation and supervision,
effective laws that are enforced, and sound accounting and disclosure
regimes.

The report proposes a general method for the benefit of countries
considering the adoption or the reform of an explicit, limited-coverage
deposit insurance system. It first presents the contextual issues
related to different forms of depositor protection and identifies the
issues that need to be addressed when adopting or reforming a deposit
insurance system. It then sketches out the design features that help to
ensure the effectiveness and credibility of a system, and finally
outlines the key issues and considerations involved in resolution
options, the reimbursement of depositors, and claims and recoveries.

It is the conviction of the FSF that this report, with such a pragmatic
approach, will serve its role as a useful tool for policy makers who
want to design deposit insurance systems that preserve the benefits of
heightened financial stability and small depositors\' protection,
without at the same time increasing moral hazard or reducing market
discipline.

Andrew Crockett

Chairman

**Table of Contents**

I. Executive Summary [4](#__RefHeading___Toc523901127)

II\. Introduction [6](#ii.-introduction)

III\. Contextual Issues for Deposit Insurance Systems
[8](#iii.-contextual-issues-for-deposit-insurance-systems)

1\. The role of the banking sector and the financial safety net
[8](#the-role-of-the-banking-sector-and-the-financial-safety-net)

2\. Forms of depositor protection [8](#forms-of-depositor-protection)

3\. Moral hazard [9](#moral-hazard)

IV\. Processes for Adopting and Maintaining a Deposit Insurance System
[12](#iv.-processes-for-adopting-and-maintaining-a-deposit-insurance-system)

1\. Public-policy objectives [12](#public-policy-objectives)

2\. Situational analysis and implementation considerations
[13](#situational-analysis-and-implementation-considerations)

\(a\) Economic factors, the state and structure of the banking system
and public attitudes and expectations
[13](#a-economic-factors-the-state-and-structure-of-the-banking-system-and-public-attitudes-and-expectations)

\(b\) The state of legal, prudential regulatory, supervisory, accounting
and disclosure regimes
[14](#b-the-state-of-legal-prudential-regulatory-supervisory-accounting-and-disclosure-regimes)

3\. Transitioning from a blanket guarantee to a deposit insurance system
[15](#transitioning-from-a-blanket-guarantee-to-a-deposit-insurance-system)

4\. Self-assessment methodology (SAM)
[16](#self-assessment-methodology-sam)

Figure 1 (SAM) [17](#figure-1-sam)

V. Structure and Design Features [18](#v.-structure-and-design-features)

1\. Mandates, powers and structure [18](#mandates-powers-and-structure)

\(a\) Mandates and powers [18](#a-mandates-and-powers)

\(b\) Basic structure and operational issues
[19](#b-basic-structure-and-operational-issues)

\(c\) Basic governance arrangements
[19](#c-basic-governance-arrangements)

\(d\) Human resources and statutory indemnification
[20](#d-human-resources-and-statutory-indemnification)

2\. Interrelationships among financial safety-net participants
[20](#interrelationships-among-financial-safety-net-participants)

3\. Membership and coverage [21](#membership-and-coverage)

\(a\) Membership [21](#a-membership)

\(i\) Compulsory membership [21](#i-compulsory-membership)

\(ii\) Considerations when granting membership to banks
[22](#ii-considerations-when-granting-membership-to-banks)

\(iii\) Foreign banks [22](#iii-foreign-banks)

\(iv\) Non-bank financial institutions
[23](#iv-non-bank-financial-institutions)

\(v\) State-owned banks [23](#v-state-owned-banks)

\(b\) Coverage [23](#__RefHeading___Toc523901155)

\(i\) Scope and level [23](#i-scope-and-level)

\(ii\) Coinsurance [25](#ii-coinsurance)

\(iii\) Adjusting coverage limits [25](#iii-adjusting-coverage-limits)

\(iv\) Foreign-currency deposits [26](#iv-foreign-currency-deposits)

4\. Funding [26](#funding)

\(a\) Funding on an ex-ante or ex-post basis
[27](#a-funding-on-an-ex-ante-or-ex-post-basis)

\(b\) Issues related to the establishment and size of a deposit
insurance fund [28](#__RefHeading___Toc523901162)

\(c\) Deposit insurance assessments: flat-rate versus risk-adjusted
differential premium systems
[28](#c-deposit-insurance-assessments-flat-rate-versus-risk-adjusted-differential-premium-systems)

5\. Public awareness [29](#__RefHeading___Toc523901164)

Box: Cross-Border Issues [31](#box-cross-border-issues)

Vl. Resolutions, Reimbursements, Claims and Recoveries
[32](#vl.-resolutions-reimbursements-claims-and-recoveries)

1\. Private-sector solutions [32](#private-sector-solutions)

2\. Resolving troubled banks [33](#__RefHeading___Toc523901168)

\(a\) Options [33](#a-options)

\(i\) Liquidation and reimbursement of depositors' claims
[33](#i-liquidation-and-reimbursement-of-depositors-claims)

\(ii\) Purchase-and-assumption transactions (sales)
[33](#ii-purchase-and-assumption-transactions-sales)

\(iii\) Open-bank financial assistance
[34](#iii-open-bank-financial-assistance)

\(b\) Costs and other considerations
[34](#b-costs-and-other-considerations)

3\. Reimbursing depositors [35](#reimbursing-depositors)

\(a\) Conditions for effective reimbursement
[35](#a-conditions-for-effective-reimbursement)

\(b\) Eligibility for coverage [35](#b-eligibility-for-coverage)

\(c\) Procedures for reimbursing depositors
[36](#c-procedures-for-reimbursing-depositors)

\(d\) Payments to depositors [36](#d-payments-to-depositors)

4\. Claims and recoveries [36](#__RefHeading___Toc523901179)

\(a\) General issues [37](#a-general-issues)

\(b\) Asset-management and disposition strategies
[37](#b-asset-management-and-disposition-strategies)

\(c\) Marketing methods [38](#c-marketing-methods)

\(d\) Claims and litigation [38](#d-claims-and-litigation)

5\. Depositor ranking, collateralisation and rights of set-off
[39](#depositor-ranking-collateralisation-and-rights-of-set-off)

\(a\) Depositor ranking [39](#a-depositor-ranking)

\(b\) Collateralisation [39](#__RefHeading___Toc523901186)

\(c\) Rights of set-off [40](#c-rights-of-set-off)

VII\. Key Points of Guidance [41](#vii.-key-points-of-guidance)

Annex I: Members of the Working Group
[52](#annex-i-members-of-the-working-group)

Annex II: Approach to Developing Discussion Papers
[53](#annex-ii-approach-to-developing-discussion-papers)

Annex III: Organisations that Assisted the Working Group
[56](#annex-iii-organisations-that-assisted-the-working-group)

Glossary of Terms [58](#glossary-of-terms)

[]{#__RefHeading___Toc523901127 .anchor}I. Executive Summary

The Financial Stability Forum's Working Group on Deposit Insurance has
developed guidance for the benefit of countries considering the adoption
or the reform of an explicit, limited-coverage deposit insurance system
(hereinafter referred to in this Report as "a deposit insurance
system"). The guidance was developed through the preparation of a series
of discussion papers and a consultative process that involved over 100
countries. In developing guidance, the Working Group drew heavily on the
practical experience of its members and other countries. Thus, the
guidance is reflective of, and designed to be adaptable to, a broad
range of country circumstances, settings and structures.

The principal objectives of a deposit insurance system are to contribute
to the stability of a country's financial system and to protect
less-financially-sophisticated depositors from the loss of their
deposits when banks fail. There are a variety of options available for
achieving these objectives.

A deposit insurance system is preferable to implicit protection if it
clarifies the authorities' obligations to depositors and limits the
scope for discretionary decisions that may result in arbitrary actions.
To be credible, however, and to avoid distortions that may result in
moral hazard, such a system needs to be properly designed, well
implemented and understood by the public. A deposit insurance system
needs to be part of a well-designed financial safety net, supported by
strong prudential regulation and supervision, effective laws that are
enforced, and sound accounting and disclosure regimes.

The first step in adopting a deposit insurance system or reforming an
existing system is to specify appropriate public-policy objectives and
to ensure that their implications are fully understood. In conjunction
with identifying public-policy objectives, policymakers will need to
assess a large variety of conditions and factors that can have a bearing
on the design of the system. This self-assessment process is referred to
in this Report as a situational analysis. Conditions and factors that
should be taken into consideration include: the state of the economy,
current monetary and fiscal policies, the state and structure of the
banking system, public attitudes and expectations, the strength of
prudential regulation and supervision, the legal framework, and the
soundness of accounting and disclosure regimes. In many cases, country
conditions may not be ideal and, therefore, it is important to identify
gaps between existing conditions and more-desirable situations and
thoroughly evaluate available options, since the establishment of a
deposit insurance system is not a remedy for dealing with major
deficiencies.

Countries transitioning from a blanket guarantee to a deposit insurance
system should undertake the same type of situational analysis as
countries moving from implicit protection. The transition from a blanket
guarantee should be as rapid as the country's circumstances permit;
since adjustment can become more difficult the longer it is in place.
Public awareness plays a particularly important role in enabling a
smooth transition.

After the self-assessment process has been completed, policymakers
should turn their attention to specific deposit insurance system design
features. The starting point should be to address the mandates, powers
and basic organisational structure of the deposit insurer. Although no
single set of mandates, powers and structures is suitable in all
circumstances, those elements should be well defined, understood, and
consistent with public-policy objectives, and there should be clear
oversight and accountability for the system. It also is critical to
address explicitly interrelationship issues among safety-net
participants by specifying clear mandates, effective information
exchange, confidentiality of information, and close coordination of the
activities relevant to the deposit insurer.

Policymakers then should consider membership and coverage issues.
Explicit eligibility rules should exist and be transparent, and
membership generally should be compulsory. When deciding on the scope
and level of coverage, policymakers should consider the relative
importance of different deposit instruments in relation to stated
public-policy objectives and the effect that the level of coverage may
have on moral hazard. The level of coverage can then be set through an
examination of relevant data from banks.

Deposit insurance systems need to have access to adequate funds in order
to reimburse depositors promptly. The characteristics of the system and
its benefits and limitations should be publicised regularly so that its
credibility can be maintained and strengthened.

There are a variety of methods available to safety-net participants for
resolving failed banks or to deal with banks that are in danger of
failing. The methods are: liquidation and reimbursement of depositors'
claims, purchase-and-assumption transactions and open-bank financial
assistance. Asset-management and disposition strategies should be guided
by commercial considerations and their economic merits.

Finally, the Working Group recommends that a continuous-improvement
process be instituted for reviewing the extent to which a deposit
insurance system is meeting its objectives. In this way, a country can
ensure that its deposit insurance system remains consistent with
economic and social conditions and lessons learned, and is better able
to deal with evolving challenges.

# 

# II. Introduction

The Financial Stability Forum (FSF) was created in 1999 to promote
international financial stability, to improve the functioning of
markets, and to reduce systemic risk. In recognition of the increasing
use of deposit insurance as an integral component of an effective
financial safety net, the FSF established a Study Group on Deposit
Insurance. The Study Group was asked to assess the desirability and
feasibility of setting out international guidance on deposit insurance
arrangements. The Study Group's report was tabled at a meeting of the
FSF in March 2000. On the basis of the conclusions in that report, the
FSF invited Mr. Jean Pierre Sabourin, President and Chief Executive
Officer, Canada Deposit Insurance Corporation, to constitute a Working
Group on Deposit Insurance (the Working Group) to develop such guidance
and to deliver a final report to the FSF by September 2001.[^1]

The mandate of the Working Group was to develop guidance on sound
deposit insurance arrangements for countries considering the adoption of
a deposit insurance system or the reform of an existing one. The mandate
specified that such guidance should be developed through a consultative
process that included countries interested in deposit insurance issues.
The guidance was to be reflective of, and adaptable to, the broadest set
of circumstances, settings and structures.

In fulfilling its mandate the Working Group engaged in a wide range of
activities. These included: the publication of a series of business
plans and discussion papers on specific issues[^2], outreach sessions,
seminars, conferences, utilisation of a Web site to solicit feedback and
share knowledge, and the production of this Final Report. The discussion
papers identified critical issues associated with adopting an explicit,
limited-coverage deposit insurance system or with reforming an existing
one. The Working Group met with over 400 people from over 100 countries
and they have been kept fully informed about the development of the
guidance topics.

This report is organised as follows. Section III explores the contextual
issues related to forms of depositor protection. Section IV sets out the
issues and processes that need to be addressed when adopting or
reforming a deposit insurance system. Section V presents the design
features that help to ensure the effectiveness and credibility of a
system. Section VI outlines the key issues and considerations involved
in resolution options, the reimbursement of depositors, and claims and
recoveries. The final section summarises the key guidance points.

# 

# III. Contextual Issues for Deposit Insurance Systems

This section discusses issues that policymakers should consider when
adopting or reforming a deposit insurance system. The first part
examines the role of the banking sector and the financial safety net.
Next, there is a discussion on the forms depositor protection can take
in different countries. The last part focuses on how the financial
safety-net participants can mitigate moral hazard.

## 1. The role of the banking sector and the financial safety net

Financial institutions that accept deposits from the public (hereinafter
referred to as banks) are important in the economy because of their
involvement in the payments system, their role as intermediaries between
depositors and borrowers, and their function as agents for the
transmission of monetary policy. Banks are in the business of assuming
and managing risks. By their nature, banks are vulnerable to liquidity
and solvency problems, among other things, because they transform
short-term liquid deposits into longer-term, less-liquid loans and
investments. They also lend to a wide variety of borrowers whose risk
characteristics are not always readily apparent.

The importance of banks in the economy, the potential for depositors to
suffer losses when banks fail, and the need to mitigate contagion risks,
lead countries to establish financial safety nets. A financial safety
net usually includes prudential regulation and supervision, a lender of
last resort and deposit insurance. The distribution of powers and
responsibilities between the financial safety-net participants is a
matter of public-policy choice and individual country circumstances. For
example, some countries incorporate all financial safety-net functions
within the central bank, while others assign responsibility for certain
functions to separate entities.

## 2. Forms of depositor protection

Policymakers have many choices regarding how they can protect
depositors. Some countries have implicit protection that arises when the
public, including depositors and perhaps other creditors, expect some
form of protection in the event of a bank failure. This expectation
usually arises because of the government's past behaviour or statements
made by officials. Implicit protection is, by definition, never formally
specified. There are no statutory rules regarding the eligibility of
bank liabilities, the level of protection provided or the form which
reimbursement will take. By its nature, implicit protection creates
uncertainty about how depositors, creditors and others will be treated
when bank failures occur. Funding is discretionary and often depends on
the government's ability to access public funds. Although a degree of
uncertainty can lead some depositors to exert greater effort in
monitoring banks, it can undermine stability when banks fail.

