ing runs on depository institutions. Finally, deposit insurance promotes fair compe- tition in the banking industry. On the other hand, there are arguments against a
DPS for the reasons that they are expensive, unnecessary, ineffective or impractical in some countries. If a DPS is properly designed, most of the undesirable effects
will be greatly minimized if not completely eliminated. Therefore, it is hardly surprising that there is almost unanimous advocacy for deposit insurance in
developing countries by the IMF, the World Bank and other such policy advisors McKinnon, 1991.
Most advanced as well as some developing countries have created a DPS of one form or another. Currently, we are aware of 51 countries that have set up their
DPSs. Another 20 countries either intend to have or are making preparations for a DPS. Out of these countries, four have drafted their DPSs
3
. In the next few sections, we shall discuss the components of a DPS in detail. For easy of reference,
these major components are summarized in the bottom half of Fig. 1.
3. The administration of deposit insurance
3
.
1
. Public 6s pri6ate schemes Some academics advocate private sector solutions for deposit insurance. Their
main argument is that private providers of insurance will encourage efficiency and effectiveness by removing institutions from the tangles of government bureaucracy.
England 1985
4
and Ely 1986 list the following advantages of a private deposit insurance system:
1. a private insurer is more selective in choosing the insured; 2. a private insurer is not subject to political pressure and can therefore view each
bank as a separate entity; 3. a private system is more flexible in monitoring and controlling risks undertaken
by individual institutions; 4. a private insurer can move quickly to limit an insured institution’s incentive to
take excessive risk; and 5. any private insurer who systematically under- or over-values the assets of an
insured institution would soon be out of business. Despite the above theoretical merits of private deposit insurance, the evidence
supporting the superiority of private deposit insurance is not overwhelming. Unlike a public scheme, a private deposit insurance system can eliminate many potential
3
As reported in the survey by the Canada Deposit Insurance Corporation 1993 and Fry et al. 1996, the countries that intend to set up deposit insurance schemes are: the Bahamas, Barbados, Bermuda,
Botswana, Bulgaria, the Dominican Republic, Jamaica, Lithuania, Malta, the Netherlands, Antilles, Pakistan, Portugal, Russia, and Sierra Leone. The countries that have already drafted deposit insurance
are: Cyprus, Egypt, Jordan and Surinam. As reported in Foo 1998, China is preparing its DPS for medium- and small-sized banks.
4
For a discussion on the pros and cons of private deposit insurance, see England 1985.
Fig. 1. Design of deposit insurance — A framework of analysis.
distortions. However, it faces many significant obstacles such as the problem of insurability, necessity of regulatory authority over insured members, lack of cred-
itability, lack of risk measurement information to measure risk, possibility of higher premiums, diversification problems, and adverse selection. The main drawback is
whether it can generate enough public confidence concerning the safety of their deposits. Diamond and Dybvig 1983, for instance, support public deposit in-
surance on the grounds that ‘‘… the government may have a natural advantage in providing deposit insurance because private companies that have no power to tax
would have to hold reserves in order to make their promises credible’’ p. 416.
Some scholars have demonstrated that deposit insurance cannot be provided successfully by the private sector. For example, Chan et al. 1992 p. 243
concludes that ‘‘Subsidies are also shown to be necessary to cope with the moral hazard
5
associated with deposit insurance. Thus, fairly priced deposit insurance and by implication, competitive private-sector deposit insurance is impossible in a
competitive banking system in which private information and moral hazard distort equilibrium.’’ Therefore, sufficient government involvement is needed to inspire the
necessary public confidence. However, private deposit insurance schemes are nor- mally run under the control of the government. Thus the distinction between
private and public is not as fundamental as it first appears.
Information regarding the administration of deposit insurance schemes in differ- ent countries is summarized in Table 1. There are now 34 countries with public
deposit insurance systems. Private deposit insurance systems are available in only seven countries. Iceland, Japan and five other countries have joint schemes.
Information is not currently available for the remaining four countries.
3
.
2
. Relationship between regulator and deposit insurance agency Even if a DPS is public, it can be run as a separate unit of government
administration or incorporated by the regulator of depository institutions. Good- hart 1988 strongly favors the combined functions of deposit insurance, supervi-
sion and regulation undertaken by public-sector bodies. There are several advantages to deposit insurance being organized and adminis-
tered by a regulatory authority. First, this would avoid any unnecessary andor undesirable duplication of facilities, particularly in the supervision and regulation
of banks. Second, a deposit insurance scheme run by the government enjoys economies of scale in its fund investments. Third, a regulatory authority has both
accumulated experience and valuable information on depository institutions. Such information is particularly useful for deciding on appropriate remedial action
against troubled banks. Fourth, a deposit insurance fund run by the government has credibility with depositors. Fifth, a public deposit insurance system would
eliminate another layer of bureaucracy, thus resulting in lower cost. This is especially important for a small economy.
5
Moral hazard refers to an attitude of indifference to loss created by the purchase of an insurance contract.
