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Session II. Funding and Coverage Limit

Session II. Funding and Coverage Limit. Coverage Limits Jorge A. Chávez Presa Board of Directors 18-20 November Amman, Jordan. Overview. Some background The rule of coverage limits Coverage limits and cross border issues Transitioning: Mexico’s case Final remarks. Some background.

JasminFlorian
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Session II. Funding and Coverage Limit

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  1. Session II. Funding and Coverage Limit Coverage Limits Jorge A. Chávez Presa Board of Directors 18-20 November Amman, Jordan

  2. Overview • Some background • The rule of coverage limits • Coverage limits and cross border issues • Transitioning: Mexico’s case • Final remarks

  3. Some background • Theoretical framework (moral hazard – market discipline) • Core principles. Principle 9 – Coverage. • Deposit Insurance Coverage Discussion Paper

  4. 1. Some Background • Theoretical framework(moral hazard -market discipline) • Limit insurance since: • Source of moral hazard • A cost for depositors and taxpayers • To encourage market discipline • Without a limit, depositors would seek the highest return regardless of risk level and banks would invest in financial instruments with higher risk • Maximize return by risking the most • Moral hazard can be limited by offering partial insurance (align incentives)

  5. 1. Some Background • Theoretical framework (moral hazard – market discipline) • When facing a serious financial crisis, it is common for financial authorities to apply an explicit full coverage or even a blanket guarantee in order to calm down financial markets • In the event that a bank has liquidity problems, it represents a high cost for depositors not to access their deposits. Hence, they try to anticipate the behavior of other depositors, withdraw their deposits and seek a better bank or start hoarding cash. • Experience has demonstrated that limited insurance is not sufficient to protect banks from runs in a weakened financial system

  6. 1. Some Background • Core principles. Principle 9 – Coverage • examination of relevant data • credible and internally consistent • cover the large majority of depositors • public-policy objectives • adjusted periodically

  7. 1. Some Background • Deposit Insurance CoverageDiscussion Paper This paper gives a guidance to: • the determination of the level and scope of deposit insurance coverage • The setting of coverage level • Adjustment of coverage limits • Cross border issues • Coverage of retirement and pension funds • The emergence of new financial instruments, and • The importance of effective communication of deposit insurance coverage is also stressed

  8. 1. Some Background • Deposit Insurance CoverageDiscussion Paper Coverage is a fundamental issue in designing a deposit insurance system Coverage can be classified in: Eligibility of deposit instruments Scope Amount of deposits to be covered (coverage limit) Level

  9. The rule of coverage limits • Importance of setting the coverage limit right • How to set it? • What is the optimal coverage? • Constraints that Mexico considered to set coverage limits • What are the consequences of exceeding the coverage limit?

  10. The rule of coverage limits • Importance of setting the coverage limit right • Financial stability • Moral hazard • Market discipline Coverage limit

  11. The rule of coverage limits • How to set it? Start by considering reality • Policymakers must gather data on the financial instruments held by the population • Number of accounts, and • Size distribution • These data will allow policymakers to determine what proportion of accounts and total deposits would be covered at various levels

  12. The rule of coverage limits • How to set it? • One that covers a proportion of depositors and deposits beyond which the benefits accruable to a small number of depositors are negligible Appropriate coverage limit • A limit that covers at least 80% of depositors and 20% – 40% of total deposits* • Accounts • Amounts * Rule of thumb accepted at the First Annual Conference of the International Association of Deposit Insuresrs in Basel, Switzerland, May 2002.

  13. The rule of coverage limits • What is the optimal coverage? If the objective is: • High or relatively generous coverage limits are an attractive option • To ensure banking stability Regulation and Oversight • To protect small depositors and reduce moral hazard • Low or less generous coverage limits are preferred

  14. The rule of coverage limits • Constraints that Mexico considered to set coverage limits • Conditions of the financial system • Flow of funds among countries (Mexico – US) • Financial - legal framework • Political conditions • A small number of accounts contain a large amount

  15. The rule of coverage limits • What are the consequences of exceeding the coverage limit? Full protection to both depositors and creditors • Erodes market discipline • Heightens moral hazard Blanket coverage Protect all depositors 100% Fullcoverage

  16. Coverage limits and cross border issues

  17. Coverage limits and cross border issues • In Mexico the definition of coverage limits had to consider: • Trading partner and neighbor • Convergence of banking and financial markets • In 2005, Mexico reached a coverage limit of 400,000 UDIs.