Statutes or other legal instruments usually stipulate explicit deposit
insurance systems. Typically, there are rules governing insurance
coverage limits, the types of instruments covered, the methods for
calculating depositor claims, funding arrangements and other related
matters. A deposit insurance system is preferable to implicit protection
if it clarifies the authorities' obligations to depositors and limits
the scope for discretionary decisions that may result in arbitrary
actions. A deposit insurance system can also provide countries with an
orderly process for dealing with bank failures.

The introduction of a deposit insurance system can be more successful
when a country's banking system is healthy. A deposit insurance system
can contribute effectively to the stability of a country's financial
system if it is part of a well-designed safety net. To be credible, a
deposit insurance system needs to be properly designed, well implemented
and understood by the public. It also needs to be supported by strong
prudential regulation and supervision, sound accounting and disclosure
regimes, and the enforcement of effective laws. A deposit insurance
system can deal with a limited number of simultaneous bank failures, but
cannot be expected to deal with a systemic banking crisis by itself.

## 3. Moral hazard

A well-designed financial safety net contributes to the stability of a
financial system; however, if poorly designed, it may increase risks,
notably moral hazard. Moral hazard refers to the incentive for excessive
risk taking by banks or those receiving the benefit of protection. Such
behaviour may arise, for example, in situations where depositors and
other creditors are protected, or believe they are protected, from
losses or when they believe that a bank will not be allowed to fail. In
these cases, depositors have less incentive to access the necessary
information to monitor banks. As a result, in the absence of regulatory
or other restraints, weak banks can attract deposits for high-risk
ventures at a lower cost than would otherwise be the case.

Moral hazard can be mitigated by creating and promoting appropriate
incentives through good corporate governance and sound risk management
of individual banks, effective market discipline and frameworks for
strong prudential regulation, supervision and laws. These elements
involve trade-offs and are most effective when they work in concert.

Good corporate governance and sound risk management of individual banks
help to ensure that business strategies are consistent with
safe-and-sound operations, and thus can act as the first line of defence
against excessive risk taking. Good corporate governance and sound risk
management includes standards, processes, and systems for ensuring
appropriate direction and oversight by directors and senior managers,
adequate internal controls and audits, management of risks, the
evaluation of bank performance, the alignment of remuneration with
appropriate business objectives, and management of capital and liquidity
positions.

Moral hazard can be mitigated by market discipline exercised by
shareholders as well as by larger creditors and depositors who are
exposed to the risk of loss from the failure of a bank. However, for
market discipline to work effectively, these groups must have the
knowledge required to assess the risks they face. Information should be
readily available and be generally understandable by the public. Sound
accounting and disclosure regimes are required, as well as ongoing
attention to a bank's soundness by ratings agencies, market analysts,
financial commentators and other professionals.

Many countries rely heavily on prudential regulatory and supervisory
discipline to mitigate moral hazard and control excessive risk taking.
Regulatory discipline can be exercised through sound and effective
regulations covering the establishment of new banks, the implementation
of minimum capital requirements, the qualifications of directors and
managers, sound-business activities, fit-and-proper tests for
controlling shareholders, standards for risk management, strong internal
controls, and external audits. Supervisory discipline can be exercised
by ensuring that banks are monitored for safety and soundness as well as
compliance issues and that corrective actions are taken promptly when
problems surface, including the closure of banks when necessary.

Specific deposit insurance design features can also mitigate moral
hazard. These features may include: placing limits on the amounts
insured; excluding certain categories of depositors from coverage; using
certain forms of coinsurance; implementing differential or risk-adjusted
premium assessment systems; minimising the risk of loss through early
closure of troubled banks; and demonstrating a willingness to take legal
action, where warranted, against directors and others for improper acts.

Many of the methods used to mitigate moral hazard require certain
conditions to be in place. For example, differential or risk-adjusted
differential premium assessment systems may be difficult to design and
implement in new systems and in emerging or transitional economies.
Early intervention, prompt corrective action and, when warranted, bank
closure require that supervisors and deposit insurers have the necessary
legal authority, in-depth information on bank risk, financial resources,
and incentives to take effective action. Personal-liability provisions
and availability of sanctions can reinforce incentives of bank owners,
directors, and managers to control excessive risk, but they depend on
the existence of an effective legal system that provides the necessary
basis for action against inappropriate behaviour.

Policymakers should consider a country's conditions and factors that may
determine the effectiveness of particular measures for mitigating moral
hazard, the commitment and the ability to implement them, and the
advancement of a reform agenda to eliminate gaps that may limit their
effectiveness.

# IV. Processes for Adopting and Maintaining a Deposit Insurance System

This section sets out the general policy issues and processes that need
to be addressed when adopting or reforming a deposit insurance system.
The discussion begins with a focus on the public-policy objectives of a
deposit insurance system. It is then suggested that policymakers conduct
a situational analysis to guide their deliberations. Some special issues
related to transitioning from a blanket guarantee to a deposit insurance
system are discussed in the penultimate part of this section. In the
final part, a six-step iterative self-assessment methodology is
presented.

## 1. Public-policy objectives

The first step in designing a deposit insurance system is to identify
the public-policy objectives that it is expected to achieve and these
objectives must be well understood. The principal objectives for deposit
insurance systems are to contribute to the stability of the financial
system and to protect less-financially-sophisticated depositors.
Although the determination of such objectives is the responsibility of
governments, the private sector can play a role in their achievement.
The choice of how a deposit insurance system is to be operated depends
on many factors that are unique to each country and its governmental and
financial systems.

A well-designed and well-understood deposit insurance system contributes
to the stability of a country's financial system by reducing the
incentives for depositors to withdraw their insured deposits from banks
because of a loss of confidence. Policymakers should ensure that the
authorities and the public view all components of the deposit insurance
system as credible. The level and scope of coverage, the speed with
which insured deposits are repaid, and the credibility of the underlying
guarantee will affect the deposit insurance system's ability to enhance
the stability of the financial system. Public attitudes and expectations
play a particularly important role in reinforcing the credibility and
the effectiveness of a deposit insurance system.

Deposit insurance protects insured depositors against the consequences
associated with the failure of a bank but it is not designed to protect
banks from failing. The provision of deposit insurance relieves insured
depositors of the difficult tasks of monitoring and assessing the
condition of banks and their asset quality. At the same time, deposit
insurance contributes to the maintenance of confidence, so that
less-financially-sophisticated depositors, or those who find it hard to
assess the financial condition of a bank, are less likely to participate
in bank runs.

A continuous-improvement process should exist for reviewing the extent
to which a deposit insurance system is meeting its public-policy
objectives and its mandate. Also, the appropriateness of the mandate,
powers and elements that make up a deposit insurance system should be
periodically reviewed. In this way, countries can ensure that their
deposit insurance arrangements remain consistent with economic and
social conditions and lessons learned, and that financial safety-net
participants are better able to deal with the challenges they may
encounter.

## 2. Situational analysis and implementation considerations

In conjunction with the identification of public-policy objectives,
policymakers should conduct a situational analysis to guide their
decision-making. Among the conditions and factors that should be taken
into consideration are: the level of economic activity; current monetary
and fiscal policies; the state and structure of the banking system;
public attitudes and expectations; the legal framework; prudential
regulatory, supervisory, accounting and disclosure regimes. Where
existing conditions and factors are not ideal, it is important to
identify gaps and thoroughly evaluate the options available since the
establishment of a deposit insurance system is not a remedy for dealing
with major deficiencies. If actions are necessary, they can be taken
before, or in concert with, the adoption or reform of a deposit
insurance system.

### (a) Economic factors, the state and structure of the banking system and public attitudes and expectations

The establishment of a deposit insurance system is more difficult if
underlying issues relating to the stability of the financial system have
not been addressed. Policymakers should undertake an analysis of
conditions and factors such as the level of economic activity, current
monetary and fiscal policies, inflation and the condition of financial
markets. These conditions and factors affect the banking system and will
influence the effectiveness of a deposit insurance system. A situational
analysis also requires an assessment of the soundness of the banking
system, including a detailed evaluation of the condition of banks'
capital, liquidity, credit quality, risk-management policies and
practices, and the extent of any problems. When problems exist, an
assessment should be made as to whether they are confined to individual
banks or are systemic in nature.

The number, type and characteristics of banks will have design
implications for a deposit insurance system and so the structure of the
banking system should be analysed. Policymakers also may need to examine
the extent of competition, concentration, and the degree of state
ownership as well as state direction. The issue of concentration is of
growing importance for deposit insurance systems given the globalisation
of capital markets and financial industry consolidation. For example, in
a concentrated system the capacity of a deposit insurance system to fund
or cope with the failure of a large and complex bank may be problematic.

When resource distribution and credit decisions are directed mainly by
the state, the state is viewed as being responsible for the results of
such operations. Deposits in such systems generally are perceived as
having a full government guarantee.

It is advisable to undertake an analysis of public attitudes and
expectations before adopting or reforming a deposit insurance system. If
there are significant gaps between expectations and planned systems or
reforms, they will need to be addressed through greater public
awareness. Public awareness plays a particularly important role in
enhancing the credibility and the effectiveness of a deposit insurance
system.

### (b) The state of legal, prudential regulatory, supervisory, accounting and disclosure regimes

It is important for policymakers to assess the state of legal,
prudential regulatory and supervisory, accounting and disclosure
regimes. Policymakers have a wider range of options available for
designing a deposit insurance system if these regimes are robust.

A critical element of a sound legal regime is the ability to enforce
laws. Deposit insurance systems cannot be effective if relevant laws do
not exist or if the legal regime is characterised by inconsistencies.
The situational analysis should focus on the level of enforcement, the
efficiency of the judicial system, and the effectiveness of creditors'
redress mechanisms. Additional factors that should be considered
include: the ability of a legal regime to support early intervention and
prompt corrective action, the ability to close troubled banks promptly,
and provisions for the clear and orderly liquidation of assets and
resolution of creditors' claims.

The strength of prudential regulation and supervision will have
implications for the effectiveness of a deposit insurance system. Strong
prudential regulation and supervision should allow only viable banks to
operate. Banks should be well capitalised and follow sound-and-prudent
risk management, governance and other business practices. Other
characteristics include an effective licensing or chartering regime for
new banks, regular and thorough examinations, and the risk assessment of
individual banks.

Sound accounting and financial reporting regimes are necessary for an
effective deposit insurance system. Accurate, reliable and timely
information reported by these regimes can be used by management,
depositors, the marketplace, and authorities to make decisions regarding
the risk profile of a bank, and thereby increase market, regulatory and
supervisory discipline. Attributes of a sound accounting regime include
accurate and meaningful assessments of information in areas such as
asset valuation, the measurement of credit exposures, loan-loss
provisioning, measurement of nonperforming loans, the treatment of
unrealised losses, off-balance-sheet exposures, capital adequacy, and
bank earnings and profitability. In many countries, increased market
discipline has been fostered by the adoption of sound and prudent
accounting principles and practices, and methods to ensure compliance
with agreed-upon accounting conventions.

Comprehensive disclosure regimes also enhance the effectiveness of a
deposit insurance system. This can be accomplished by requiring banks to
release timely, detailed and useful financial information so the market
can assess the performance of a bank.

## 3. Transitioning from a blanket guarantee to a deposit insurance system

Some countries have introduced an explicit blanket guarantee during a
financial crisis to fully protect all bank depositors and creditors. The
provision of such guarantees may be unavoidable in periods of extreme
financial distress to maintain domestic and international confidence in
the banking system. However, blanket guarantees can have a number of
adverse effects if retained too long, notably an increase in moral
hazard. If a country decides to transition from a blanket guarantee to a
deposit insurance system, the transition should be as rapid as a
country's circumstances permit.

A country considering transitioning from a blanket guarantee to a
deposit insurance system should undertake the same type of situational
analysis as a country moving from implicit protection. In addition,
countries transitioning from a blanket guarantee will need to consider
three special issues.

The first issue arises from the fact that protection for depositors and
other creditors is being reduced. This may present a concern to the
public. Therefore, policymakers should pay particular attention to
public attitudes and expectations. In addition, countries with a high
level of capital mobility, and/or a regional integration policy, should
consider the effects of different countries' protection levels and other
related policies.

Second, policymakers should consider the capacity of the banking system
to fund a new deposit insurance system. The final issue concerns how
fast the transition should proceed. Some countries have implemented
so-called fast-track transitions successfully soon after the crisis has
passed. These are countries that have restored the banking system to
financial health rapidly; and where strong prudential regulation and
supervision, effective legal frameworks, and sound accounting and
disclosure regimes were already in place. When a fast-track approach is
adopted, policymakers should consider phase-in provisions such as
continuing to protect deposits with maturities extending beyond the
expiration date of a blanket guarantee.

In other countries, the implementation of a blanket guarantee has been
associated with a comprehensive post-crisis bank restructuring strategy
and measures to improve prudential regulation and supervision, the legal
framework, and the accounting and disclosure regimes. This has
implications both for the length of time that the blanket guarantee
needs to stay in place and for the speed of the transition. The gradual
removal of a blanket guarantee allows banks time to adjust to new
prudential standards. In addition, a gradual transition permits bank
managers to be trained in a risk-management culture and gives depositors
time to become accustomed to the new arrangements. A major disadvantage,
however, is that the transition period might be perceived as being too
long, raising doubts among depositors and creditors about the
government's commitment to withdraw the blanket guarantee. In addition,
the longer the blanket guarantee remains in place, the more likely it is
to give rise to additional moral hazard.

## 4. Self-assessment methodology (SAM)

In its outreach sessions the Working Group suggested that policymakers
use an iterative "self-assessment methodology" as a tool to design,
implement, modify and continually assess a deposit insurance system. The
six-step methodology presented below allows policymakers to begin from
general principles and then modify, as appropriate, the specific design
features to meet their own country's needs.

