Early and incomplete draft – not for quotation

A DEPOSIT INSURANCE MODEL FOR EUROPE

David G Mayes, Maria J Nieto and Larry D Wall University of Auckland, of Spain, Bank of Atlanta

Abstract

This paper explores the viable structures for an EU/EEA-wide deposit insurance scheme that could overcome the problems that have been experienced with existing schemes in the present crisis. It takes current EU plans for improvements to financial regulation and supervision as given and suggests that unless a comprehensive scheme is implemented the problems of the past and their associated moral hazard will recur as incentives will not be aligned.

Until the present financial crisis deposit insurance has remained rather a backwater in the study of the financial system safety net at both the academic and policy levels in Europe. This is in stark contrast to the United States and Canada, for example, where the deposit insurer has a clearly defined central role. The lack of interest in Europe simple reflects the limited role such schemes had played in the resolution of financial problems across the continent over the previous seventy-five years. In the main, in the event of small problems, in difficulties were taken over by others or the losses were small enough that they could be neglected politically. In the event of large problems, such as the Nordic crises, the state stepped in in a major way, often with blanket guarantees, and the role of the deposit insurer became minor by comparison. Now we have seen with the advent of the present crisis that the deposit insurance system did not work as expected. It did not offer the necessary confidence to avoid bank runs and it was unable to provide people with the sort of uninterrupted access to their deposits that they need in the modern world. As a result both the EU directive on deposit insurance and the structures in individual countries have been reformed and further changes are in train. Some of the changes have been immediate crisis responses and will need to be reviewed when the crisis is firmly over but other

 The views expressed here are those of the authors and do not necessarily represent any that may be held by the Federal Reserve Bank of Atlanta, the Board of Governors of the Federal Reserve System or the Bank of Spain. We are grateful to Ken Jones for helpful comments on the first version of the paper, presented at the WEAI conference in Portland, Oregon on 30 June 2010.

1 Early and incomplete draft – not for quotation issues have remained untackled, in particular the questions of how deposit insurance should be organized for international banks that run across borders and how the spillover effects from the actions of one authority onto the others should be managed. However, on 26 May 2010, the (Commission, 2010) made a proposal to create ‘resolution funds’ in each of the Member States to cover the costs over and above deposit insurance of resolving the failure of large financial institutions. In itself this does not address the cross-border problem but it is proposed to review the arrangements in 2014 ‘with the aim of creating EU integrated crisis management and supervisory arrangements, as well as an EU Resolution Fund in the longer term’. In this paper we take into account these proposals and the recommendations of the de Larosière report and the other ways in which the EU is currently planning to implement it and other suggestions. Thus we work on the basis that the European Banking, Securities, and Insurance and Occupational Pension Agencies and the European Systemic Risk Board are all fully implemented and running. Clearly we also need to assume that much of the proposals for enhanced capital requirements, liquidity requirements, leverage limits, improved risk management, heightened supervision and the widening of the regulatory net to related institutions go through. This paper explores four scenarios that between them illustrate the range of options that are available for running deposit insurance in the new environment. The first is simply the status quo: (a) use the existing institutional setting where both prudential supervision and deposit insurance are decentralized, accountability and financing are national responsibilities and considerable variety in structures prevails. The remaining three consider the three possible ways in which a European level could be introduced – just for deposit insurance; just for the regulation and supervision of cross-border banks; and both. We regard less co-ordination than at present and moving to European level schemes that cover all banks as being less plausible and hence do not pursue them. All intermediate steps between our four specific scenarios are of course possible and will in effect be covered by our treatment of the boundary cases. Thus starting with the full extent of an EU-level system our remaining scenarios are:

2 Early and incomplete draft – not for quotation

(b) a setting where both prudential supervision of cross-border financial institutions and deposit insurance is a supranational concern accountable to EU institutions as well as to national authorities (c) a supranational approach to supervision but deposit insurance remains decentralized (d) a supranational approach to deposit insurance but prudential supervision remains decentralized. We consider the appropriate institutional structures and powers in each case and the effectiveness of each scenario in minimizing agency problems, enabling prompt payment and providing the confidence to prevent retail bank runs.1

