CROSS-BORDER AND REGIONAL ISSUES

Abstract

In general, relevant laws, regulations, and other provisions applicable
to banks, their customers, and deposit insurers, are that of the bank's
country of charter or incorporation. Circumstances change if a bank
operates branches in other jurisdictions, or provides services on a
cross-border basis to customers located abroad. Depending on the volume
of these activities, the implementation of appropriately adapted
policies by home- and host-country deposit protection schemes can be
crucial for the effective operation of deposit protection arrangements
and for the achievement of public-policy goals.

Issues that require particular consideration from a cross-border and
regional perspective are: membership, coverage, funding,
interrelationships between safety-net participants and, in the case of
failures, the process of reimbursing depositors and the recovery of
assets. This paper identifies relevant cross-border and regional issues
from the perspective of deposit protection, and will examine the
trade-offs associated with a variety of approaches. It also includes
considerations with regard to the process of accession to the European
Union (EU) by candidate countries.

CROSS-BORDER AND REGIONAL ISSUES

In general, relevant laws, regulations, and other provisions applicable
to banks, their customers, and deposit insurers, are that of the bank's
country of charter or incorporation. Circumstances change if a bank
operates branches in other jurisdictions, or provides services on a
cross-border basis to customers located abroad. Depending on the volume
of these activities, the implementation of appropriately adapted
policies by home- and host-country deposit protection schemes can be
crucial for the effective operation of deposit protection arrangements
and for the achievement of public-policy goals.[^1]

Issues that require particular consideration from a cross-border and
regional perspective are: membership, coverage, funding,
interrelationships between safety-net participants and, in the case of
failures, the process of reimbursing depositors and the recovery of
assets. This paper identifies relevant cross-border and regional issues
from the perspective of deposit protection, and will examine the
trade-offs associated with a variety of approaches. It also includes
considerations with regard to the process of accession to the European
Union (EU) by candidate countries.[^2]

In most countries, deposit taking is primarily a domestic business.
However, cross-border aspects of this business are increasing in many
jurisdictions (for example, e-finance developments). In some countries,
cross-border aspects play a considerable role in the design of deposit
insurance arrangements. This is the case, for example, if a banking
system is characterised by a strong presence of foreign-bank branches.
In weak banking systems, especially after a crisis, the outflow of
deposits to foreign countries may have to be taken into account when
establishing or reforming deposit insurance arrangements. Special
considerations may apply in regions where economies are closely
related---for example, North America---or closely integrated---for
example, the EU.

The considerations presented in this paper regarding cross-border claims
and recoveries of foreign branches also are applicable to domestic banks
with foreign subsidiaries and domestically chartered foreign-bank
subsidiaries, but these are not the focus of this paper.[^3]

# Membership Issues

Policy approaches with regard to the membership of banks from foreign
countries in deposit protection schemes vary widely. Foreign branches
could be included in or excluded from a host-country deposit protection
scheme. Host countries also could choose to prohibit foreign branches
from accepting deposits that are covered by the host-country deposit
protection scheme unless the branches participate in this scheme and
comply with entry criteria. Another approach is to waive or limit
protection to supplementary coverage in circumstances where the deposit
protection scheme of the bank's home country is recognised by the host
country. Finally, countries may require banks from foreign jurisdictions
to set up legally separate subsidiaries if they wish to accept covered
deposits.

It may not be necessary to include foreign-bank branches in host-country
deposit protection schemes to achieve public-policy objectives when
foreign banks play a limited role in a country's financial system.
Excluding foreign-bank branches may facilitate the administration of the
scheme and prevent it from covering deposits at banks that it may not be
able to supervise adequately. A drawback of this policy is that consumer
protection may be weakened because depositors may be uncertain about the
coverage provided for their deposits.

Some countries choose to include all foreign branches in their deposit
insurance scheme. In countries where foreign-bank branches have a large
market share, the inclusion of foreign branches may be considered
necessary to achieve stated public-policy objectives. The mandatory
inclusion of foreign branches in the host-country deposit protection
scheme ensures that all eligible depositors benefit from deposit
protection. However, this strategy could threaten the viability of the
host-country deposit protection system, if the respective bank and its
foreign branches are not subject to an adequate supervisory regime. To
ensure adequate supervision and the financial strength of foreign
branches, supervisors may require foreign banks to pledge assets as a
capital substitute, and to conform with capital adequacy and other
regulatory requirements of the host country.