+-----------------------------------------------------------------------+
| ######                                                                |
|                                                                       |
| ###### Figure 1 (SAM)                                                 |
|                                                                       |
| ![](media/image3.png)                                                 |
+-----------------------------------------------------------------------+
| **1. Setting out the public-policy objectives.** The process begins   |
| with an articulation of the relevant public-policy objectives to be   |
| attained. This analysis should take into account the conditions and   |
| factors that are present in a given country. A public-policy paper    |
| should outline the mandate and the role that the deposit insurer is   |
| expected to achieve within the financial safety net and set out the   |
| key attributes and important elements of the system.                  |
|                                                                       |
| **2. Situational analysis of conditions** **and factors.** The        |
| analysis should consider: economic factors, current monetary and      |
| fiscal policies, the state and structure of the banking system,       |
| public attitudes and expectations, the state of the legal, prudential |
| regulatory and supervisory, and the accounting and disclosure         |
| regimes. The analysis should expose the strengths, weaknesses,        |
| opportunities and threats of the system and identify the changes      |
| required in constructing a deposit insurance system.                  |
|                                                                       |
| **3. Validation. A** review and validation process of the proposed    |
| public-policy objectives, key attributes and important elements       |
| should be undertaken and adjustments made if necessary.               |
|                                                                       |
| **4. Strategic action plan.** A strategic action plan should be       |
| developed after the validation phase has been completed This plan     |
| should set out the goals and their priorities, time frames, critical  |
| paths, communication strategies, and consultative processes. It       |
| should define how the deposit insurance system will be made           |
| operational and how it will deal with transitional issues.            |
|                                                                       |
| When transitioning from a blanket guarantee, care must be taken to    |
| ensure that the banking system is not disrupted. Policymakers should  |
| have contingency plans to deal with any adverse developments. It is   |
| critical that the public understand the planned changes and the time  |
| frame for completion.                                                 |
|                                                                       |
| **5. Implementation and acceptance phase.** Implementation and other  |
| changes should be supported by mechanisms to track progress and       |
| identify required adjustments. The purpose of this phase is to make   |
| the system operational and deal with transitional issues. For         |
| example, appropriate corporate governance arrangements (the governing |
| body, senior management, internal controls, and an accountability     |
| regime) will need to be put in place. Also, budgets, funding, and     |
| access to information, including information-exchange arrangements,   |
| will need to be addressed at the outset.                              |
|                                                                       |
| **6. Ongoing evaluations and validation.** Ongoing evaluation and     |
| validation is needed to ensure the effectiveness of a deposit         |
| insurance system, and to make changes when required. This             |
| continuous-improvement process should incorporate new developments in |
| the financial system and the lessons learned at home and abroad.      |
| Deposit insurance systems should be reviewed in a timely fashion.     |
| Benchmarking against core principles, guidelines and best practices   |
| enhances the continuous-improvement process.                          |
+-----------------------------------------------------------------------+

# V. Structure and Design Features

This section focuses on the structure and design features of a deposit
insurance system. After policymakers have completed a situational
analysis, as part of a self-assessment process, attention should turn to
issues such as the mandate, powers and structure of the deposit
insurance system. In recognition of the interconnectedness of a deposit
insurance system with the other safety-net functions, it is critical to
address interrelationship issues among financial safety-net
participants. Once those issues have been addressed, design features
such as membership, coverage, funding and public awareness can be
considered. At the end of this section there is a discussion of
cross-border deposit insurance issues.

## 1. Mandates, powers and structure

### (a) Mandates and powers

A mandate is a set of official instructions or statement of purpose.
There is no single mandate or set of mandates suitable for all deposit
insurers. Existing deposit insurers have mandates ranging from narrow,
so-called "paybox" systems to those with broader powers and
responsibilities, such as risk-minimisation, with a variety of
combinations in between. Whatever the mandate selected, it is critical
that there be consistency between the stated objectives and the powers
and responsibilities given to the deposit insurer.

Paybox systems largely are confined to paying the claims of depositors
after a bank has been closed. Accordingly, they normally do not have
prudential regulatory or supervisory responsibilities or intervention
powers. Nevertheless, a paybox system requires appropriate authority, as
well as access to deposit information and adequate funding, for the
timely and efficient reimbursement of depositors when banks fail.

A "risk-minimiser" deposit insurer has a relatively broad mandate and
accordingly more powers. These powers may include: the ability to
control entry and exit from the deposit insurance system, the ability to
assess and manage its own risks, and the ability to conduct examinations
of banks or request such examinations. Such systems also may provide
financial assistance to resolve failing banks in a manner that minimises
losses to the deposit insurer. Some risk-minimisation systems have the
power to set regulations, as well as to undertake enforcement and
failure-resolution activities.

Formally specifying the mandate of a deposit insurer (either in law, in
a formal policy statement, an agreement, or by private contract)
clarifies the role of deposit insurance within the financial safety net.
Clarity of the mandate reinforces the stability of the financial system
and contributes to sound governance and greater accountability.

As a general principle, a deposit insurer should have all powers
necessary to fulfil its mandate. All deposit insurers require the
ability to enter into contracts, set appropriate requirements, and
access timely and accurate information to ensure that they can meet
their obligations to depositors promptly.

### (b) Basic structure and operational issues

Regardless of the scope of a deposit insurer's mandate, there are
certain structural and operational issues that must be addressed. One of
the first tasks is to determine whether the deposit insurance function
should be assigned to an existing organisation or whether a separate
entity should be established.

Assigning the deposit insurance function to an existing entity, (for
example adding a department to a central bank), has the advantage of
allowing the deposit insurer to draw on staff resources and skills from
the larger organisation. However, this approach also has drawbacks. The
primary disadvantage is that a larger organisation may have difficulties
separating its other responsibilities and interests from the deposit
insurance function. Whether or not the deposit insurer is a separate
organisation, it is vitally important to set clearly the responsibility
and accountability of each safety-net function.

### (c) Basic governance arrangements

There are a variety of forms of governance that can be used by a deposit
insurance system. The form of governance utilised should reflect the
mandate and the degree to which the deposit insurer is legally separated
from the other financial safety-net participants.

The governing body of the deposit insurance system should include
individuals with the requisite knowledge who understand the
organisation's activities as well as the environment in which it
operates, and they should have the authority to make decisions. The
deposit insurer should have access to the input and views of the other
safety-net participants and relevant interested parties. Members of the
governing body and management of the deposit insurer should be subject
to a fit-and-proper test, and they should be free from conflicts of
interest.

Governance systems and practices should be developed on the basis of
sound strategic planning, risk-management processes, and good internal
control and audit systems. The governance structure should be
transparent and subject to clear oversight and accountability. Rules
specifying corporate governance practices should be developed.

### (d) Human resources and statutory indemnification

The ability to attract and retain qualified employees is a key challenge
for most deposit insurers. Indeed, a lack of skilled staff, capable of
dealing with the complex and rapidly evolving issues that characterise
periods of financial stress, has increased costs for a number of
governments and deposit insurers.

Several approaches have been employed to ensure the availability of
qualified people to meet the operational objectives of deposit insurance
systems. They include the use of dedicated resources, access to the
resources of other financial safety-net participants and/or reliance on
outside service providers.

The importance of statutory indemnification should be recognised and
employees should receive legal protection against lawsuits for their
actions taken in good faith. The lack of legal protection for employees
can reduce incentives to be vigilant in carrying out their
responsibilities, particularly in cases where mandates emphasise early
detection, intervention and closure of troubled banks.

## 2. Interrelationships among financial safety-net participants

Policymakers should address the deposit insurer's relationships and
coordination with the other safety-net participants. A need for close
coordination exists in any institutional setting and information sharing
among safety-net participants is essential.

When a single organisation performs all of the safety-net functions the
smooth resolution of potential tensions is dependent on clarity of
mandates and an adequate accountability regime among the relevant
departments. However, when the functions are assigned to different
organisations, issues related to information sharing, allocation of
powers and responsibilities, and coordination of actions among different
functions are more complex and need to be addressed clearly and
explicitly.

The supervisory authority usually is the primary source of information
on banks. In order to ensure that the deposit insurer obtains the
information it needs, while minimising reporting burdens on banks, it is
important to closely coordinate the collection and sharing of
information. Depending on the breadth of their individual mandates,
deposit insurers may need to supplement information provided by
supervisors with information collected directly from banks.

A deposit insurer's information needs vary significantly according to
its mandate and powers. All deposit insurers need information to be able
to reimburse depositors' claims when necessary, including information on
the amount of insured deposits held by individual depositors. A deposit
insurer should have ready access to specific information related to
banks' deposit base, including the amount of insured and total deposits,
so that plans for resources and funding needs can be developed.
Accordingly, guidelines may need to be issued to ensure that banks
maintain and safeguard appropriate records.

A deposit insurer with a risk-minimisation mandate must have access to
timely and accurate information so that it can assess the financial
condition of individual banks, as well as the banking industry. It also
must anticipate the financial troubles of individual banks and deal with
them effectively when they arise. The deposit insurer also needs
information regarding the value of the bank's assets and the expected
time frame for the liquidation process, given that the value of a bank's
assets depends, in part, on the time necessary to liquidate them.

Although informal arrangements for information sharing and coordination
can work well, clearly specified agreements are highly desirable, given
the sensitivity of bank-specific information and the need to maintain
confidentiality. The challenge of maintaining open communication
channels suggests that it may be useful to formalise these arrangements
either through legislation, memoranda of understanding, legal
agreements, or a combination of these techniques. These arrangements
also may be useful in providing a general framework for safety-net
participants to coordinate their related activities. Rules regarding
confidentiality of information should apply to all safety-net
participants.

## 3. Membership and coverage

This subsection deals with specific design features, such as which
institutions should be eligible for membership, what financial
instruments should be covered, and the level of coverage. A number of
different factors should be taken into consideration to determine which
financial institutions should be members of a deposit insurance system.
Of particular importance is whether they are subject to strong
prudential regulation and supervision. Explicit eligibility rules for
membership should exist and membership should be compulsory, in most
circumstances. In addition, it is important to define clearly in law or
private contract what is an insurable deposit.

### 

### (a) Membership

#### (i) Compulsory membership

In general, membership should be compulsory to avoid adverse selection.
There are some cases, however, where a strong commitment of banks to
participate in a deposit protection system can be observed and broad
participation of banks may be achieved without a legal obligation. This
can occur if depositors are aware of and sensitive to the existence of
deposit insurance, thus creating strong incentives for banks to be part
of a system. In other cases, if depositors are less concerned about
deposit insurance or are not aware that coverage is limited to certain
banks, then the stronger banks may opt out. Further, in a voluntary
system strong banks may opt out if the cost of failures is high and this
may affect the financial solvency and the effectiveness of a deposit
insurance system.

#### (ii) Considerations when granting membership to banks

There are two circumstances that may require different approaches to
granting membership to banks. First, when a deposit insurance system is
established and second, when membership is granted to new banks in an
existing system.

When a deposit insurance system is created, policymakers are faced with
the challenge of minimising the risks to the deposit insurer, while
granting extensive membership. Generally, two options are available:
automatic membership or requiring banks to apply for entry.

Automatic membership for all banks may be the simplest option in the
short term. However, the deposit insurer may then be faced with the
difficult task of having to accept banks that create an immediate
financial risk or that pose other adverse consequences for the deposit
insurance system.

Alternatively, banks may be required to apply for membership. This
option provides the deposit insurer with the flexibility to control the
risks it assumes by establishing entry criteria. It also can serve to
enhance compliance with prudential requirements and standards. In such
cases, an appropriate transition plan should be in place that details
the criteria, process and time frame for attaining membership. The
criteria should be transparent.

The way that policymakers grant membership in existing deposit insurance
systems varies. In some countries, the licensing or chartering of new
banks and the granting of membership in a deposit insurance system are
separate functions of different safety-net participants. In other
countries the relevant safety-net participants jointly approve new
members and in others, membership is automatic with the issuance of a
bank charter or license. Whichever option is chosen, appropriate
mechanisms are necessary to ensure that membership requests are handled
expeditiously and effectively, and that eligible banks meet minimum
prudential standards and entry requirements.

#### (iii) Foreign banks

Although domestically incorporated or chartered banks are the principal
members of most deposit insurance systems, some countries require
foreign-bank subsidiaries and branches to participate in the system as
well. Several arguments are made for their inclusion: the stability of
the domestic financial system; the goal of providing a minimum level of
deposit insurance to all depositors; the notion that foreign banks
benefit from a stable domestic financial system and should therefore
participate in the deposit insurance system as part of doing business in
a country; the desire to minimise competitive issues by placing foreign
banks on the same footing as domestic banks; and the diversification
that arises from wider membership and expansion of the funding base.

#### (iv) Non-bank financial institutions

Policymakers take different approaches to non-bank financial
institutions that offer deposits and deposit-like products. The
rationales for expanding membership beyond banks include: the desire not
to introduce competitive distortions among different types of
institutions offering similar products; the objective of enhancing the
stability of the financial system by including all institutions that
accept deposits or deposit-like products; and the desire to apply
prudential regulatory and supervisory rules to all such institutions.

There are many cases, however, where non-bank financial institutions are
excluded from membership. The most common reasons are that such
institutions may not be as relevant as banks to a country's financial
stability, that they may be subject to different regulatory and
supervisory standards, and they may have different authorities
overseeing their affairs. In such circumstances, policymakers may
establish separate protection schemes to cover non-bank financial
institutions.

#### (v) State-owned banks

State-owned banks present unique issues for deposit insurance systems.
These banks are usually the beneficiaries of an implicit or full
government guarantee that may make their inclusion in a deposit
insurance system appear unnecessary. Nevertheless, some countries have
chosen to include them in their systems. Some of the reasons are: to
facilitate privatisation; to ensure competitive equality with
private-sector banks in terms of the level of coverage and premium
contributions; to provide a mechanism to bring such banks under the same
prudential regulatory and supervisory rules applicable to other banks;
and to diversify the deposit insurer's risks and increase its funding
base.

[]{#__RefHeading___Toc523901155 .anchor}(b) Coverage

#### (i) Scope and level

Policymakers should define clearly in law or by private contract what is
an insurable deposit. In doing so, they should consider the relative
importance of different deposit instruments, including foreign-currency
deposits and the deposits of non-residents in relation to the
public-policy objectives of the system. Once the relevant deposits are
selected, exclusions of specific deposits and/or depositors can be
determined.

Many deposit insurance systems exclude deposits held by depositors who
are deemed capable of ascertaining the financial condition of a bank and
exerting market discipline. Examples include deposits held by banks,
government bodies, professional investors such as mutual funds, and
deposits held by bank directors and officers. In some cases, deposits
held by individuals who bear responsibility for the financial well-being
of a bank are excluded from reimbursement. Also, deposits with extremely
high yields are sometimes excluded from coverage; or reimbursement may
be limited to the principal owed, with a lower rate of interest applied.
Many countries exclude bearer deposits because it is difficult to
establish ownership of the account and to ensure that coverage limits
are respected.

Once the scope is determined, the level of coverage can be set. This can
be done through an examination of relevant data, such as statistical
information describing the size distribution of deposits held in banks.
This gives policymakers an objective measure, such as the fraction of
depositors covered, with which to assess the adequacy of a certain level
of coverage. Whatever coverage level is selected, it must be credible
and internally consistent with other design features, and meet the
public-policy objectives of the system. Policymakers should consider the
relationship between coverage levels and moral hazard.

There are a number of ways to apply coverage limits. Usually coverage
limits are applied per deposit or per depositor. Using the per deposit
method may be incompatible with ensuring limited coverage since a
depositor can easily circumvent the limit by opening multiple accounts
in a single bank for an amount equal to or below the insured limit.
Focusing the coverage limit solely on the depositor avoids that pitfall
but information requirements are greater since all deposit accounts held
by a single depositor need to be identified and aggregated for deposit
insurance purposes.

Coverage limits can also be applied per bank or across all member banks.
Although coverage across all banks is likely to instill more market
discipline, depositors may be affected by multiple bank failures even
though they had diversified their risks among member banks. As a result,
this approach may increase the potential for bank runs. Providing
deposit insurance across all member banks requires detailed data of all
depositor accounts in all banks. This type of coverage is highly
difficult and costly to administer as it requires not only a great deal
of information regarding ownership of deposit instruments but also
requires a process for combining depositor accounts at different banks
when they fail. It also requires that a time element be attached to the
coverage limit- such as per calendar year. A mechanism would also be
needed to track depositor reimbursements to determine when a particular
depositor reached the coverage limit. This option is seldom used because
of its complexity and its potential to undermine depositor confidence.