1 The Objectives of Deposit Insurance

On the whole the point of deposit insurance has not been very explicit but it has two main characteristics.2 The first is to provide insurance for the less informed in society and for those who could not easily bear the losses ensuing from the failure of a bank in which they have deposited their funds. The second is to provide sufficient confidence for ordinary depositors that problems in the financial system should not lead to retail bank runs, especially on banks that are not directly experiencing the problem. Thus the first motive is primarily an aspect of social policy whereas the second is an integral part of the concern to maintain financial stability and avoid contagion of a limited problem round the system. It is unlikely that the deposit insurance system can cope with failures in the very largest banks or widespread failure in the system and additional special measures will be required.3 As a result

1 Other organizational forms are possible. Ayadi and Lastra (2009) for example suggest that there could be a European System of Deposit Insurers whereby the existing organisations work together more closely in a supportive group. They do not consider whether this would be with or without an EU level Deposit Insurer at the heart of it. 2 See the first principle for a good deposit insurance scheme set out jointly by the International Association of Deposit Insurers (IADI) and the IMF (IADI, 2008). 3 As an illustration, even in the present crisis, the US deposit insurance system could cope with over 250 banks failures in the period since the collapse of , the largest equal in size to many of the larger European banks. Only Bank of America and Citibank were too large for the standard mechanisms, although Wachovia would also have been too big to handle had it not been taken over by Wells Fargo. However as Jones and Nguyen (2005) and Jones and Oshinksy (2009) point out the very

3 Early and incomplete draft – not for quotation countries are discussing either compelling banks/banking groups to be small or simple enough for standard methods to apply or having special tools in place to cope with them, as illustrated by the Commission (2010) initiative which is part of a wider concern by the G20. As having these mechanisms is essential to our discussion of the financing of deposit insurance of cross-border institutions we return to it below. In the first case of protecting the vulnerable, it has become clear that in the course of coping with the crisis, how far deposits should be insured has now gone beyond a simple social objective. Before the crisis the minimum required protection of retail deposits in the EU was €20,000, which would have covered the normal deposits of most households, although a rather larger proportion of deposits in the lower income new member states. Some countries had noticeably higher levels (Campbell et al, 2009) particularly Italy and Norway.4 Now the minimum level is €50,000 with plans to increase it to €100,000.5 At these sorts of levels not only will almost all retail depositors have their entire deposit covered but almost all retail deposits will be covered. Europe was not alone in making this change. Even before the crisis, deposits in the US were insured up to $100,000 per account holder. This increase in coverage means that the cost of deposit insurance has now risen and the particular levels chosen do not bear any specific regard to the welfare or social costs of the scheme. They have been chosen far more with the second objective in mind – if virtually all retail deposits are fully covered then there will not be retail runs and this source of threat to financial stability will be eliminated. There would only be a bank run if people thought the system as a whole might default. Of course, the degree to which people use bank deposits as a vehicle to hold their wealth will be altered this change in arrangements. Even in countries with relatively small numbers of banks it will be possible for almost all individuals to open fully insured accounts with enough banks that all of their financial wealth can be guaranteed. Governments will want to evaluate whether this effective subsidy to the banking system will have any distorting effect on the ability of firms to raise finance through capital markets and whether it will affect the flexibility of the financial system and hence its ability to

rapid consolidation of the banking sector in the US means that the top 10 banks are all so large that the failure of any one of them might well exhaust the resources of the FDIC. 4 These rules apply to the whole of the European Economic Area and not just to the EU. 5 Ayadi and Lastra (2009, Fig.2) set how coverage levels were changed in 2008.

