Adoption of Deposit Insurance System
The deposit insurance system has been established at the end of 1995 in Korea and has been operated since then. Events during the Asian financial crisis of 1997 and the global financial crisis of 2007-2008 have demonstrated the importance of effective depositor protection schemes.
The adoption of an explicit deposit insurance system is considered a way of either containing financial crises, or creating one of the important pillars of modern financial safety nets in the liberalized and globalized financial system. [Note]Moon-Soo Kang, Knowledge Sharing program 2012 Modularization of Korea’s Development Experience: Deposit Insurance System in Korea, 2013 View
Deposit insurance systems have been set up to maintain public confidence in the banking system, offer to the government a formal mechanism for dealing with problem banks, and ensure that small depositors are protected in the event of failures of insolvent banks. An effective deposit insurance system is an essential pillar of the financial safety net and performs an important role in contributing to the stability of the financial system and the protection of depositors. Moreover, by boosting depositors’ confidence in the stability of the financial system, deposit insurance is generally thought to contribute in the long run to a deeper financial system, which could lead to higher economic growth. [Note]Levine, Ross, “Financial Development and Economic Growth: Views and Agenda,” Journal of Economic Literature 35:2, pp. 688-726, June 1997.View Deposit insurance is an important and potentially beneficial component of a country’s financial safety net.
The goals of implicit deposit protection systems (IDPSs) and explicit (formal) deposit insurance systems (EDISs) are fundamentally the same – to promote financial stability and to protect small depositors from losses when financial institutions fail. [Note]Demirguc-Kunt, A., E. J. Kane and L. Laeven, “Determinants of Deposit-Insurance Adoption and Design,” Journal of Financial Intermediation 17, 2008, pp.407-438.View
However, there are some differences in the features of IDPSs and EDISs. The EDIS results in faster and smoother failure resolutions because it operates on the basis of established rules and procedures set in deposit insurance law. In contrast, the whole process of dealing with failing financial institutions and protecting depositors of an IDPS is discretionary and ad hoc. The government will have to decide a source of funding. Moreover, an IDPS is liable to be subject to substantial political pressures, thereby producing less foreseeable and consistent results over time.
Financial Crisis and Deposit Insurance
Events during the Asian financial crisis of 1997 and the global financial crisis of 2007- 2008 demonstrated the importance of effective depositor protection schemes. It is an enormous challenge for the developing countries to design and operate an efficient deposit insurance system. One challenge is to strike an optimal balance between the benefits of preventing crises in advance and the cost of controlling insured financial institutions and customer risk-taking.
There are various different designs for deposit insurance arrangements that may meet the objectives of deposit insurance systems. Deposit insurance arrangements should be adaptable to country environments and circumstances.
The global financial crisis prompted changes in the prevailing views about the role of the deposit insurance system. The crisis brought about convergence in practices and provided the momentum for consensus about the proper design features to come out. The explicit limited deposit insurance system has been chosen by many Financial Stability Board member countries including Korea.
The prompt adoption of extraordinary arrangements to improve depositors’ confidence reveals the importance and necessity of operating an effective deposit insurance system.
At present, most OECD members have deposit insurance systems (DISs). Some developing countries also have deposit insurance systems, and other developing countries are contemplating the establishment of a deposit insurance system or improvement of the current system. In many countries, the creation of a deposit insurance system has been as a result of a financial crisis.
In countries with inadequate and ineffective supervision and regulation, deposit insurance may offer a false sense of security and result in the taking of reckless and undesirable risks. [Note]Polizatto, Vincent P., “Prudential Regulation and Banking Supervision,” Dimitri Vittas (ed.), Financial Regulation, EDI of the World Bank, 1992, pp.283-319.View The effects of the explicit deposit insurance are strongly dependent on the quality of banking regulation and supervision.