Given the importance of effectively limiting coverage and contributing
to financial system stability, as well as keeping the requirement for
information reasonable, it is preferable to apply deposit insurance on a
per depositor per bank basis.

#### (ii) Coinsurance

One approach to foster market discipline and to reduce somewhat the
costs of deposit insurance is the use of coinsurance, whereby a
pre-specified proportion of deposits is insured. Depositors in a
limited-coverage deposit insurance system should be aware that they may
suffer losses if their deposits exceed the limit when a bank fails. This
awareness will be heightened under coinsurance because depositors may
suffer losses if their deposits are below the insurance limit. However,
even under a coinsurance system, individuals who have small account
balances may not exercise market discipline because of a lack of
financial incentives or sophistication, or because the costs of doing so
exceed the benefits. In this case, individuals bear a cost for bank
failure without increasing market discipline. As well, for coinsurance
to be effective, extensive information needs to be provided to the
public regarding the financial condition of banks.

A negative consequence of coinsurance is that depositors may opt out of
the banking system. One way to protect against these potentially adverse
effects is to apply it above a certain amount so that individuals
holding small account balances are protected fully against the risk of
loss, while maintaining the incentive for depositors holding larger
account balances to monitor banks.

#### (iii) Adjusting coverage limits

Inflation, the growth of real income, the development of new financial
instruments, and the way in which these factors influence the
composition and size of deposits may require the adjustment of coverage
limits. A trade-off exists, however, between the goal of maintaining the
level of deposit insurance constant for a sufficiently long period of
time so that depositors know the coverage limit with certainty, and the
goal of setting the level of coverage that is appropriate to meet the
objectives of the system. This problem is especially acute for
high-inflation countries.

Adjustments to the level of deposit insurance coverage may take place
either on a discretionary basis or they may be made systematically
through automatic or periodic indexing. Indexed adjustments may be
automatically implemented, which requires care in choosing the frequency
and amounts of adjustments. If adjustments occur too often, or for odd
amounts, this could confuse the public. Alternatively, if adjustments
occur too infrequently, the deposit insurance system may be unable to
meet its stated public-policy objectives.

#### (iv) Foreign-currency deposits

The decision whether to cover deposits denominated in foreign currencies
depends heavily on a country's usage of foreign currency. When usage is
high, it would be of little value to institute a deposit insurance
system without covering these deposits.

If foreign-currency deposits are to be covered by deposit insurance, it
is important to consider whether these deposits are to be reimbursed in
local or foreign currency when a bank fails. This decision is important
because it has implications as to who bears the foreign-exchange risk.
If reimbursements are made in foreign currency, the deposit insurer may
bear this risk. If foreign-currency deposits are converted into local
currency before reimbursing depositors after a bank failure, the risk is
transferred to the depositors. If reimbursements are made in local
currency, a transparent rule should be set out in advance with respect
to the date chosen for the exchange rate that will be used to calculate
the amount to be reimbursed. At a minimum, a system that offers to repay
depositors in a foreign currency must have access to sufficient foreign
assets or other sources of foreign-currency funding to make this
commitment credible.

To mitigate foreign-exchange risk, policymakers should ensure that banks
have sound foreign-exchange risk-management systems and controls in
place. Furthermore, the deposit insurer should develop sound policies
and procedures to prudently manage any foreign-exchange risk it faces.
In designing such policies and procedures, the deposit insurer may wish
to draw on the expertise residing in banks.

## 4. Funding

Sound funding arrangements are critical to the effectiveness of a
deposit insurance system and the maintenance of public confidence. A
deposit insurance system should have available all funding mechanisms
necessary to ensure the prompt reimbursement of depositors' claims after
a bank failure. Inadequate funding can lead to delays in resolving
failed banks, to significant increases in costs and a loss of
credibility of the deposit insurance system. Funding can be assured in
many ways, such as government appropriations, levies or premiums
assessed against member banks, market borrowings, or a combination
thereof.

Premiums or levies can be assessed on an *ex-ante* or *ex-post* basis.
Beyond the decision of how to fund a deposit insurance system, some
additional issues should be considered by policymakers. Among these are:
how deposit insurance assessments should be determined, verified, and
collected; and whether it is appropriate to establish separate deposit
insurance funds for different types of deposit-taking institutions.

Member banks should pay the cost of deposit insurance since they and
their clients directly benefit from having an effective deposit
insurance system. Policymakers should consider the effect of premium
levels on the financial health of the banking industry, and an
assessment base should be chosen against which a given premium rate will
be applied. One choice is insured deposits; alternatively, a bank's
total deposit liabilities may be used. Although the use of total deposit
liabilities may be easier administratively, there may be issues of
equity since banks that rely more heavily on uninsured deposits for
funding could be required to pay a disproportionate share of premiums.

### (a) Funding on an ex-ante or ex-post basis

*Ex-ante* funding, which refers to the accumulation of a reserve or a
fund, provides an opportunity to smooth the premiums paid by banks over
the course of a business cycle. Because all banks contribute to building
and maintaining a reserve or fund, banks that subsequently fail will
have contributed to paying for the cost of their failure. *Ex-ante*
funding sources may be supplemented by measures such as *ex-post* levies
or premium assessments on member banks, draws on government lines of
credit, and/or government guarantees. *Ex-ante* funding has the
potential to remove capital from the banking system because premiums
paid to the deposit insurer cannot be used for other purposes. If
policymakers decide to use *ex-ante* funding, the deposit insurer should
ensure that funds are well managed and readily available to cover losses
as they arise. This can be accomplished by implementing appropriate
investment policies and procedures, and by instituting sound internal
controls, disclosure and reporting systems.

*Ex-post* funding requires member banks to pay premiums or levies only
after failures occur and are most likely to be assessed during an
economic downturn. *Ex-post* funding may improve inter-bank monitoring
because each bank has an incentive to avoid the costs associated with
the failure of a member. Such incentives may be particularly strong in
banking systems characterised by a small number of large banks. Because
assessments and collections occur post-failure, prompt reimbursement of
insured depositors may be more problematic if other funding mechanisms
are unavailable at the time. Moreover, banks that fail will not have
contributed to funding the costs associated with their failure.

Failures often occur during an economic downturn and, in some
circumstances, this may create pressure to provide forbearance because
the banking system's ability to pay is weakened. In some cases, this can
be offset if the deposit insurer has access to other resources such as
government assistance through temporary funding mechanisms, guarantees
or backstops. The costs associated with providing such assistance should
be recovered through future assessments against banks.

In practice, deposit insurance systems often are funded on a combined
*ex-ante* and *ex-post* basis. The advantages and disadvantages
associated with *ex-ante* and *ex-post* funding are generally applicable
to hybrid funding arrangements.

[]{#__RefHeading___Toc523901162 .anchor}(b) Issues related to the
establishment and size of a deposit insurance fund

In principle, there are two approaches available to establishing a
deposit insurance fund. First, banks may be assessed a steady premium
rate over a long period. This approach allows a deposit insurance fund
to fluctuate in response to insurance losses and movements in the
deposit insurance fund do not trigger automatic changes in premium
rates. Using this approach the insurer could be dependent on government
or other financial support in times when the fund is inadequate to meet
obligations to depositors.

Second, a premium assessment system can be designed to maintain a target
fund ratio or range. Using this approach, premiums could be set and
adjusted over time by taking into account some ratio of the deposit
insurance fund to insured deposits, for example. This approach helps to
mitigate the loss exposure that the deposit insurer is assuming. In
principle, the target fund ratio should be sufficient to reduce the
probability of the fund's insolvency to an acceptable minimum, although
estimating probabilities of loss is very complicated in practice.
Policymakers in economies that are subject to greater financial-system
volatility should take this into account when determining their funding
needs.

Using a target fund ratio method could lead to a *de facto ex-post*
system after the deposit insurance fund achieves a certain level. This
method can also result in banks paying few premiums in good economic
times, but paying higher premiums during an economic downturn.

A case can be made either for establishing and maintaining one fund or
for establishing and maintaining separate funds for different types of
financial institutions that accept deposits from the public. If separate
funds are established, policymakers should ensure that distinctions
among the institutions and their funds do not contribute to competitive
distortions.

### (c) Deposit insurance assessments: flat-rate versus risk-adjusted differential premium systems

Policymakers have a choice between adopting a flat-rate premium system
or a premium system that is differentiated on the basis of
individual-bank risk profiles. The primary advantage of a flat-rate
premium system is the relative ease with which assessments can be
calculated and administered. However, in a flat-rate system, low-risk
banks effectively pay for part of the deposit insurance benefit received
by high-risk banks.

Most newly established systems initially adopt a flat-rate system given
the difficulties associated with designing and implementing a
risk-adjusted differential premium system. However, because flat-rate
premiums do not reflect the level of risk that a bank poses to the
deposit insurance system, banks can increase the risk profile of their
portfolios without incurring additional deposit insurance costs. As a
result, flat-rate premiums may be perceived as encouraging excessive
risk taking by some banks, unless there is a mechanism to impose
financial sanctions or penalties.

Risk-adjusted differential premium systems can mitigate such criticisms
and may encourage more prudent risk-management practices at member
banks. When the information required to implement a risk-adjusted
differential premium system is available, relating premiums to the risk
a bank poses to the deposit insurer is preferable.

The information-intensive nature of the intermediation process, however,
makes risk measurement a complicated task. The particular difficulties
related to risk-adjusted differential premium systems include: finding
appropriate and acceptable methods of differentiating bank risk;
obtaining reliable and timely data; ensuring that rating criteria are
transparent; and examining the potential destabilising effects of
imposing high premiums on already troubled banks. As well, risk-adjusted
differential premium systems require resources necessary to administer
the system appropriately. An important but delicate issue that
policymakers should consider is whether to allow the release of
information related to the risk profile of each bank, or to restrict
this information for confidentiality or other reasons.

[]{#__RefHeading___Toc523901164 .anchor}5. Public awareness

In order for a deposit insurance system to be effective, it is essential
that the public be informed about its benefits and limitations.
Experience has shown that the characteristics of a deposit insurance
system need to be publicised regularly so that its credibility can be
maintained and strengthened.

A well-designed public-awareness program can achieve several goals,
including the dissemination of information that promotes and facilitates
an understanding of the deposit insurance system and its main features.
Also, a public-awareness program can build or help restore confidence in
the banking sector. Additionally, such a program can help to disseminate
vital information when failures occur, such as guidance regarding how to
file claims and receive reimbursements.

When designing a public-awareness program, it is critical to identify
the target audience. Bank employees, especially those in operations, as
well as those on the front-line, are important conduits for providing
information about deposit insurance.

Care should be taken to select strategies that meet the goals set in the
public-awareness program. A public-awareness plan that addresses issues
related to failures should be carefully developed before an actual
failure occurs. A well-designed public-awareness program helps to
counteract the potentially disruptive effects of bank failures and helps
maintain confidence in the stability of the financial system.

In countries where public confidence in the banking system is high and
awareness of an existing deposit insurance system is very low, special
communication strategies need to be developed to ensure that the stated
goals are achieved while public confidence is maintained.

+-----------------------------------------------------------------------+
| ## Box: Cross-Border Issues                                           |
|                                                                       |
| Deposit taking is usually a domestic business, but cross-border       |
| issues are increasing in many jurisdictions. In some countries,       |
| cross-border issues already play a considerable role in the creation  |
| and design of a deposit insurance system. This is the case, for       |
| example, where banking systems are characterised by a significant     |
| presence of foreign-bank branches. In weak banking systems            |
| (especially after a crisis), the outflow of deposits to other         |
| countries may have to be taken into account when establishing or      |
| reforming a deposit insurance system. In regions where economies are  |
| closely related, or in closely integrated regions, such as in the     |
| European Union (EU), special considerations may apply. The EU minimum |
| requirements for deposit insurance are harmonised and the             |
| responsibility for providing deposit insurance rests primarily with   |
| the home country.                                                     |
|                                                                       |
| Relevant laws, regulations and other provisions applicable to banks,  |
| their customers and deposit insurers are generally those of the       |
| bank's country of incorporation or charter. However, if a bank        |
| operates branches in other jurisdictions or provides services to      |
| customers' abroad, the laws and regulations of other countries may    |
| apply. Depending on the volume of these activities, the               |
| implementation of policies by home and host countries regarding       |
| issues such as coverage and asset disposition can be crucial for the  |
| effective operation of deposit insurance systems and for the          |
| achievement of public-policy objectives.                              |
|                                                                       |
| Deposits collected from individuals located in countries where a bank |
| has not established a physical presence (that is, a branch or         |
| subsidiary) normally are covered by the deposit insurance system the  |
| bank belongs to in its home country. Deposits at foreign branches may |
| be protected by the bank's home-country                               |
|                                                                       |
| deposit insurance system, by the host-country system where the branch |
| is located, by a combination of both systems, or not protected at     |
| all. Where deposits are covered by a combination of both systems, the |
| home-country system may provide basic coverage that is supplemented   |
| by the host country.                                                  |
|                                                                       |
| Foreign banks may expose the deposit insurer to risks that it has a   |
| limited capacity to mitigate. Additionally, they may complicate the   |
| recovery process in the event of a failure, because assets located    |
| abroad may be subject to another country's bankruptcy/insolvency      |
| regime.                                                               |
|                                                                       |
| Foreign branches participating in a host country deposit insurance    |
| system should conform generally to the membership criteria of the     |
| host-country system, which may possibly include the application of    |
| supervisory requirements on a stand-alone basis. If the host-country  |
| system provides supplementary coverage, multiple reimbursements of    |
| insured depositors should be avoided. The deposit insurance already   |
| provided by the home-country system should be recognized in the       |
| determination of levies and premiums.                                 |
|                                                                       |
| In general, information received by safety-net participants in other  |
| jurisdictions should be subject to the same strict confidentiality    |
| rules applicable to information received from other domestic          |
| safety-net participants. Provided confidentiality is ensured, all     |
| relevant information should be exchanged between deposit insurers in  |
| different jurisdictions and possibly between deposit insurers and     |
| other foreign safety-net participants when appropriate. In any case,  |
| deposit insurers should receive all information necessary to enable a |
| prompt reimbursement of claims of depositors and to enable them to    |
| meet their mandate.                                                   |
+-----------------------------------------------------------------------+

#  Vl. Resolutions, Reimbursements, Claims and Recoveries

Timely and effective exit strategies for handling failed banks enhance
confidence in a deposit insurance system, help contain costs, and avoid
adverse effects on other safety-net participants, the government, the
public, the banking industry, and the economy. Cooperation among the
various financial safety-net participants, both before and after a
failure, is essential if these results are to be achieved.