Table 1 Administration of deposit insurance schemes
a
Administration Membership
Set up in Country
1979, 1995
b
Voluntary Official
Argentina Official
Compulsory 1979
Austria Compulsory
1984 Official
Bangladesh 1985
Compulsory Official
Belgium Official
Compulsory Brazil
1989 Compulsory
1967 Official
Canada Official
Chile 1977
Compulsory Official
Compulsory 1985
Columbia Compulsory
1994 Official
Czech Republic Denmark
Compulsory Official
1988 Voluntary
Joint 1962
Dominican Republic
El Salvador NA
NA 1991
Official Finland
1965 Compulsory
Private Voluntary
1980 France
Voluntary 1966
Private Germany
Official Greece
1995 Compulsory
Official Compulsory
Hungary 1993
Compulsory 1986
Official for commercial banks; pri- Iceland
vate for savings banks Official
India 1962
Compulsory Official
Compulsory 1989
Ireland Voluntary
1987 Private
Italy Japan
Joint 1971
Compulsory Official
Compulsory Kenya
1985 Official
Korea 1997
Compulsory NA
NA Kuwait
NA Compulsory
1967 Private
Lebanon Private
Voluntary 1989
Luxembourg Voluntary
1975 Official
Marshall Islands Compulsory
1986 Official
Mexico Official
Voluntary Micronesia
1963 Compulsory
1979 Official
Netherlands Official
Nigeria 1988
Compulsory Private
Compulsory 1961
Norway Compulsory
1995 Official
Oman Paraguay
Official 1971
Voluntary Joint
Voluntary 1993
Peru Joint
Philippines 1963
Compulsory Joint
Compulsory Poland
1995 NA
1992 Joint
Portugal Official
Voluntary 1977
Spain Compulsory
1996 Official
Sweden 1984
Voluntary Private
Switzerland Official
Voluntary Taiwan
1985 Compulsory
1993 Official
Tanzania Trinidad and
Compulsory 1986
Official Tobago
Table 1 Continued Administration
Country Set up in
Membership Official
Turkey 1983
Compulsory Uganda
1995 Official
Compulsory UK
1982 Official
Compulsory US
1933 Compulsory for federal and state Official
banks, varies by state Venezuela
1985 Compulsory
Joint Yugoslavia
1985 NA
NA
a
Sources: Abdulrahman 1995; Andre and Axel 1995 pp. 18–20; Banker 1991 p. 19; Bruyneel and Miller 1995; Canada Deposit Insurance Corporation 1993; Carisano 1992; Economist 1990,
1995; Fry et al. 1996; Hong Kong Government 1992; Ko 1997; Kyei 1995; Fredbert 1995 pp. 60–61; McCarthy 1980; Norwegian Banking Law Commission 1995; OECD 1995; Pennacchi 1987
pp. 269–277; and Tally and Mas 1990, 1992.
b
In Argentina, explicit deposit protection was eliminated in 1991 and replaced with improved supervision and higher transparency. Explicit deposit guarantee was reintroduced in 1995.
In contrast, Kane 1985 emphasizes that regulators have their own objectives and therefore cannot be presumed to always have the best interests of the deposit
insurance in mind. There is no definite rule on whether the regulator and deposit insurer should be
separate or combined in function. Garcia 1996 advises that one should take into consideration the history, institutional tradition, size and resources of the country.
According to a survey conducted by the Canada Deposit Insurance Corporation 1993 on 20 DPSs, a separation of the two roles is found in 15 countries. Only
Ireland, the Philippines and the US have combined the roles of the regulator and deposit insurance into one authority.
3
.
3
. Compulsory 6s 6oluntary membership Assuming that a deposit insurance system is publicly run, should membership be
voluntary or compulsory? To Baltensperger and Dermine 1986, voluntary in- surance may be enough if the only objective of a DPS is to offer bank customers
the opportunity of holding a risk-free deposit. There are strong arguments for compulsory membership, even though this
involves greater government intrusion into the private sector. With a compulsory deposit insurance scheme, all depositors have a designated amount of protection.
Compulsory deposit insurance is certainly in the best interest of the public. If the avoidance of bank runs and system crises is regarded as the main goal of deposit
insurance, the scheme should be compulsory.
Voluntary deposit insurance allows each depositor to choose the amount of insurance coverage, but it may reduce aggregate social welfare if there is insufficient
deposit insurance. A voluntary deposit insurance scheme would be exposed to the problem of adverse selection
6
in the sense that risk-prone banks are more likely to
6
When an insured depository institution has more relevant information than the deposit insurance fund, the insured institution with superior information can take advantage of the situation.
join than those that are better managed. A voluntary system may fail to attract a sufficient number of members to accomplish its objectives. Also, large banks may
be able to opt out of the system and avoid the cost of the premiums without markedly affecting depositors’ willingness to place funds with them. In countries
with an uneven distribution of deposits, the cost of the scheme may become prohibitive for small banks without the full participation of large banks. Further-
more, a voluntary deposit insurance scheme is likely to produce periodic large-scale transfers of deposits within the banking system — from insured to uninsured banks
during good times and from uninsured to insured banks when individual banks are in trouble.
Unless a deposit insurance system is private
7
, most of the current systems in force make membership compulsory. From Table 1, we can see that out of 51 countries’
deposit insurance schemes, membership is compulsory in 34 countries e.g. Canada, Ireland, Japan, Sweden, the UK, and the US. Membership is optional in 13
countries, of which five France, Germany, Italy, Luxembourg, and Switzerland have private systems. Membership of a DPS can also be based on type of
depository institution. For example, in the US and Iceland, deposit protection schemes are compulsory for member banks and commercial banks, but are optional
for private banks and other depository institutions. Details on membership of the remaining four systems are not currently available.
4. Scope of coverage