  18. Coverage limits and cross border issues • Your neighbor matters

  19. Transitioning: Mexico’s case • Antecedents • Transition Program of the coverage of guaranteed obligations • Types of banking guaranteed deposits in Mexico • Data of banking guaranteed deposits in Mexico • Number of accounts, amounts for coverage and accumulated percentages • Number of accounts and deposits (Mexican Financial System)

  20. Transitioning: Mexico’s case • Number of accounts and amounts for coverage (Banks A and B) • Accumulated percentages number of accounts and amounts for coverage (Banks A and B) • Sight and time accounts (Banks A and B) • Sight and Time deposits (Banks A and B) • Annually average total current income per household by deciles of households (2008) • Deposit Insurance Coverage 2008-2009

  21. Transitioning: Mexico’s case • Antecedents • Meltdown of the financial system • Re-privatization of the banking system (in order to capitalize banks) • Government assumed banks’ losses(toxic assets) • Updating the financial regulatory framework • Early corrective measures (first stage) • Bank liquidation (second stage) • Bankruptcy (third stage)

  22. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Derivatives on Shares and metals Derivatives in well-known Stock exchanges and capitalization instruments Guarantee deposits, tax collection, payments to the TESOFE and securities liquidation accounts Coverage Obligations held by full service banking institutions, except: subordinate obligations, interbank loans, Obligations on behalf of intermediaries of their own financial groups, unlawful transactions, and obligations with related parties Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 I

  23. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Derivatives in well-known Stock exchanges and capitalization instruments Guarantee deposits, tax collection, payments to the TESOFE and securities liquidation accounts Coverage Obligations held by full service banking institutions, except: subordinate obligations, interbank loans, Obligations on behalf of intermediaries of their own financial groups, unlawful transactions, and obligations with related parties Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 II I

  24. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Guarantee deposits, tax collection, payments to the TESOFE and securities liquidation accounts Coverage Obligations held by full service banking institutions, except: subordinate obligations, interbank loans, Obligations on behalf of intermediaries of their own financial groups, unlawful transactions, and obligations with related parties Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 1-January-01 II III I

  25. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Coverage Obligations held by full service banking institutions, except: subordinate obligations, interbank loans, Obligations on behalf of intermediaries of their own financial groups, unlawful transactions, and obligations with related parties Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 1-January-01 1-January-02 II III IV I

  26. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Coverage Up to 10 million UDIS Obligations held by full service banking institutions, except: subordinate obligations, interbank loans, Obligations on behalf of intermediaries of their own financial groups, unlawful transactions, and obligations with related parties Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 1-January-01 1-January-02 1-January-03 II III IV V I

  27. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Coverage Up to 5 million UDIS Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 1-January-01 1-January-02 1-January-03 1-January-04 II III IV V VI I

  28. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Coverage Up to 5 million UDIS Up to 400,000 UDIS 3_/ Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 1-January-01 1-January-02 1-January-03 1-January-04 1-January-05

  29. Transitioning: Mexico’s case • Transition Program of the coverage of guaranteed obligations1_/ Derivatives on Shares and metals Derivatives in well-known Stock exchanges and capitalization instruments Guarantee deposits, tax collection, payments to the TESOFE and securities liquidation accounts Coverage Up to 10 million UDIS Obligations held by full service banking institutions, except: subordinate obligations, interbank loans, Obligations on behalf of intermediaries of their own financial groups, unlawful transactions, and obligations with related parties Up to 5 million UDIS Up to 400,000 UDIS 3_/ Deposits, loans and credits mentioned in Article 46, Sections I and II of the Law of Credit Institutions 1-June-99 1-January-00 1-January-01 1-January-02 1-January-03 1-January-04 1-January-05

  30. Transitioning: Mexico’s case • Types of banking guaranteed deposits in Mexico • Banking monetary sight deposits, such as checking accounts; • Saving accounts; • Term deposits or deposits that can be withdrawn with prior notice, such as certificates of deposits • Deposits that can be withdrawn on predefined days • Current account deposits associated with debit cards

  31. Transitioning: Mexico’s case • Data of banking guaranteed deposits in Mexico (September, 2009)

  32. Transitioning: Mexico’s case • Data of banking guaranteed deposits in Mexico (September, 2009) i) Accounts

  33. Transitioning: Mexico’s case • Data of banking guaranteed deposits in Mexico (September, 2009) ii) Balances

  34. Transitioning: Mexico’s case • Number of accounts, amounts for coverage and • accumulated percentages 70’313,488 Accumulated percentages Number of accounts 3’158,732 498,166 273,207 143,191 111,688 Range Up to 10 10 to 50 50 to 100 100 to 200 200 to 400 More of 400 Note 1: Data to September, 2009