It is critical to determine when a bank is in serious financial
difficulty. This determination should be made on the basis of
well-defined and transparent criteria by a safety-net participant with
authority to act. Prompt and decisive actions are crucial to reduce the
cost of a bank failure but care needs to be taken to address
confidentiality issues to protect the exchange of information among
financial safety-net participants. There are a number of steps necessary
to liquidate a bank's business and affairs. These steps include the
resolution or disposition of the failed bank, reimbursement of insured
depositors, liquidation of the bank's assets, settlement of claims in
accordance with applicable laws, and disposition of pending or
outstanding litigation.

From a deposit insurance perspective, the objectives of an effective
failure-resolution process are to: meet the deposit insurer's
obligations; ensure depositors are reimbursed promptly and accurately;
minimise resolution costs and disruption of markets; maximise recoveries
on assets; settle *bona-fide* claims on a timely and equitable basis;
and reinforce discipline through legal actions in cases of negligence or
other wrongdoings. There are potential tensions and trade-offs among
these objectives that need to be addressed by policymakers.

## 1. Private-sector solutions

Before a troubled bank reaches the point of failure, it usually has been
the subject of various efforts to strengthen its operations. Such
actions may have included restructuring efforts that are broadly similar
to resolution transactions, in that they involve a merger with, or
acquisition by, a healthy bank. These efforts are frequently described
as private-sector solutions and do not impose a cost on the deposit
insurer.

Private-sector solutions require that action be taken early while
acquirers are still willing to take over the troubled bank. They also
require the existence of healthy banks, which have the financial and
managerial capabilities to combine with weaker ones and that can
continue to comply with regulatory and supervisory requirements.
Finally, the responsible authority must be prepared to close a troubled
bank if the private-sector solution fails, otherwise the bank\'s
bondholders and shareholders may have little incentive to make the
financial concessions necessary to help make a solution work.

[]{#__RefHeading___Toc523901168 .anchor}2. Resolving troubled banks

A resolution may be defined as a method of disposing of a failed bank,
which is directed by the responsible safety-net participant, and
generally is designed to reimburse insured depositors while minimising
costs to the deposit insurer.

### (a) Options

Three basic resolution options exist: liquidation and reimbursement of
depositors' claims, purchase-and-assumption transactions (sales) and
open-bank financial assistance. Bankruptcy/insolvency and other laws may
heavily influence the choice of resolution methods since such laws vary
considerably among countries and, in some cases, may make a particular
resolution method difficult to implement. Because of the special
significance of banks and bank failures, policymakers may wish to review
whether bankruptcy/insolvency laws facilitate the orderly exit of
troubled banks.

#### (i) Liquidation and reimbursement of depositors' claims

Reimbursement of depositors' claims occurs when an acquisition or merger
is unattractive to potential acquirers or merger partners. The failed
bank is closed and the assets and uninsured claims are transferred to a
receiver/liquidator for liquidation and settlement. Reimbursing claims
may be accomplished by directly paying depositors or by transferring
their insured deposits to another bank.

#### (ii) Purchase-and-assumption transactions (sales)

In a purchase-and-assumption transaction, a healthy bank or group of
investors assumes some or all of the obligations, and purchases some or
all of the assets, of the failed bank. Assets purchased by the acquirer
typically include performing loans and other good-quality investments.
Assets not sold to the acquirer at resolution are passed on to the
receiver/liquidator for disposition. Clearly, acquirers must have
sufficient resources to absorb the acquisition, sufficient capital to
handle the new bank's costs, and qualified management.

Variants of the purchase-and-assumption method include the "bridge
bank," or other interim arrangements, which have been used primarily to
manage failures of large and complex banks. In such arrangements, the
responsible safety-net participant takes ownership or control of the
failed bank and operates it for a period of time. The goals are to
prevent further deterioration of the bank, give the authorities more
time to seek a permanent resolution, and provide potential acquirers a
greater opportunity to review the quality of the bank's assets. If the
bank remains too long under official control, however, it may lose value
and may draw deposits away from other banks. The authorities, as well,
may be tempted to postpone a permanent solution unduly. As a result, it
may be desirable to establish limits on the length of time that such
arrangements remain in operation.

#### (iii) Open-bank financial assistance

Financial assistance may be provided to an operating bank that is in
danger of failing. The deposit insurer may retain ownership rights in
the bank and additional capital from outside investors and replacement
of managers and directors may be required. Uninsured depositors and
certain other creditors are generally fully protected, although
bondholders and shareholders may be required to bear significant
losses^.^[^3] Open-bank assistance usually is provided to banks when it
is believed that closing them would pose significant risks for the
stability of the financial system.

Open-bank assistance has features that some countries regard as
undesirable. Bondholders and shareholders, while suffering losses, may
receive compensation or benefits that they would not otherwise receive.
Depending on the legal system, closed-bank transactions also may have
other advantages. For example, the appropriate authority may have the
right to abrogate certain contracts without penalty. Finally, where
small banks are generally ineligible for open-bank assistance, they may
believe that they are being treated unfairly.

### (b) Costs and other considerations

Choices among resolution methods involve various considerations,
including statutory requirements and mandates. Where least-cost
resolutions are mandated to the deposit insurer, the chosen method must
be demonstrated to be less costly than any other possible method.
Alternatively, a less-stringent cost test might require that the chosen
method be less expensive than a liquidation and reimbursement of
depositors' claims. An implicit assumption in cost-test calculations is
that the resolution of one failed bank will not affect the cost of
subsequently resolving other banks. This is most likely to be true in
countries where occasional bank failures are regarded as a normal
occurrence and the failed bank does not represent a major proportion of
the banking industry.

There may be special provisions for large and complex banks that are
perceived to have special significance from the standpoint of
financial-system stability or for banks whose closure would result in a
harmful interruption of banking services in particular markets or
regions. Such banks often have been resolved in ways that are not
designed primarily to minimise resolution costs. In such circumstances,
consideration should be given as to how these costs should be allocated.

## 3. Reimbursing depositors

Determining who should be reimbursed and ensuring that deposit insurance
limits are respected are the most crucial steps in the reimbursement
process and are important to the effectiveness of a variety of
resolution methods. This is most evident in a liquidation process where
depositors' claims need to be reimbursed up to their insured limits. In
other resolution transactions, determining the insurance status of
individual accounts is also necessary, if such resolutions are to meet a
least-cost test or when acquirers of failed banks assume only insured
deposits. A determination of the status of individual accounts is also
necessary when applicable statutes mandate the priority of insured
depositor claims.

Systems and processes should be developed in order to undertake
preparatory reviews of deposit liabilities held by troubled banks. This
requires development of administrative practices and procedures and the
ongoing review of the quality and security of bank deposit records.

### (a) Conditions for effective reimbursement

Depositors need to know when and under what conditions the deposit
insurer will start the reimbursement process, as well as the applicable
coverage limits. If reimbursement does not occur immediately after
closure of the bank, depositors should be told the time frame over which
reimbursement will take place. The deposit insurer should know, as soon
as possible, when a bank will be closed. Access to the necessary deposit
data before the bank is closed lessens the risk of record manipulation,
shortens the time for completing the reimbursement process, and helps
preserve public confidence. The deposit insurer must decide whether to
maintain adequate resources internally or whether it will outsource the
function by employing contractors to handle reimbursements as they
arise.

### (b) Eligibility for coverage

The deposit insurer must assess the amount in each deposit account at
the time of closure and determine whether the accounts are within the
scope and limits of the deposit insurance system. In making such a
determination, the deposit insurer must apply the laws governing
ownership rights and capacities with respect to coverage of single
accounts, joint accounts, business accounts, retirement accounts, and
fiduciary accounts. In some countries, the deposit insurance limit is
applied by combining all deposit accounts held by a depositor, while in
others, deposit accounts held under different rights and capacities are
insured separately. Other important steps in the reimbursement process
include the need to reconcile suspense accounts, process deposit and
other items in transit and deal with clearing and settlement issues.

As discussed later in this section, rules regarding set-off and
collateral must be applied in determining the amount of coverage. If the
depositor reimbursement and claims/liquidation functions are
administered separately, close cooperation between the responsible
organisations is necessary in applying any set-off and collateralisation
rules.

### (c) Procedures for reimbursing depositors

The deposit insurer's administrative practices and procedures should
specify the necessary steps to ensure the accuracy of the reimbursement
process. An important consideration is whether the verification and
reconciliation of accounts can be achieved on the basis of the bank's
own records, or whether the depositor is required to submit a claims
form, effectively proving ownership of the account. In some cases
requiring submission of a claims form may be inconvenient for depositors
and can delay the reimbursement process, but this procedure may be
necessary if the quality of the bank records is suspect or poor, or if
bank-secrecy laws prevent accurate identification of depositors and
their accounts.

Another important consideration is whether to pay depositors quickly or
only after extensive verification of account data. A reasonable position
would be to issue payments after best efforts to ensure accuracy and
completeness have been made. In some situations, a possible remedy is to
make partial payments to insured depositors before all the steps
necessary for an accurate reimbursement process have been completed. The
final action before reimbursement is the preparation of reconciliation
statements specifying the amount to be paid to depositors and claimed
from the liquidator/receiver. The reimbursement process should be
evaluated *ex-post* to incorporate lessons learned.

### (d) Payments to depositors

Actual reimbursement can proceed after the deposit records, claims and
rights have been reconciled. Reimbursements may be simplified if another
bank agrees to make the payments. If this option is not available, the
deposit insurer must select a method of payment such as: providing cash
or issuing some other form of payment; mailing cheques; transferring
funds to another bank designated by the depositor; issuing a debit card;
or making a postal transfer.

Open communication channels through press releases, the news media,
advertisements, posters, the Internet, and other means are crucial in
maintaining public confidence in the deposit insurance system. The
public should receive practical and accurate information about when and
how they will receive reimbursement of their claims. Direct
communication through letters and telephone calls are necessary to
respond to depositors' questions and complaints.

[]{#__RefHeading___Toc523901179 .anchor}4. Claims and recoveries

### (a) General issues

The powers provided to the entity responsible for the
claims-and-recoveries function should be guided by applicable laws and
should include control of the failed bank's assets; contract rights and
privileges; the ability to allow or disallow claims; the capability to
enforce or repudiate certain contractual obligations; and the ability to
challenge fraudulent transfers and transactions. At the same time,
fiduciary responsibilities imposed on the entity may limit its ability
to fulfil other responsibilities.[^4]

### (b) Asset-management and disposition strategies

Asset-management and disposition strategies should be guided by
commercial considerations and their economic merits, given the quality
of the assets, the depth and condition of markets, the availability of
expertise in asset management and disposition, legal requirements
relating to the disposition of assets, and public-policy objectives. The
goal of maximising recoveries may conflict with other goals, such as
environmental considerations, or the pursuit of actions to enhance
standards of business conduct.

Performing assets may be sold as part of the resolution transaction or
as soon as possible thereafter, because they are marketable and have
little or no potential for additional value. This also has the advantage
of returning assets to the market quickly, thereby, distributing funds
earlier to the deposit insurer, minimising carrying costs while assets
are in the hands of the receiver/liquidator, and minimising government
involvement. Other assets may be sold or otherwise liquidated over a
period of time under professional management, with a view to optimising
recoveries and reducing costs. Negotiations with borrowers also may be
effective in the disposition of hard-to-sell assets. With respect to
assets not sold immediately, it is vital that their value be preserved
through effective asset-management procedures in an effort to minimise
costs to the financial system.

Effective asset management should include tools for validating
assumptions used in valuing assets and developing disposition plans.
Risks relating to market fluctuations, particular asset-disposition
strategies, and asset-specific and legal issues should be identified,
quantified, managed or hedged. The use of discounted cash-flow analysis
or other appropriate valuation techniques is required to take into
account differences in timing of recoveries and expenses and differences
in risk among asset types. Consideration also may be given to
differences in valuation among potential purchasers that arise from
differences in plans and financing costs.

### (c) Marketing methods

Transparency and access to information are key factors in marketing
failed-bank assets. The quality of the information may have an important
bearing on the price. Therefore, information should be available,
complete and arranged in as orderly a manner as possible.

In principle, a wide range of methods is available for disposition of
the assets of failed banks. They include: asset-by-asset sales; auctions
or sealed bids; asset pools; securitisation; asset-management companies;
and equity partnerships.

In some instances, recoveries may be enhanced with seller financing,
put-back arrangements that provide the buyer with the option of
returning certain assets for refund within a specified period, or
limited guarantees against loss. Guarantees will generally result in
increased market prices because of the reduced risk to the purchaser,
but have the disadvantage of creating contingent liabilities, which may
be mitigated by limiting their duration and total value.

### (d) Claims and litigation

Claims and litigation advanced by the failed bank or the
receiver/liquidator against directors, officers, auditors and other
parties related to the bank failure are potentially important assets.
These claims may result in significant recoveries and may serve as a
tool for fostering discipline in the banking sector. For these reasons,
potential claims should be identified and investigated carefully to
determine the appropriateness and potential for recovery before being
pursued.

It is important to identify claims and to distribute the proceeds of the
liquidation of assets in a fair and cost-effective manner, and in
accordance with applicable laws. This involves notifying potential
claimants of the reimbursement process, reviewing and resolving asserted
claims, distributing dividends to proven claimants, and transferring
unclaimed dividends to the appropriate authority. Claims include those
of the deposit insurer, uninsured depositors, and other unsecured
creditors. They also include legal actions against the failed bank and
the cost of any financial assistance that may have been provided by
safety-net participants. Litigation instituted by creditors,
shareholders, or other claimants and plaintiffs against the failed bank
or the liquidator/receiver may result in significant costs and delays.
In this regard, it may be advisable to conduct regular evaluation of the
claims in order to estimate the potential liability exposure and
consider alternative means for resolution.

## 5. Depositor ranking, collateralisation and rights of set-off

How funds are distributed among claimants is heavily influenced by legal
provisions regarding the ranking of depositors and other creditors,
collateralisation of the bank's obligations, and the extent to which a
creditor's debts to a bank are set-off against the creditor's claims.
The rules governing these matters vary among countries, reflecting
differences in laws, traditions and public-policy objectives, and are
typically not subject to change by the deposit insurance system. Such
rules can have important effects on the deposit insurer's costs and on
the behaviour of safety-net participants, depositors and other
creditors.

### (a) Depositor ranking

Policymakers should be aware of the potential effects of existing
depositor priority laws or statutes on failure-resolution costs and the
incentive for depositors or other creditors to exert market discipline.
If depositors rank equally with other unsecured creditors, they will
receive *pro-rata* shares of recoveries from asset liquidation. If
depositors and the deposit insurer are accorded some superior right to
share in such recoveries, their claims must be paid in full before other
unsecured claimants are compensated. However, depositor priority does
not necessarily reduce the losses of uninsured depositors or the deposit
insurer. Lower-ranking creditors have incentives to protect themselves
by collateralising their claims, shortening terms of maturity,
exercising early-withdrawal provisions, or imposing additional penalties
or charges. Such actions may offset the effects of preferential ranking.