4 Early and incomplete draft – not for quotation cope with both favorable and adverse shocks. Mayes (2010) argues that this dramatic rise in the sums insured confuses protecting ill-informed, vulnerable individuals in the case of the failure of a single bank with avoiding a collapse in confidence in the banking system as a whole. Idiosyncratic risk can be fully covered for almost all individuals with much lower coverage limits. Systemic risk can require intervention by the taxpayer or the triggering of much more drastic recapitalisation through contingent arrangements such as those suggested by the Squam Lake Group (2009) or the special ‘resolution funds’ proposed by Commission (2010). See Wall (2009) for a helpful analysis. Measures imposed to instil confidence in the crisis, are not only not needed for dealing with the occasional failure of small banks in normal times but they increase the incentive to take risks and the costs to the insurer and hence the other banks in handling the failure. However, sheer coverage is not enough. There will still be a run if people think there will be a material break in the access to their deposits. If a break of any length is expected it would still make good sense for people to switch their holding from a troubled bank to a strong one. In the EU before the crisis, it was only necessary for deposit insurers to be able to pay out within 90 days, although this could be extended by a further 90 days twice. Such insurance schemes were not credible and plans are in hand to reduce the maximum delay to a matter of days. This has consequences for the design of the system which we discuss in Section 3.6 How long the period of loss of access can be without triggering a run is a behavioral issue that will vary both with the society and over time.7 However, assessing this is difficult and assuming that anything longer than a day so is a risk. The technical ability to pay out or transfer deposits rapidly, while a necessary requirement for credibility, is not sufficient on its own. Clearly a deposit insurer must have an immediate claim on adequate funds if failure resolution is to appear a viable prospect in any circumstances. In general this implies prior contribution to a fund by the banking industry if the problem of public finding is to be avoided. However, such funds are a cost to the industry and need to be of the order of magnitude sufficient to

6 There are other aspects of deposit insurance system that have had to be changed, such as the avoidance of netting or coinsurance, to make them credible and be able to pay out rapidly but we do not consider them here (see Campbell et al, 2009 or Mayes and Wood, 2008). 7 In the US the maximum break is normally just over the course of a weekend.

5 Early and incomplete draft – not for quotation cover the sorts of losses that can reasonably be expected outside a crisis. An additional facility where a loan can be provided to the insurer at short notice by the government on request would be needed to cover the failure of a large bank or a more general banking problem when there are many demands on the fund at the same time.8 The latter is likely to be exactly the time when it is impossible to raise new funds from the industry as all of the banks are under pressure. Ex ante funding has the advantage that it is counter cyclical. Banks have to pay into the fund in good times and it is drawn down during the problem period. Thus taken together the lessons from the crisis and the reactions of the European authorities would imply a deposit insurance system where almost all retail deposits are covered and almost all failures of individual banks can be dealt with without any material break in facilities for depositors, using funds from the industry and without any need for discretionary financing calls on the government. If the government needs to be involved on each occasion this will make the solution of cross-border failures much more complex as each issue will be political and not technical.9 Full blown financial crises usually require much wider measures.

2 The Agency Problems Facing European Deposit Insurance

A more important problem of institutional design and one central to our concerns is the agency problem when banks run across borders. Each country is responsible for financial stability within its own jurisdiction, although there is now increasing

8 Any involvement of public funds is going to be a problem in the case of cross-border banks. An alternative would be the option of calling on private sources of funding. Wall (199?) considers the case of suspension of servicing of bonds issued by the insurer as a possible route but any facility that has an adverse effect on private sector balance sheets in a crisis will be a risk. 9 There are ways round this. In Australia for example the government has made it clear that the four large retail banks that between them dominate the market are vital pillars of the financial system. On the one hand they will therefore expect not to fail and on the other solutions that involve amalgamation will not be acceptable because of their adverse effect on competition. It is therefore possible to have a clear agreement between APRA (the Australian Prudential Regulatory Authority), the supervisor, and the government over how such events should be handled. It might be possible to have specific intergovernmental agreements about how the largest banks, which are not capable of ‘routine’ resolution through the system, might be handled as their number is small (Jones and Nguyen, 2005). Similarly an EU level agreement could be envisaged but this would introduce a layer of complexity that would make clear analysis difficult.