  35. Transitioning: Mexico’s case • Number of accounts, amounts for coverage and • accumulated percentages 100.00% 99.85% 70’313,488 99.66% 99.29% 98.62% Accumulated percentage Number of accounts 3’158,732 498,166 94.38% 273,207 143,191 111,688 Range Up to 10 10 to 50 50 to 100 100 to 200 200 to 400 More of 400 Note 1: Data to September, 2009

  36. Transitioning: Mexico’s case • Number of accounts, amounts for coverage and • accumulated percentages 100.00% 99.85% 70’313,488 99.66% 99.29% 98.62% Accumulated percentage Number of accounts 3’158,732 498,166 94.38% 273,207 143,191 111,688 Range Up to 10 10 to 50 50 to 100 100 to 200 200 to 400 More of 400 32,876 Accumulated percentage 34,868 Amounts 36,581 40,327 65,586 219,499 Note 1: Amounts in millions of UDIs Note 2: Data to September, 2009

  37. Transitioning: Mexico’s case • Number of accounts, amounts for coverage and • accumulated percentages 100.00% 99.85% 70’313,488 99.66% 99.29% 98.62% Accumulated percentage Number of accounts 3’158,732 498,166 94.38% 273,207 143,191 111,688 Range Up to 10 10 to 50 50 to 100 100 to 200 200 to 400 More of 400 32.30% 9.38% 40.41% 24.65% 32,876 48.92% Accumulated percentage 34,868 Amounts 36,581 40,327 65,586 219,499 Note 1: Amounts in millions of UDIs Note 2: Data to September, 2009 100.00%

  38. Transitioning: Mexico’s case • Number of accounts and deposits (Mexican Financial System) Deposits (millions of UDIs) Number of accounts Note 1: Data to September, 2009

  39. Transitioning: Mexico’s case • Number of accounts and amounts for coverage (Banks A and B) Number of accounts 13’995,821 13’921,684 114,983 714,607 841,213 106,297 61,985 31,808 55,155 25,183 26,717 17,772 Range Up to 10 10 to 50 50 to 100 100 to 200 200 to 400 More of 400 6,492 7,099 7,456 7,145 7,903 8,262 8,790 11,337 35,669 59,471 14,865 16,826 Amounts Bank A Bank B Note 1: Amounts in millions of UDIs Note 2: Data to September, 2009

  40. Transitioning: Mexico’s case • Accumulated percentages: number of accounts and coverage amounts (Banks A and B) 100.0% 99.88% 99.71% 99.34% 98.63% Accounts accumulated percentage 93.84% 99.82% 99.61% 99.20% 98.43% 92.82% Range Up to 10 10 to 50 50 to 100 100 to 200 200 to 400 More of 400 10.2% 25.3% 32.0% Amounts accumulated percentage 39.1% 46.5% 11.0% 29.5% 38.4% 47.3% 55.4% Bank A Bank B Note: Data to September, 2009 100.0%

  41. Transitioning: Mexico’s case • Number of accounts and amount of deposits in the Mexican banking system) Deposits (millions of UDIs) Number of accounts Note 1: Data to September, 2009

  42. Transitioning: Mexico’s case • Sight and time accounts (banks A and B) Note 1: Number of accounts Note 2: Data to September, 2009

  43. Transitioning: Mexico’s case • Sight and time deposits (Banks A and B) Note 1: Data in millions of UDIs Note 2: Data to September, 2009

  44. Transitioning: Mexico’s case • Annually average total current income per household • by deciles of households(2008) 100.0 127,188 63.8 47.6 36.0 UDIs 26.8 Accumulated percentage 56,576 19.4 40,964 13.4 8.5 4.6 32,244 25,820 1.7 - 20,984 17,184 13,760 10,216 5,848 I II III IV V VI VII VIII IX X Note: Gini coefficient = 0.457

  45. Transitioning: Mexico’s case • Deposit Insurance Coverage 2008-2009

  46. Final remarks

  47. Final remarks • The establishment of coverage limits an important action for deposit insurance. • Setting coverage limits is not an easy job • There is no recipe • The banking authorities should establish coverage limits of deposit insurance system according to its sensitivity, avoiding incentives to moral hazard and by encouraging market discipline • We should investigate the relationship between the coverage limits and premiums or levies, as well as institutions too big to fail.

  48. Jorge A. Chávez Presa Thank you

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