If uninsured depositors believe they will not sustain losses because of
their priority ranking, they may have less incentive to exercise market
discipline. Also, safety-net participants may have reduced incentives to
act promptly in dealing with problem banks. The net effects depend on
the characteristics of non-deposit creditors, their ability to utilise
the available means of limiting their loss exposure and their
willingness to exercise market discipline, legal provisions governing
these matters, and the existence of strong governance and accountability
regimes at the responsible safety-net participant.

[]{#__RefHeading___Toc523901186 .anchor}(b) Collateralisation

Policymakers also should be aware of the effects of collateralisation.
In some countries, depositors, the deposit insurer, and other unsecured
claimants share only in the unencumbered assets of the failed bank and
their recoveries are reduced by the collateralisation of other parties'
claims. However, collateralisation may have some offsetting advantages
from the standpoint of the payments system and the public-policy
objectives. Extensive collateralisation of a bank's liabilities may also
increase the deposit insurer's cost and impinge on its ability to
provide financial assistance to a troubled bank, because certain assets
may not be available. As in the case of depositor priority,
collateralisation may give unsecured creditors greater incentives to
effect early withdrawals, shorten maturities, or impose additional
charges in order to mitigate expected losses.

### (c) Rights of set-off

The term "set-off" refers to situations where the claim of a creditor
(for example, a deposit) in an insolvent bank is deducted from a claim
of the bank (for example, a loan) against the creditor. Where set-off is
available or imposed, creditors who are also debtors of the failed bank
may increase their recoveries, while other creditors' recoveries are
diminished.

Set-off can reduce administrative costs by reducing the number of
individual creditors and debtors. Netting of the cross-obligations of
members of the payments system lessens the credit risk of the remaining
participants in the event of the failure of one or more participants,
thus reducing the possibility of contagion. Depending on the
jurisdiction, banks that operate in the derivatives-market may be able
to effect transactions (for example, a swap transaction) that might not
be available (or available only on less-favourable terms) if netting
were not assured.

Some countries emphasise the importance of set-off while others believe
that it can lead to unequal treatment. If set-off is allowed, a number
of issues should be considered, including whether set-off should apply
to all loans or only those due or in default. Set-off against a
performing loan could result in a "call" on a loan to a viable business;
as a result, many countries restrict set-off to cases where the loan is
in default. Even where set-off is accepted, the extent to which it
should apply may be an issue. Set-off of obligations against loans in
good standing may reduce the value of a portfolio of loans as a
realizable asset. Coordination of the rules of set-off and the
reimbursement of insured depositors also raise issues, such as whether
deposit insurance is to be paid on the gross amount of the deposit or
the net amount after set-off. Finally, set-off also can be influenced by
the priority of claims in a bank failure. These issues generally involve
trade-offs among public-policy objectives and require country-specific
solutions.

# VII. Key Points of Guidance

The Working Group was asked to develop guidance for the benefit of
countries considering the adoption or the reform of an explicit,
limited-coverage deposit insurance system. The following points of
guidance summarize the main conclusions and suggestions by the Working
Group to help policymakers design, implement and continually assess a
deposit insurance system. These points are reflective of, and adaptable
to, a broad set of circumstances, settings and structures.

**1. Contextual issues**

\(a\) Policymakers have many choices regarding how they can protect
depositors. Explicit, limited-coverage deposit insurance ("a deposit
insurance system") is preferable to implicit protection if it clarifies
the authorities' obligations to depositors and limits the scope for
discretionary decisions that may result in arbitrary actions. However,
such a system needs to be properly designed, well implemented and
understood by the public in order to be credible. It also needs to be
supported by strong prudential regulation and supervision, sound
accounting and disclosure regimes, and the enforcement of effective
laws. (pages 8-9)

(b) A deposit insurance system can deal with a limited number of
    simultaneous bank failures, but cannot be expected to deal with a
    systemic banking crisis by itself.

(page 9)

**2. Moral hazard**

\(a\) A well-designed financial safety net contributes to the stability
of the financial system; however, if poorly designed, it may increase
risks, notably, moral hazard. Good corporate governance and sound risk
management of individual banks, effective market discipline, and
frameworks for strong prudential regulation, supervision and laws, can
mitigate moral hazard and these elements are most effective when used in
concert. (page 9)

\(b\) Good corporate governance and sound risk management of individual
banks help to ensure that business strategies are consistent with
safe-and-sound operations, and thus can act as the first line of defence
against excessive risk taking. Good corporate governance and sound risk
management includes standards, processes, and systems for ensuring
appropriate direction and oversight by directors and senior managers;
adequate internal controls and audits; management of risks and the
evaluation of bank performance; the alignment of remuneration with
appropriate business objectives; and management of capital and liquidity
positions. Effective market discipline requires sound accounting and
disclosure regimes and the ongoing attention to a bank's soundness by
rating agencies, market analysts, financial commentators and other
professionals. Regulatory discipline can be exercised through effective
regulation covering the establishment of new banks, the imposition of
minimum capital requirements, the qualifications of directors and
managers, sound business activities, a fit-and-proper test for
controlling shareholders, standards for risk management, strong internal
controls and external audits. Supervisory discipline can be exercised by
ensuring that banks are monitored for safety and soundness as well as
compliance issues and that corrective actions are taken promptly when
problems surface, including the closure of banks when necessary. (pages
9-10)

\(c\) Ensuring that a deposit insurance system contains certain design
features can also mitigate moral hazard. These features may include:
placing limits on the amounts insured; excluding certain categories of
depositors from coverage; using certain forms of coinsurance;
implementing differential or risk-adjusted premium assessment systems;
minimising the risk of loss through early closure of troubled banks; and
demonstrating a willingness to take legal action, where warranted,
against directors and others for improper acts. (page 10)

**3.** **Public-policy objectives**

\(a\) The first step in designing a deposit insurance system is to
identify the public-policy objectives that it is expected to achieve and
these objectives must be well understood. The principal objectives for
deposit insurance systems are to contribute to the stability of the
financial system and to protect less-financially-sophisticated
depositors. The choice of how a deposit insurance system is to be
operated depends on many factors that are unique to each country and its
governmental and financial systems. (page 12)

\(b\) A continuous-improvement process should exist for reviewing the
extent to which a deposit insurance system is meeting its public-policy
objectives and its mandate. (page 12)

**4. Situational analysis**

\(a\) Policymakers should conduct a situational analysis when adopting
or reforming a deposit insurance system. This analysis should examine
conditions and factors such as: the level of economic activity; current
monetary and fiscal policies; the state and structure of the banking
system; public attitudes and expectations; the legal framework;
prudential regulatory, supervisory, accounting and disclosure regimes.
(page 13)

\(b\) Where existing conditions and factors are not ideal, it is
important to identify gaps and thoroughly evaluate the options available
since the establishment of a deposit insurance system is not a remedy to
deal with major deficiencies. If actions are necessary, they can be
taken before, or in concert with, the adoption or reform of a deposit
insurance system. (page 13)

\(c\) Deposit insurance systems cannot be effective if relevant laws do
not exist or if the legal regime is characterised by inconsistencies.
(page 14)

\(d\) The strength of prudential regulation and supervision will have
implications for the effectiveness of a deposit insurance system. Strong
prudential regulation and supervision should allow only viable banks to
operate. Banks should be well capitalised and follow sound-and-prudent
risk management, governance and other business practices. (page 14)

**5. Transitioning from a blanket guarantee to a deposit insurance
system**

\(a\) When transitioning, policymakers should pay particular attention
to public attitudes and expectations. Countries with a high level of
capital mobility, and/or a regional-integration policy, should consider
the effects of different countries' protection levels and other related
policies. (page 15)

\(b\) If a country decides to transition from a blanket guarantee to a
deposit insurance system, the transition should be as rapid as a
country's circumstances permit. A country considering such a transition
should undertake the same type of situational analysis as a country
moving from implicit protection to a deposit insurance system. In
addition, three special issues will need to be considered. First, how to
allay fears because protection for depositors and other creditors is
being reduced. Second, policymakers should consider the capacity of the
banking system to fund a new deposit insurance system. The third issue
concerns how fast the transition should proceed. (page 15)

**6. Self-assessment methodology (SAM)**

> Policymakers should consider the use of an iterative self-assessment
> methodology to assist them in the design, implementation, modification
> and continuous assessment of a deposit insurance system. (pages 16-17)

**7. Mandate and powers**

\(a\) There is no single mandate or set of mandates suitable for all
deposit insurers. Existing deposit insurers have mandates ranging from
narrow, so-called "paybox" systems to those with broader powers and
responsibilities, such as risk minimisation with a variety of
combinations in between. Whatever the mandate selected, it is critical
that there be consistency between the stated objectives and the powers
and responsibilities given to the deposit insurer. (page 18)

\(b\) Formally specifying the mandate of a deposit insurer (either in
law, in a formal policy statement, an agreement or by private contract)
clarifies the role of deposit insurance within the financial safety net.
Clarity of the mandate reinforces the stability of the financial system
and contributes to sound governance and greater accountability. (page
18)

\(c\) As a general principle, a deposit insurer should have all powers
necessary to fulfil its mandate. All deposit insurers require the
ability to enter into contracts, set appropriate requirements, and
access timely and accurate information to ensure that they can meet
their obligations to depositors promptly. (page 19)

**8. Structure**

> Policymakers must determine whether the deposit insurance function
> should be assigned to an existing organisation or whether a separate
> entity should be established. Regardless of how the deposit insurance
> system is structured, it is vitally important to set clearly the
> responsibility and accountability of each safety-net function. (page
> 19)

**9. Governance**

\(a\) The form of governance utilised in a deposit insurance system
should reflect the mandate and the degree to which the deposit insurer
is legally separated from the other financial safety-net participants.
The governing body of the deposit insurance system should include
individuals with requisite knowledge to understand the organisation's
activities and the environment in which it operates, and they should
have the authority to make decisions. The deposit insurer should have
access to the input and views of the other safety-net participants and
relevant interested parties. Members of the governing body and
management of the deposit insurer should be subject to a fit-and-proper
test, and they should be free from conflicts of interest. (page 19)

(b) Governance systems and practices should be developed on the basis of
    sound strategic planning, risk-management processes, and good
    internal-control and audit systems. The governance structure should
    be transparent and subject to clear oversight and accountability.
    Rules specifying corporate governance practices should be developed.
    (page 19)

**10: Human resources and statutory indemnification**

\(a\) The ability to attract and retain qualified employees is a key
challenge for most deposit insurers. Deposit insurers may meet this
challenge by: the use of dedicated resources, access to the resources of
other financial safety-net participants and/or reliance on outside
service providers. (page 20)

\(b\) The importance of statutory indemnification should be recognised
and employees of the deposit insurance system should receive legal
protection against lawsuits for their actions taken in good faith. The
lack of legal protection for employees can reduce incentives to be
vigilant in carrying out their responsibilities, particularly in cases
where mandates emphasise early detection, intervention and closure of
troubled banks. (page 20)

**11. Interrelationships among safety-net participants**

\(a\) When a single organisation performs all of the safety-net
functions the smooth resolution of potential tensions is dependent on
clarity of mandates and an adequate accountability regime among the
relevant departments. However, when the functions are assigned to
different organisations, issues related to information sharing,
allocation of powers and responsibilities, and coordination of actions
among the different functions is more complex and need to be addressed
clearly and explicitly. (page 20)

\(b\) A deposit insurer's information needs vary significantly according
to its mandate and powers, but the need for close coordination and
information sharing among safety-net participants is essential in all
cases. Rules regarding confidentiality of information should apply to
all safety-net participants. (pages 20-21)

\(c\) It is highly desirable to formalise information-sharing
arrangements either through legislation, memoranda of understanding,
legal agreements, or a combination of these techniques. These
arrangements also may be useful in providing a general framework for
safety-net participants to coordinate their related activities. (page
21)

**12. Membership**

\(a\) Banks that are to be included in a deposit insurance system should
be subject to strong prudential regulation and supervision. (page 21)

\(b\) In general, membership should be compulsory to avoid adverse
selection. (page 21)

\(c\) Policymakers should determine whether eligible banks will be given
membership automatically or whether they should be required to apply for
entry. The latter option provides a degree of flexibility for the
deposit insurer to control the risks it assumes by establishing entry
criteria. It can also serve to enhance compliance with prudential
requirements and standards. In such cases, an appropriate transition
plan should be in place that details the criteria, process and time
frame for attaining membership and the criteria should be
transparent.(page 22)

\(d\) Appropriate mechanisms are necessary to ensure that membership
requests are handled expeditiously and effectively, and that eligible
banks are required to meet minimum prudential standards and entry
requirements. (page 22)

\(e\) Policymakers take different approaches in deciding which financial
institutions should be covered by deposit insurance. Domestic banks are
the principal members of most deposit insurance systems; in some
countries, foreign banks and branches, non-bank financial institutions,
and state-owned banks also are members. Such entities might be included
to enhance the stability of the financial system, to ensure competitive
equity, to diversify the deposit insurer's risks, and to apply
prudential regulatory and supervisory rules to non-bank financial
institutions that accept deposits and deposit-like products. (pages
21-23)

**13. Coverage**

(a) Policymakers should define clearly in law or by private contract
    what is an insurable deposit. In doing so, they should consider the
    relative importance of different deposit instruments, including
    foreign-currency deposits and the deposits of non-residents, in
    relation to the public-policy objectives of the system. (page 24)

\(b\) The level of coverage can be set through an examination of
relevant data, such as statistical information describing the size
distribution of deposits held in banks. Whatever coverage level is
selected, it must be credible and internally consistent with other
design features, and meet the public-policy objectives of the system.
(page 24)

\(c\) Given the importance of effectively limiting coverage and
contributing to financial system stability, as well as keeping the
requirement for information reasonable, it is preferable to apply
deposit insurance on a per depositor per bank basis. (page 25)

\(d\) One approach to foster market discipline and to reduce somewhat
the costs of deposit insurance is the use of coinsurance. If coinsurance
is adopted, it should be applied above a certain amount. This will
provide individuals holding small account balances full protection
against the risk of loss, while maintaining the incentive for depositors
holding larger account balances to monitor banks. In order for
coinsurance to be effective, extensive information needs to be provided
to the public regarding the financial condition of banks. (page 25)

\(e\) Coverage limits may need to be adjusted periodically because of
inflation, the growth of real income, the development of new financial
instruments, and the way in which these factors influence the
composition and size of deposits. (page 25)

\(f\) The decision whether to cover deposits denominated in foreign
currencies depends heavily on a country's usage of foreign currency.
When usage is high, it would be of little value to institute a deposit
insurance system without covering these deposits. An important decision
is whether to reimburse insured deposits in local or in foreign currency
when a bank fails. Policymakers should ensure that banks have sound
foreign-exchange risk-management systems and controls in place.
Furthermore, the deposit insurer should develop sound policies and
procedures to manage prudently any foreign-exchange risk it faces. In
designing such policies and procedures, the deposit insurer may wish to
draw on the expertise residing in banks. (page 26)