If special membership or entry criteria for deposit protection schemes
exist, foreign branches should comply with them in order to preserve the
financial strength of the system and competitive equity. Accession
criteria could include supervisory capacity to carry out audits at the
branch- or head-office level, and the possibility of receiving
information from the head office or the home country's supervisor.

It may be appropriate to recognise the coverage already provided through
membership in a home-country scheme, if this scheme also covers deposits
collected by foreign branches. In such cases, the relevant host-country
authorities (generally banking supervisors) would have to be informed
about the level of coverage provided by the branch's home-country scheme
during the licensing or chartering process, if the coverage of deposits
is mandatory. Authorities should be given the ability to not recognise
the branch's home-country deposit protection scheme, if they conclude
that the protection policies of the home-country scheme are inadequate.

Membership in a deposit insurance scheme for banks that only collect
deposits directly from customers abroad without having established a
branch or a subsidiary (that is, a physical presence) in the foreign
jurisdiction generally is not appropriate. Cross-border deposits
generally are protected by the bank's home-country scheme (in cases
where one exists), since deposits are booked in the home country where
the bank is physically located and licensed to operate. In all cases,
depositors should be appropriately informed of whether the home-country
deposit protection scheme, the host-country deposit protection scheme or
a combination of both is applied.

# Coverage Issues

Deposits that are collected by a bank directly from depositors in other
countries (for example, *via* the Internet) may or may not be covered by
the bank's deposit protection scheme. If a bank has established a branch
in a foreign country, a wide spectrum of coverage arrangements for the
branch's deposits may apply.

The coverage of deposits of foreign branches that only participate in
the host-country deposit protection scheme is, in general, determined
according to that scheme's regulations. This does not rule out that the
scope and level of coverage may be fixed with a view to the coverage
provided in other countries, so that, in addition to domestic factors,
external aspects are taken into account. Coverage that is comparable to
that in competitor countries may be one element of an overall strategy
to strengthen the financial system and to stop the outflow of deposits,
especially in weak banking systems and banking systems that have
experienced a recent crisis. However, it is important to avoid a
competitive process by which national deposit insurance schemes adapt to
the ones with the most encompassing features and the lowest premiums or
levies without taking due regard of the country's domestic situation.
Such a process may have negative implications for the viability of the
protection scheme and could jeopardise financial stability.

The determination of an appropriate coverage policy could become more
complex if the bank's home-country scheme also covers deposits raised by
foreign branches in foreign jurisdictions. The coverage of deposits at
foreign branches may be appropriate because the branch is a legal part
of the bank and its solvency and liquidity cannot be separated from the
soundness of the bank itself. Furthermore, domestic customers of the
bank doing business with its foreign branches might expect to be
protected in the same manner as that provided when they deal with the
bank's head office. If the coverage of the home-country scheme is lower
or less encompassing than the coverage provided by the host-country
scheme, the branch could be given the opportunity to top-up the
home-country coverage; this supplementary coverage could be provided by
the home- or by the host-country deposit protection scheme. On the other
hand, if the coverage of the home-country scheme of the branch is higher
or of broader scope, the branch's customers would benefit from
more-encompassing protection than that provided by the host-country
scheme. Limitations may run counter to policies that allow free
provision of financial services on a cross-border basis.

If a branch that already benefits from coverage by its home-country
scheme is obliged, or granted the right, to join a host-country scheme,
care should be taken to ensure that insured deposits are not covered
twice. This might require appropriate provisions in contracts, statutes
and laws, and possibly mutual agreements between the deposit protection
schemes concerned.

In the EU, the home-country deposit protection scheme of a bank also
covers deposits of the bank's branches in other EU jurisdictions
according to the deposit protection directive.[^4] This directive
specifies minimum features for deposit protection schemes in member
countries and supplements the overall harmonisation of banking
supervisory regulations in the EU. As the minimum coverage in the EU
already is provided by the branch's home-country scheme, the branch
cannot be obliged to join the host-country deposit protection scheme. If
the coverage of a host-country deposit protection scheme is higher or of
broader scope, branches may choose supplementary coverage by this
scheme, provided that they accept the membership conditions of the
host-country scheme.

