A success story Deposit Guarantee Schemes (DGSs) have a proven track record of protecting depositors and enhancing financial stability, and are a cornerstone for European citizens’ trust in banking systems. The evolution of their regulatory framework has fostered this success. The European Directive on DGSs (DGSD) established a first set of common provisions for DGSs in the EU in 1994. Following the Great Financial Crisis, the framework has further evolved with a revision of the DGSD, finalised in 2014. This review further harmonised rules for the national DGSs. It enhanced DGSs’ financial resources as well as their functions, reinforcing depositor confidence.
In parallel, the Bank Recovery and Resolution Directive (BRRD) introduced an entirely new common framework for resolution across the EU, notably linking resolution to DGSs. These two frameworks complement each other. The resolution framework is designed to deal with larger banks’ crises, lowering the pressure on DGSs, and reducing the likelihood that a DGS is actually used. At the same time, an efficient liquidation framework, dealing with smaller lenders, allows resolution authorities to focus their resources on the most significant institutions. Still, pay-outs for small bank failures can prove very costly, potentially depleting DGS resources. Beyond pay-outs While the role of deposit guarantee schemes in the EU has evolved over the past 30 years, their core function has remained protecting depositors through pay-outs. These are performed when a failing bank is wound up to reimburse its covered depositors. Beyond this function, DGSD provides the possibility for DGSs to intervene to prevent failures through preventive measures (support provided to avoid the failure) or, in the context of liquidation, alternative measures (the transfer of the deposit book, as an alternative to pay-out). These measures can be implemented only if they comply with the least-cost test. So far, only 12 EU Member States – including Poland – have included such alternative measures in their DGSs’ toolkits, and very few have used them in practice. In 2022, Polish authorities clearly demonstrated the importance of these tools when dealing with the crisis of Getin Noble Bank, the 10th largest bank in Poland at the time.
A broader safety-net DGSs, as safety-net providers, should have a larger role in facilitating bank resolution and shield depositors from losses. In fact, the applicable legislation also allows EU resolution authorities to use DGS funds in resolution, under certain conditions. But in reality, the DGS’ super priority in the creditor hierarchy means the outcome of the required least-cost test always tilts towards pay-out, limiting the use of DGS funds in resolution. To address this and other issues of the current legislative framework, in 2023, the European Commission brought forward a set of proposals, known as the Crisis Management and Deposit Insurance (CMDI) review. The core of the reform aims to ensure that the resolution toolkit can be applied to any bank whose failure would put financial stability at risk, regardless of size or business model, enabling its orderly exit from the market through a sale of business, including its uncovered deposits. The proposal provides more optionality for DGS and resolution authorities in managing crises in smaller banks. The CMDI review makes the use of DGS and resolution funds, instead of depositors’ money, more realistic through the so-called DGS bridge. This funding would help sell an ailing bank, including its deposit book, to a solid acquirer. As set out in a SRB staff working paper assessing the European Commission’s proposals, the changes proposed are expected to have a limited impact on DGS resources. This is mostly driven by the fact that the banks expected to be resolved with the support of DGS are relatively small in size, and the DGS would step in only after equity and debt instruments (as part of MREL) have contributed to loss absorption and recapitalisation.
Europe is not alone seeking a more prominent role for DGSs in resolution. As recently observed by the International Association of Deposit Insurers, the past decade has witnessed an increasing use of deposit insurers in funding bank resolution. In the United States, resolution funds and deposit insurance funds have long been integrated. The Federal Deposit Insurance Corporation extensively used funds to handle the failure of institutions since the beginning of the Great Financial Crisis. Closer to home, UK policy-makers are also working on a reform that enables Bank of England to use DGS funds to finance the resolution of failing small banking institutions.8 Conclusions DGSs have proved that they can be very effective in contributing to ensuring financial stability, also assuming functions beyond the pure insurance or payout of deposits in liquidation. Now it is time for a further evolution – not a revolution – of the DGSs’ function in Europe. An enhanced role of DGS funds in resolution, as proposed in CMDI, would provide a broader and more robust safety-net to our banking sector. A better crisis management toolkit, especially one that further protects depositors, would in turn increase European citizens’ trust in the financial system.