**14. Funding**

\(a\) Sound funding arrangements are critical to the effectiveness of a
deposit insurance system and the maintenance of public confidence. A
deposit insurance system should have available all funding mechanisms
necessary to ensure the prompt reimbursement of depositors' claims.
Inadequate funding can lead to delays in resolving failed banks, to
significant increases in costs and to a loss of credibility of a deposit
insurance system. (page 26)

\(b\) Member banks should pay the cost of deposit insurance since they
and their clients directly benefit from having an effective deposit
insurance system. However, policymakers should consider the effect of
premium levels on the financial health of the banking industry. (page
27)

\(c\) Policymakers should choose an assessment base against which a
given premium rate will be applied. (page 27)

\(d\) The deposit insurer should ensure that funds are well managed and
readily available to cover losses as they arise. This can be
accomplished by implementing appropriate investment policies and
procedures, and by instituting sound internal controls, disclosure and
reporting systems. (page 27)

\(e\) In practice, deposit insurance systems often are funded on a
combined *ex-ante* and *ex-post* basis. The advantages and disadvantages
with *ex-ante* and *ex-post* funding are generally applicable to hybrid
funding arrangements. (page 27)

\(f\) In principle, there are two approaches available to establishing a
deposit insurance fund. One approach is to assess a steady premium rate
over a long period, while the other involves developing a premium system
designed to maintain a target fund ratio or range. If the target fund
ratio method is chosen it should be sufficient to reduce the probability
of the fund's insolvency to an acceptable minimum, although estimating
probabilities of loss is very complicated in practice. (page 28)

\(g\) A case can be made either for establishing and maintaining one
fund or for establishing and maintaining separate funds for different
types of financial institutions that accept deposits from the public. If
separate funds are established, policymakers should ensure that
distinctions among the institutions and their funds do not contribute to
competitive distortions. (page 28)

\(h\) Policymakers have a choice between a flat-rate premium system or a
premium system that is differentiated on the basis of individual-bank
risk profiles. The bases and criteria used in a risk-adjusted
differential premium system should be transparent to all participants.
As well, policymakers who adopt risk-adjusted differential premium
systems should ensure that necessary resources are in place to
administer the system appropriately. If policymakers choose to adopt
risk-adjusted differential premiums, consideration should be given to
the advantages and disadvantages of keeping the risk profiles of
individual banks confidential. (pages 28-29)

**15. Public awareness**

> In order for a deposit insurance system to be effective, it is
> essential that the public be informed about its benefits and
> limitations. Experience has shown that the characteristics of a
> deposit insurance system need to be publicised regularly so that its
> credibility can be maintained and strengthened. (page 30)

**16. Cross-border issues**

\(a\) If the host-country system provides supplementary coverage,
multiple reimbursements of insured depositors should be avoided. The
deposit insurance already provided by the home-country system should be
recognised in the determination of levies and premiums. (page 31)

\(b\) Provided confidentiality is ensured, all relevant information
should be exchanged between deposit insurers in different jurisdictions
and possibly between deposit insurers and other foreign safety-net
participants when appropriate. In any case, deposit insurers should
receive all information necessary to enable a prompt reimbursement of
depositors' claims and to enable them to meet their mandate. (page 31)

**17. Failure resolution**

\(a\) Cooperation among the various financial safety-net participants,
both before and after a failure, is essential if troubled banks are to
be handled in a timely and effective manner. (page 32)

\(b\) The determination and recognition of when a bank is in serious
financial difficulty should be made on the basis of well-defined and
transparent criteria by a safety-net participant with authority to act.
Prompt and decisive actions are crucial to reduce the cost of a bank
failure, but care needs to be taken to address confidentiality issues to
protect the exchange of information among financial safety-net
participants. (page 32)

\(c\) An effective failure-resolution process should: meet the deposit
insurer's obligations, ensure that depositors are reimbursed promptly
and accurately, minimise resolution costs and disruption of markets,
maximise recoveries on assets, settle *bona-fide* claims on a timely and
equitable basis, and reinforce discipline through legal actions in cases
of negligence or other wrongdoings. (page 32)

\(d\) Three basic failure resolution options exist: liquidation and
reimbursement of depositors' claims; purchase-and-assumption
transactions (sales); and open-bank financial assistance.
Bankruptcy/insolvency and other laws may heavily influence the choice of
resolution methods since such laws vary considerably among countries
and, in some cases, may make a particular resolution method difficult to
implement. Because of the special significance of banks and bank
failures, policymakers may wish to review whether bankruptcy/insolvency
laws facilitate the orderly exit of troubled banks. (page 33)

**18. Reimbursing depositors**

\(a\) Systems and processes should be developed in order to undertake
preparatory reviews of deposit liabilities held by troubled banks. This
requires development of administrative practices and procedures and the
ongoing review of the quality and security of bank deposit records.
(page 35)

\(b\) The deposit insurer should know, as soon as possible, when a bank
will be closed. Access to the necessary deposit data before the bank is
closed lessens the risk of manipulation of records, shortens the time
for completing the reimbursement process, and helps preserve public
confidence. (page 35)

\(c\) The reimbursement process should be evaluated *ex-post* to
incorporate lessons learned. (page 36)

**19. Claims and recoveries**

\(a\) The powers provided to the entity responsible for the
claims-and-recoveries function should be guided by applicable laws and
should include control of the failed bank's assets; contract rights and
privileges; the ability to allow or disallow claims; the capability to
enforce or repudiate certain contractual obligations; and the ability to
challenge fraudulent transfers and transactions. (page 37)

\(b\) Asset-management and disposition strategies should be guided by
commercial considerations and their economic merits, given the quality
of the assets, the depth and condition of markets, the availability of
expertise in asset management and disposition, legal requirements
relating to the disposition of assets, and public-policy objectives.
(page 37)

\(c\) Transparency and access to information are key factors in
marketing failed-bank assets. In principle, a wide range of methods is
available for disposition of the assets of failed banks, including:
asset-by-asset sales; auctions or sealed bids; asset pools;
securitisation; asset-management companies; and equity partnerships.
(page 38)

\(d\) Claims and litigation advanced by the failed bank or the
receiver/liquidator against directors, officers, auditors and other
parties related to the bank failure are potentially important assets.
These claims may result in significant recoveries and may serve as a
tool for fostering discipline in the banking sector. For these reasons,
potential claims should be identified and investigated carefully to
determine the appropriateness and potential for recovery before being
pursued. (page 38)

**20. Depositor ranking, collateralisation and rights of set-off**

\(a\) Policymakers should be aware of the potential effects of existing
depositor priority laws or statutes on failure-resolution costs and the
incentive for depositors or other creditors to exert market discipline.
(page 39)

\(b\) Policymakers should be aware of the effects of collateralisation.
Extensive collateralisation of a bank's liabilities may affect the
deposit insurer's cost and impinge on its ability to provide financial
assistance to a troubled bank. (pages 40)

(b) Some countries emphasise the importance of set-off while others
    believe that it can contribute to unequal treatment. If set-off is
    allowed, a number of issues should be considered, including whether
    set-off should apply to all loans or only those due or in default.
    Set-off also can be influenced by the priority of claims in a bank
    failure. These issues generally involve trade-offs and require
    country-specific solutions. (page 40)

##### Annex I: Members of the Working Group

+-----------------------------------+----------------------------------+
| **Chairman**                      |                                  |
|                                   |                                  |
| #########                         |                                  |
|  *Mr. Jean Pierre Sabourin, Presi |                                  |
| dent and Chief Executive Officer* |                                  |
|                                   |                                  |
| **Canada Deposit Insurance        |                                  |
| Corporation**                     |                                  |
+-----------------------------------+----------------------------------+
| **Argentina - Seguro de Depósitos | **Canada - Canada Deposit        |
| Sociedad Anónima**                | Insurance Corporation (CDIC)**   |
|                                   |                                  |
| **Dr. José Carlos Jaime,**        | **Mr. Ronald N. Robertson,**     |
| Chairman                          | Chairman                         |
|                                   |                                  |
| **Dr. Adolfo César Diz**, Member  | **Mr. Guy L. Saint-Pierre,**     |
| of the Board                      | Senior Vice-President, Insurance |
|                                   | and Risk Assessment              |
| **Lic. Martin Lagos**, Adviser    |                                  |
|                                   | **Mr. Wayne Acton,** Senior      |
|                                   | Vice-President, Field Operations |
|                                   |                                  |
|                                   | **Mr. David Walker**, Director,  |
|                                   | Policy and Economics             |
+-----------------------------------+----------------------------------+
| **Chile - Banco Central de        | **France - Secrétariat général   |
| Chile**                           | de la Commission bancaire**      |
|                                   |                                  |
| **Mr. Rodrigo Cifuentes,** Senior | **Madame Sylvie Mathérat,** Chef |
| Economist                         | du service des études bancaires  |
|                                   |                                  |
| **Mr. Carlos Budnevich Le-Fort,** | **Monsieur Olivier Jaudoin,**    |
| Manager of Financial Analysis     | Adjoint au chef du service des   |
| *(until February 2001)*           | études bancaire                  |
+-----------------------------------+----------------------------------+
| **Germany -- Federal Ministry of  | **Hungary - National Deposit     |
| Finance**                         | Insurance Fund of Hungary**      |
|                                   |                                  |
| **Mr. Udo Franke,** Advisor to    | **Mr. Dániel Jánossy,** Managing |
| the Ministry                      | Director                         |
|                                   |                                  |
| **Mr. Dietrich Jahn,** Advisor to | **Mr. András Fekete-Gyor,**      |
| the Ministry *(until June 2000)*  | Deputy Managing Director         |
+-----------------------------------+----------------------------------+
| **Italy - Banca d'Italia**        | **Jamaica - Jamaica Deposit      |
|                                   | Insurance Corporation**          |
| **Mr. Giovanni Carosio,** Head of |                                  |
| the Department, Supervision of    | **Mr. Winston K. Carr,** Chief   |
| Credit Institutions               | Executive Officer                |
|                                   |                                  |
| **Mr. Alessio De Vincenzo**,      |                                  |
| Economist, Banking and Financial  |                                  |
| Supervision Department            |                                  |
+-----------------------------------+----------------------------------+
| **Japan - Financial Services      | **Mexico - Instituto para la     |
| Agency, Deposit Insurance         | Proteccion al Ahorro Bancario**  |
| Corporation of Japan, Ministry of |                                  |
| Finance**                         | **Mr. Carlos Isoard,** Member of |
|                                   | the Board of Governors           |
| **Mr. Masaru Honma,** Executive   |                                  |
| Director of General Affairs       | **Mr. Julio César Mendez,**      |
| Department, DIC                   | Executive Secretary and CEO      |
|                                   |                                  |
| **Mr. Masamichi Kono,** Director, | **Mr. Vicente Corta**, Executive |
| International Affairs Division,   | Secretary and CEO                |
| Planning and Coordination Bureau, |                                  |
| FSA                               | *(until September 2000)*         |
|                                   |                                  |
| **Mr. Yasushi Kanzaki,**          | **Ms. Ingrid Cerwinka,**         |
| International Bureau, MOF         | Assistant General Director       |
|                                   |                                  |
| *(until June 2000)*               | *(until November 2000)*          |
|                                   |                                  |
| **Mr. Noriaki Oka,** Senior       |                                  |
| Counsel - General Affairs         |                                  |
| Department, DIC                   |                                  |
+-----------------------------------+----------------------------------+
| **Philippines - Philippine        | **United States of America -     |
| Deposit Insurance Corporation**   | Federal Deposit Insurance        |
|                                   | Corporation (FDIC)**             |
| **Mr. Norberto C. Nazareno,**     |                                  |
| President and CEO                 | **Ms. Donna A. Tanoue,**         |
|                                   | Chairman *(until July 2001)*     |
| **Mr. Ricardo M. Tan,** Executive |                                  |
| Vice-President                    | **Mr. George Hanc**, Associate   |
|                                   | Director                         |
| **Ms. Rosalinda U. Casiguran**,   |                                  |
| Senior Vice-President for Legal   | **Mr. Christie Sciacca,**        |
| Affairs and Chief Legal Counsel   | Associate Director               |
|                                   |                                  |
| **Ms. Virginia P. Castillo,**     |                                  |
| Senior Vice President             |                                  |
|                                   |                                  |
| **Ms. Rescina S. Bhagwani**,      |                                  |
| Vice-President                    |                                  |
+-----------------------------------+----------------------------------+
| **The World Bank**                | **International Monetary Fund**  |
|                                   |                                  |
| **Mr. Gerard Caprio,** Director,  | **Mr. David S. Hoelscher,**      |
| Financial Policy Department, and  | Division Chief                   |
| Head, Financial Sector Research   |                                  |
|                                   | **Mr. Charles A. Enoch,**        |
| **Mr. Giovanni Majnoni,**         | Assistant Director *(until April |
| Adviser, Financial Sector         | 2000)*                           |
| Strategy and Policy Department    |                                  |
|                                   | **Mr. Michael Taylor**, Senior   |
|                                   | Economist                        |
|                                   |                                  |
|                                   | Systemic Banking Issues Division |
+-----------------------------------+----------------------------------+
| **Members of the Secretariat**    | ##                               |
|                                   | ###### Financial Stability Forum |
| **Canada Deposit Insurance        |                                  |
| Corporation**                     | **Mr. Pierre Cailleteau**        |
|                                   |                                  |
| **Ms. M. Claudia Morrow,**        |                                  |
| Corporate Secretary               |                                  |
|                                   |                                  |
| Secretary to the Working Group    |                                  |
+-----------------------------------+----------------------------------+
| **Mr. John Raymond LaBrosse,**    |                                  |
| Director, International Affairs   |                                  |
|                                   |                                  |
| Executive Director of the Working |                                  |
| Group                             |                                  |
+-----------------------------------+----------------------------------+
| **Ms. Jacqueline (Jackie)         |                                  |
| Chartrand,** Administrative and   |                                  |
| Technical Support to the Working  |                                  |
| Group                             |                                  |
+-----------------------------------+----------------------------------+
| **Research Committee:**           |                                  |
+-----------------------------------+----------------------------------+
| > Mr. George Hanc, Head (FDIC)    | > Ms. Christine Blair (FDIC)     |
| >                                 | >                                |
| > Mr. David Walker (CDIC)         | > Ms. Rose Kushmeider (FDIC)     |
| >                                 | >                                |
| > Ms. Detta Voesar (FDIC)         | > Mr. Greg Cowper (CDIC)         |
+-----------------------------------+----------------------------------+

##### Annex II: Approach to Developing Discussion Papers

1\. Research Plan

The Working Group developed a research plan on topics relating to
guidance on deposit insurance that was made available at
<http://www.cdic.ca/international>. Subgroups were formed for the 16
guidance topics, with a Working Group member acting as the coordinator.
A member of the research committee assisted each subgroup.

