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Resilience of the EU financial sector in the global context - Towards a EU DGS?

EDIS as a two tier Reinsurance system could provide an additional backstop

By Nowotny Ewald - Governor, Oesterreichische Nationalbank


Based on the five Presidents Report the European Commission proposed in November 2015 an innovative three stage approach for a fully-fledged European Deposit Guarantee Scheme (EDIS) from 2024 onwards together with the implementation of risk reducing measures. The call for deeper integration by strengthening the third pillar is a coherent step towards completing the banking union. However, the initiative comes at a time when Member States are still in the process of transposing or just have transposed the new Deposit Guarantee Scheme Directive (DGSD) into national law. By requiring the establishment of ex-ante financed systems and a shortening of the payout period the DGSD comprises key aspects to increase depositor confidence and to minimize procyclical effects.

In addition to its three-step approach – (i) re-insurance (ii) co-insurance and (iii) full insurance – EDIS provides for appropriate safeguards to ensure an effective implementation of the DGSD and was accompanied by a general communication that emphasizes the need for further measures to reduce remaining financial stability risks in the Banking Union. To break the bank-sovereign link both elements – the establishment of EDIS and risk reduction – need to proceed in parallel. Thus the level of integration and the transition from one EDIS-phase to the other should depend on the progress made in the area of risk reduction. In order to foster trust in the deposit guarantee system, we have to make sure that the risks in the banking system in combination with the corresponding crisis management tools are in line with the target level of the deposit guarantee fund.

The third EDIS phase of full insurance means full integration and risk sharing. The existing “polluter pays principle” would be set aside since the affected national deposit guarantee scheme (DGS) would not remain the first line of defense. As a precondition to depart from this principle it should be required that risks within the national banking sectors are aligned. To achieve this risk reducing measures, in particular harmonization of national options and discretions under the CRR/CRD, the BRRD and of national deposit guarantee schemes and convergence in insolvency laws should be implemented.

The level of integration should depend on the progress of risk reduction.

A true reinsurance approach could be a sustainable interim solution until the preconditions have been fulfilled. As a compromise it would be thinkable to establish EDIS as a two-tier re-insurance system with a sequencing financing structure that reduces moral hazard risk at the national level by depleting national funds first. The affected national DGS would have to use its available ex-ante financial means and to collect ex-post contributions up to the limit foreseen in the DGSD before having access to the European re-insurance system. This system would then cover remaining liquidity needs for which the financial means of the primarily affected national DGS are insufficient and any excess loss that may arise. This would increase the level of depositor confidence in a bank and ensure timely payout thereby offering protection against large local shocks which could overburden national DGS. The European re-insurance system could be designed to achieve cost-neutrality and does not need to build up its own financial means.

The Single Resolution Board (SRB) could act as administrator of such an interim solution. In a shortfall case it would calculate the contributions needed from all other national DGS and request an ad hoc transfer. Depending on the intended total cost bearing capacity of the European re-insurance system, a transfer limit could be foreseen. Compared to the first step of the EDIS approach within the two-tier re-insurance system funding would remain national and only the payouts are centrally organized without a fixed cap.

Looking ahead every European system of deposit insurance independently of the target level and the agreed design would benefit from an additional European backstop to strengthen depositor confidence even in times of systemic crisis.