For candidate countries preparing for accession to the EU, transitional
arrangements with lower initial coverage are under consideration. With
lower initial coverage there may be a risk that if an accession country
were allowed to export its lower deposit guarantee coverage to another
member state with higher coverage, depositors could be insufficiently
protected. To solve this problem, branches of banks from accession
countries could be requested by the host country to top-up to the
minimum level of the home-country scheme during the transition period.
This arrangement could be a safety device to ensure that an adequate,
minimum deposit guarantee level is offered in all member states.

On the other hand, there may be requests for a limited export
prohibition ban in the EU toward certain accession countries. This means
that an accession country may request EU branches operating in its
territory to not exceed the lower initial minimum EU deposit guarantee
during the transitional period. Implementation of this approach could be
difficult if the transitional export ban would have to be altered by
amending the law in the branch's home-member state. Furthermore, it
should be taken into account that the freedom of establishment only may
be restricted in the EU for a limited period and on exceptional grounds.

## Funding Issues

If deposits at foreign branches are covered by the bank's home-country
deposit protection scheme, the same funding mechanisms as for the head
office of the bank could apply to its foreign branches. If deposits at
foreign branches are not covered by the bank's home-country scheme, but
the foreign branch belongs to the deposit protection scheme of the host
country, the branch could be considered for funding purposes as a
separate legal entity; levies or premiums could be collected according
to balance-sheet data, the level of business and deposits, or other
relevant branch-specific information. Special adaptations could be
necessary if premiums are assessed *ex-ante* on a differential
(risk-adjusted) basis. As the financial condition of the branch can not
be separated from the situation of its head office, in principle the
risk profile of the whole bank would have be taken into account for the
calculation of differential levies and premiums. If there is a lack of
adequate data for a differential premium system, the branch could be
assessed under criteria consistent with that applied to domestic banks.
This could be an appropriate approach if the branch is required to have
endowment capital or to pledge assets as a substitute for its own funds.

More-complex approaches may be necessary if the basic coverage of the
bank's head office is provided by the home-country scheme, and
supplementary coverage would be granted by a host-country scheme. In
this case, the calculation of funding requirements for the supplementary
coverage often could not follow the standard approach for domestic
banks. It could be necessary to develop special funding formulas for
supplementary coverage, possibly adapted to the financing approach of
the home-country scheme (especially *ex-post* or *ex-ante* financing;
flat-rate or differential (risk-adjusted) premiums). Regardless of the
concrete formula developed, the protection already provided by the
home-country scheme should be recognised in the determination of levies
and premiums to avoid double charging.

# Interrelationship Issues

Cross-border deposit taking may require close interrelationships among
safety-net participants in different jurisdictions. In general,
information received by safety-net participants in other jurisdictions
should be subject to strict confidentiality rules that comply with
international standards and that are not more lenient than the rules for
information received by other domestic safety-net participants. If this
is assured, all relevant information could be exchanged between deposit
insurers in different jurisdictions. In addition, it may be helpful if
deposit insurers were able to benefit from information channels
established between supervisory authorities in different jurisdictions.
Relevant information concerning banks and branches in other countries
could, where appropriate, be requested by contacting the deposit
insurer. In some cases, it also could be useful to exchange information
directly between deposit insurers and other safety-net participants in
foreign jurisdictions. In any case, foreign deposit insurers should
receive all information necessary to enable a prompt reimbursement of
depositors.

If a foreign branch belongs to the deposit protection scheme of the host
country---possibly only for supplementary coverage---it could be
appropriate to establish information channels between this scheme and
the home-country deposit protection scheme. If the host-country scheme
is a risk minimiser, and has the power to audit banks belonging to its
scheme, including foreign branches, it may detect facts that also are
material from a supervisory point of view. Such information could be
made available to the supervisory authority, even if it is located in a
different jurisdiction under information-sharing agreements. To fulfil
its task as a risk minimiser, it also may be appropriate for the deposit
insurer to require the provision of relevant information concerning the
whole bank and to verify such information with the home country's
supervisory authority. [^5] If a crisis occurs at the bank or the
branch, the information sharing between safety-net participants also
could include the host-country deposit insurer. In any case, the
host-country deposit insurer should be informed early when a bank fails.