2\. Outreach Sessions and Conferences

The Working Group held meetings in Switzerland, the United States of
America, Mexico, Hungary, Malaysia, Argentina, Italy and Chile. It also
provided a number of *fora* for people interested in deposit insurance
issues to exchange ideas and benefit from the experience of others. The
Group met with over 400 people from over 100 countries. In addition to
the presentations by Working Group members, there were over 90
presentations delivered at the conferences and seminars from individuals
who were not directly associated with the Working Group.

The format consisted of a two-day Working Group meeting, followed by an
outreach session hosted by one of the members and a two-day conference
on specific guidance topics. Outreach sessions and conferences were
supported financially and otherwise by the Working Group members, other
organisations and, in some cases, the Financial Stability Institute
(FSI). As well, the Working Group cooperated with a number of the
regional development banks.

The Working Group's Web site includes copies of presentations, the text
of the remarks provided by many of the speakers, and videos of each
conference. The Web site also includes copies of the Working Group's
business plans and discussion papers. Messages *via* e-mail were sent
regularly to over 600 individuals and there have been over 40,000 visits
to the Web site.

**[Outreach Sessions, Conferences and Seminars]{.underline}**

+---------------------+--------------------------------+---------------+
| **Location**        | **Host**                       | **Date**      |
+---------------------+--------------------------------+---------------+
| Basel, Switzerland  | Financial Stability Institute  | May 2000      |
|                     | (FSI) and Federal Deposit      |               |
|                     | Insurance Corporation          |               |
+---------------------+--------------------------------+---------------+
| Washington D.C.,    | The World Bank                 | June and      |
| United States       |                                | October 2000  |
|                     | Inter-American Development     |               |
|                     | Bank (IADB)                    | June 2000     |
+---------------------+--------------------------------+---------------+
| Cancun, Mexico      | Instituto para la Proteccion   | October 2000  |
|                     | al Ahorro Bancario (IPAB)      |               |
+---------------------+--------------------------------+---------------+
| Budapest, Hungary   | National Deposit Insurance     | November 2000 |
|                     | Fund of Hungary (NDIF),        |               |
|                     | European Bank for              |               |
|                     | Reconstruction and Development |               |
|                     | and FSI                        |               |
+---------------------+--------------------------------+---------------+
| Chicago, IL United  | Federal Reserve Bank of        | December 2000 |
| States              | Chicago                        |               |
+---------------------+--------------------------------+---------------+
| Kuala Lumpur,       | Philippine Deposit Insurance   | January 2001  |
| Malaysia            | Corporation, FSI and South     |               |
|                     | East Asian Central Banks       |               |
|                     | (SEACEN)                       |               |
+---------------------+--------------------------------+---------------+
| Berlin, Germany     | Federal Ministry of Finance,   | March 2001    |
|                     | Germany                        |               |
+---------------------+--------------------------------+---------------+
| Paris, France       | Organization for Economic      | March 2001    |
|                     | Cooperation and Development    |               |
|                     | (OECD)                         |               |
+---------------------+--------------------------------+---------------+
| Buenos Aires,       | Seguro de Depósitos Sociedad   | March 2001    |
| Argentina           | Anónima (SEDESA)               |               |
+---------------------+--------------------------------+---------------+
| Rome, Italy         | Banca d'Italia                 | April 2001    |
+---------------------+--------------------------------+---------------+
| Lusaka, Zambia      | Common Market for Eastern and  | April 2001    |
|                     | Southern Africa (COMESA)       |               |
+---------------------+--------------------------------+---------------+

3\. Business Plans

The focus for each subgroup was articulated in a business plan, which
outlined objectives, methodology, and methods for generating feedback.
The Web site, outreach sessions and the conferences were the main
vehicles that were used to implement the approach.

4\. Discussion Papers

The Working Group took a non-prescriptive approach to developing the
discussion papers on the guidance topics. The discussion papers drew on
existing academic research, examined the pertinent elements of effective
deposit insurance systems and explored the trade-offs and implications
associated with particular approaches to deposit insurance.

Copies of the discussion papers, a sample business plan and information
related to the outreach activities are included in Volume II to this
Report and can be downloaded from the following hyperlink
[http://www.cdic.ca/international](http://www.cdic.ca/international/international_description.cfm)[/]{.underline}

5\. Final Report -- Guidance on Deposit Insurance

The Working Group's activities culminated in this Final Report to the
Financial Stability Forum. It draws together the issues presented in the
discussion papers, and the views provided during the outreach sessions
and *via* the Web site.

The process used is shown below:

##### Annex III: Organisations that Assisted the Working Group

+----------------------------------+-----------------------------------+
| **[Outreach Sessions, Seminars   |                                   |
| and Conferences]{.underline}**   |                                   |
+----------------------------------+-----------------------------------+
| Asian Development Bank           | > Federal Reserve Bank of Chicago |
+----------------------------------+-----------------------------------+
| Banca d'Italia                   | > Financial Stability Institute   |
+----------------------------------+-----------------------------------+
| Bank for International           | > Instituto para la Proteccion al |
| Settlements                      | > Ahorro Bancario, Mexico         |
+----------------------------------+-----------------------------------+
| Canada Deposit Insurance         | > Inter-American Development Bank |
| Corporation                      |                                   |
+----------------------------------+-----------------------------------+
| Canadian Bureau for              | > National Deposit Insurance Fund |
| International Education          | > of Hungary                      |
+----------------------------------+-----------------------------------+
| The Canadian High Commission,    | > Organization for Economic       |
| Malaysia                         | > Cooperation and Development     |
+----------------------------------+-----------------------------------+
| Common Market for Eastern and    | > Philippine Deposit Insurance    |
| Southern Africa                  | > Corporation                     |
+----------------------------------+-----------------------------------+
| Embassy of Canada, Rome, Italy   | > Seguro de Depósitos Sociedad    |
|                                  | > Anónima, Argentina              |
+----------------------------------+-----------------------------------+
| European Bank for Reconstruction | > South East Asian Central Banks  |
| and Development                  |                                   |
+----------------------------------+-----------------------------------+
| Federal Deposit Insurance        | The World Bank                    |
| Corporation                      |                                   |
+----------------------------------+-----------------------------------+
| Federal Ministry of Finance,     |                                   |
| Germany                          |                                   |
+----------------------------------+-----------------------------------+

**[Participation at Outreach Session and
Conferences/Seminars]{.underline}**

***From Basel, Switzerland (May 2000) to Lusaka, Zambia (April 2001)***

  ----------------------- ----------------------- ------------------------
  Albania                 Hong Kong, SAR          Panama

  Algeria                 Hungary                 Paraguay

  Argentina               Iceland                 Peru

  Armenia                 India                   Philippines

  Austria                 Indonesia               Poland

  Azerbaijan              Iran                    Portugal

  Bahamas                 Ireland                 Romania

  Bahrain                 Isle of Man             Russian Federation

  Barbados                Israel                  Rwanda

  Belgium                 Italy                   Saudi Arabia

  Bolivia                 Jamaica                 Singapore

  Bosnia and Herzegovina  Japan                   Slovak Republic

  Botswana                Jersey                  Slovenia

  Brazil                  Jordan                  South Africa

  Bulgaria                Kazakhstan              Spain

  Burundi                 Kenya                   Sri Lanka

  Cambodia                Korea                   Sudan

  Canada                  Kuwait                  Swaziland

  Chile                   Kyrgyz Republic         Sweden

  China                   Latvia                  Switzerland

  Colombia                Lebanon                 Taiwan

  Congo                   Lithuania               Tajikistan

  Côte d'Ivoire           Luxembourg              Tanzania

  Croatia                 Macau, SAR              Thailand

  Cyprus                  Macedonia, Republic of  Trinidad & Tobago

  Czech Republic          Madagascar              Tunisia

  Denmark                 Malawi                  Turkey

  Egypt                   Malaysia                Turkmenistan

  El Salvador             Malta                   Uganda

  Eritrea                 Mauritius               Ukraine

  Estonia                 Mexico                  United Kingdom

  Ethiopia                Moldova, Republic of    United States of America

  European Commission     Mongolia                Uruguay

  Finland                 Morocco                 Uzbekistan

  France                  Mozambique              Venezuela

  Germany                 Namibia                 Vietnam

  Gibraltar               Netherlands Antilles    Yugoslavia

  Greece                  New Zealand             Zambia

  Guernsey                Norway                  Zimbabwe

  Haiti                   Oman, Sultanate of      
  ----------------------- ----------------------- ------------------------

##### Glossary of Terms

**adverse selection** - The tendency for higher-risk banks to opt for
deposit insurance and lower-risk banks to opt-out of deposit insurance
when membership in a deposit insurance system is voluntary.

**bank run** - A rapid loss of deposits precipitated by fear on the part
of the public that a bank may fail and depositors may suffer losses.

**benchmark** - A standard or guideline to which other items or
processes can be compared.

**blanket guarantee** - A declaration by the government that all
deposits and perhaps other financial instruments will be protected.

**bridge bank** - A temporary bank established and operated to acquire
the assets and assume the liabilities of a failed institution until
final resolution can be accomplished.

**coinsurance** - An arrangement whereby depositors are insured for a
pre-specified portion, less than 100 percent of their deposits.

**collateralisation -** The taking of a mortgage, pledge, charge or
other form of security by a creditor over one or more assets of a
debtor.

**contagion** - The spread of an individual bank run to several other
financial institutions.

**corporate governance** - The processes, structures, and information
used for directing and overseeing the management of an organisation.

**depositor priority** - The granting of preferential treatment to
depositors such that their claims must be paid in full before remaining
creditors can collect on their claims.

**differential premium/risk-adjusted differential premium** - A levy on
a bank assessed on the basis of that bank's risk profile.

**disclosure** - A fact, condition, or description that is revealed
clearly and publicly.

***ex-ante* funding** - The accumulation of a fund to cover deposit
insurance claims in anticipation of the failure of a member bank.

***ex-post* funding** - An assessment levied after the failure of a
member bank to provide funds to cover deposit insurance claims.

**financial safety net** - Usually comprises the deposit insurance
function, prudential regulation and supervision, and the
lender-of-last-resort function.

**forbearance** - To grant an extension of time to certain distressed
banks from minimum regulatory requirements.

**foreign bank --** A foreign-bank subsidiary is incorporated as a
separate entity in the host country. A foreign-bank branch, on the other
hand, is an extension of the foreign bank itself into a host country.
Foreign-bank branches and subsidiaries may be subject to different rules
and supervised differently by a host country.

**least-cost resolution** - A procedure that requires the deposit
insurer or other designated entity to implement the resolution
alternative that is determined to be less costly to the system than all
other resolution alternatives, including the liquidation of the failed
bank.

**lender-of-last-resort function** - The provision of liquidity to the
financial system by a central bank.

**limited-coverage deposit insurance -** A guarantee that the principal
and the interest accrued on protected deposit accounts will be paid up
to a specified limit.

**mandate** - A mandate is a set of official instructions or statement
of purpose of a firm.

**market discipline** - A situation where depositors or creditors assess
the risk characteristics of a bank and act upon such assessments to
deposit or withdraw funds from a bank.

**moral hazard** - The incentive for additional risk taking that is
often present in insurance contracts and arises from the fact that
parties to the contract are protected against loss.

**netting/netting arrangements** -- This refers to the reduction of an
accountholder\'s insured deposits by the amount of outstanding loans in
a failed institution or the reduction of an accountholder\'s outstanding
loans by the amount of deposits above the coverage limit.

**open-bank assistance** - A resolution method in which an insured bank
in danger of failing receives assistance in the form of a direct loan,
an assisted merger, or a purchase of assets.

**paybox** - A deposit insurer with powers limited to paying off the
claims of depositors.

**purchase-and-assumption transaction (sales)** - A resolution method in
which a healthy bank or group of investors assume some or all of the
obligations, and purchase some or all of the assets of the failed bank.

**receiver** - The legal entity that undertakes the winding down of the
affairs of an insolvent bank.

**recovery** - The amount of net collections of a bank's assets.

**regulatory discipline** - Governs the establishment of new banks;
qualifications of directors and managers; business activities; change of
control; and standards for risk-management, internal controls, and
external audits.

**risk minimiser** -- A deposit insurer with the powers to reduce the
risks it faces. These powers may include the ability to control entry
and exit from the deposit insurance system, assess and manage its own
risks and may conduct examinations of banks, or request such
examinations.

**set-off** - Rrefers to situations where the claim of a creditor in an
insolvent bank (for example, a deposit) is deducted from a claim of the
bank against the creditor (for example, a loan).

**situational analysis --** An examination that policymakers undertake
to assess factors such as: the state of the economy; current monetary
and fiscal policies; the state and structure of the banking system;
public attitudes and expectations; the state of the legal, prudential
regulatory and supervisory; accounting and disclosure regimes.

**supervisory discipline** - Requires that banks are monitored for
safety and soundness as well as compliance issues and that corrective
actions are taken promptly, including the closure of a bank when
necessary.

**suspense account --** A suspense account is used when not enough
information is available to post a transaction with the right offset.
For example, dividends and interest are "paid" to a trust account on
their payable date even if all of the money from depositors and paying
agents is not received on time.

**systemic risk** -- A risk that has implications for the general health
of the financial system and can have serious adverse implications for
financial stability and overall economic conditions.

[^1]: The Working Group was comprised of representatives from Argentina,
    Canada, Chile, France, Germany, Hungary, Italy, Jamaica, Japan,
    Mexico, Philippines, the United States of America, the World Bank
    and the International Monetary Fund (cf Annex I). The approach that
    the Working Group used to develop discussion papers on the guidance
    topics and the techniques used in the outreach activities are set
    out in Annex II. Annex III contains the organisations and countries
    involved in the outreach sessions, seminars and conferences. A
    glossary of terms used in this report can be found at the end of
    this document. A separate volume to this report (Volume II), which
    can be downloaded from the the Internat at the following Web site
    address (www.cdic.ca/international),includes the research plan, the
    discussion papers on the 16 guidance topics, a bibliography and
    additional information on the outreach activities.

[^2]: Readers should consult the discussion papers for a more in-depth
    examination of the topics presented in this report.

[^3]: In some countries the deposit insurer may have significant legal
    exposure to dissatisfied creditors.

[^4]: After a troubled bank has been closed, the responsible entity
    effectively inherits the bank's assets and liabilities. The
    remaining tasks in winding up the affairs of the bank are the
    management and liquidation of its assets and settlement of
    *bona-fide* claims. The ability to accomplish these tasks
    effectively is an essential part of a country's financial safety
    net. There is considerable variation in the claims-and-recoveries
    roles played by deposit insurers and other safety-net participants.
    Where deposit insurance payments are made upon the liquidation of a
    bank, the deposit insurer usually is subrogated to the rights of the
    insured depositors, and is likely to file and actively manage the
    claim arising from the deposit insurance payment. In some instances,
    deposit insurers have significant roles in the risk-minimisation or
    recovery processes, for example as a lender, creditor, or possibly
    receiver. In other cases, these functions are the responsibility of
    other entities.