If the foreign branch belongs to the host-country deposit protection
scheme only for supplementary coverage, while basic coverage is provided
by the home-country deposit protection scheme, regular contacts between
the home- and the host-country deposit protection scheme also might be
useful. Close cooperation may be necessary during the reimbursement
process after a failure has occurred. Moreover, if bankruptcy
proceedings were to be initiated, all relevant deposit insurers would
have to be informed immediately about the closure of the bank, including
its foreign branches.

Also in the case of the accumulation of cross-border deposits without
the establishment of a branch, communication between the home-country
deposit insurer and the supervisory authority of the depositors
jurisdiction may be appropriate. This issue could be especially
important in a crisis, if the bank has a strong position in the foreign
market.

# Claims and Recovery Issues

In general, the determination of claims and the recovery of assets are
more complex for foreign branches than for domestic banks. As foreign
branches are a legal part of a bank chartered in a different
jurisdiction, cross-border transfers of assets and liabilities can be
easily executed and occur during the normal course of a bank's business.
If such a bank fails, and deposits at foreign branches have to be
reimbursed by the relevant home- or host-country deposit protection
scheme, the proper recognition of rights of set-off and collateral
arrangements may complicate the determination of the depositors' claims.
Furthermore, subrogation may imply that assets have to be recovered by
the deposit protection scheme in foreign jurisdictions. The issue
becomes even more complex when the branch's home-country deposit
protection scheme provides the basic coverage and the host-country
scheme provides supplementary coverage.

Deposit protection schemes should analyse cross-border legal issues and
develop solutions from a cost-benefit perspective for potentially major
legal disputes before failures occur. In some cases, memoranda of
understanding between deposit protection schemes might contribute to the
resolution of complex legal issues related to bank failures. Deposit
protection schemes should have quick access to legal advice and try to
avoid unresolved legal issues and disputes, which may lead to delays in
the reimbursement of depositors.

# Conclusions

Funds collected from depositors located in other countries where a bank
has not established a branch or subsidiary normally are covered by the
deposit protection scheme of the bank's home country. Deposits at
foreign branches may be protected by the bank's home-country deposit
protection scheme, by the host-country protection scheme, a combination
of both schemes, or not protected at all. In the case where protection
is provided by both the home- and host-country protection schemes, the
home-country scheme may provide basic coverage that is supplemented by
the host country. Foreign branches participating in a host-country
deposit protection scheme should conform to the membership criteria of
the host-country scheme, which may possibly include the application of
supervisory requirements on a stand-alone basis. If the host-country
scheme provides supplementary coverage, double reimbursement of insured
depositors should be avoided. The protection already provided by the
home-country scheme should be recognised 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 by other domestic safety-net
participants. Confidentiality rules should comply with international
standards. If this is assured, 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, foreign deposit insurers
should receive all information necessary to enable a prompt
reimbursement of depositors.

[^1]: This paper represents the work of the Subgroup on Cross-Border and
    Regional Issues. The Subgroup is comprised of representatives from
    Germany (coordinator), Canada, Hungary, Mexico and the United
    States. For the purposes of this paper, the home country is the
    jurisdiction of the bank's head office; the host country is the
    jurisdiction where the foreign branch is located.

[^2]: The EU minimum requirements for deposit insurance and other
    regulatory aspects are harmonised and the responsibilities for
    deposit protection lie primarily with the home country.

[^3]: A bank's foreign subsidiary is in general separately chartered,
    and supervised in the same way as domestic banks. The only
    differences are that its shareholder is a bank located in a
    different country and that the parent bank should be subject to
    consolidated supervision by the parent bank's supervisory authority.
    For deposit protection purposes, the subsidiary is treated like
    domestic banks. Cross-border issues arise if the subsidiary has
    transferred assets and liabilities to foreign jurisdictions or
    otherwise established business relationships, for example in
    derivative markets, that may produce claims and obligations with
    counter parties in other countries.

[^4]: The EU Directive on Deposit Guarantee Schemes (Directive
    94/19/EEC) is available in the Internet under the following address:
    [http://europa.eu.int/eur-lex/en/lif/dat/1994/en_394L0019.html]{.underline}

[^5]: See Annex II (a) of the EU Directive on Deposit-Guarantee Schemes
    (Directive 94/19/EC).