6 Early and incomplete draft – not for quotation cooperation across the EU and attention to cross-border issues through the new European Systemic Risk Board when it comes into being in 2010. The principal problems are two fold, first that actions taken in one country will have impacts on the financial stability of other countries and there is no mechanism at present for those spillover effects to be taken into account. The second and more fundamental concern is that, as a result of the passport principle, a bank registered in one country can open a branch in another member state while still subject just to the prudential supervision of the home country and without the host country having any real control over its actions. Furthermore, the responsibility for deposit insurance matches the responsibility for prudential supervision.10 The problem is smaller if the foreign operation is conducted through a subsidiary, as then the host country is responsible for prudential supervision (and deposit insurance). However in this case the resulting action will depend primarily on what the host country authority decides to do. Supervision of such cross-border groups is now undertaken through ‘colleges’ of supervisors but there are no binding rules on how the different countries’ interests should be taken into account. This is normally addressed through memoranda of understanding (MoUs), which are soft law declarations of good intent. Thus a country with substantial parts of its financial system run through foreign branches of banks might have little control over what is done prior to a banking problem and little control over what happens when the problem erupts. This is a good case of responsibility without power. For example, if the foreign deposit insurance scheme cannot pay out rapidly then the host authority will have little ability to handle the ensuing chaos. The problem is exemplified by the consequences of the failure of the main Icelandic banks in October 2008. Not only did they fail but their deposit insurance scheme could not cope with the demands on it. The Icelandic authorities therefore decided to default on their foreign obligations and the authorities in the UK and the Netherlands, which had extensive operations by the Icelandic banks, both

10 There is a top up option, which allows a bank to buy additional insurance from the host country insurer to bring its coverage up to that of the host country. There is no symmetric mechanism for reducing coverage if the home system is more generous than that in the host. This can thus offer a competitive advantage in the competition for deposits and is one of the reasons for pressure for a common level of coverage.

7 Early and incomplete draft – not for quotation through branches and subsidiaries,11 had to try to live with the consequences. In effect they lent Iceland the money to repay insured depositors by paying out themselves but many depositors were uninsured and Icelandic banks had not bought top up insurance to bring their insurance up to the levels of that in the UK, which exceeded the EU minimum. There are thus twin concerns: host authorities have an interest both in the prudential supervision of the other parts of any significant banking group operating in its territory and in the operation of its deposit insurance fund. In fact the interest in the latter case is somewhat wider as actions taken to shore up a weak insurance fund, say by offering a guarantee could have implications in a host country. is a case in point. In 2008, when Sweden offered guarantees to its banks, some of whom were operating in Latvia, this posed a problem for the Latvian authorities, who felt they could not afford to offer similar guarantees to their own banks. Parex bank which had a market share of around a third and was facing some problems then faced a run as depositors switched to the Swedish owned banks.12 It took an IMF loan and a considerable obligation for the country for the Latvian government to be able to stabilize the position in Parex, effectively through nationalization. Ideally what the host country authorities would like is that the home country authorities would run supervision in the same way that they would if this were purely a bank in their jurisdiction. In some cases the interests of the two authorities will be the same but in others, a range of reasonable actions could be taken that would have different relative and absolute impacts on the two countries. Eisenbeis and Kaufman (2008) and Mayes (2009) adumbrate the likely actions and concerns of the authorities in the event of the pending failure of a cross-border bank, see Table 1. If the bank is of systemic proportions in both countries then the interests of the two countries are aligned. If the bank is systemic in the home country then it is likely to save it and the host country will not object. If the bank is not systemic in either country then neither will object to closure and the operation of the normal rules. It is only where the bank is systemic in the host country and not the home that there is a clear conflict of

11 In the UK alone there were more depositors in Icelandic banks than there was population in Iceland – children included. 12 Given the weaknesses in Parex there could easily have been a different trigger, so there is no telling if the depth of the crisis in Latvia could have been different.

8 Early and incomplete draft – not for quotation interest, which cannot readily be resolved. In those circumstances it is unlikely that the host country can make a payment to the creditors in the banking group such that an orderly resolution can occur. It is also unlikely that the home country will be willing to incur the extra cost of an orderly resolution if it is only to the benefit of the host country.13 We have not distinguished between branches and subsidiaries in the Table nor made clear where the source of the problem lies. Table 1 implicitly relates to the case of branches, where the bank has to be treated as a whole, so the origin of the problem may be of secondary importance. In the case of subsidiaries it is theoretically possible that the two authorities can pursue differing strategies and the host step in to a subsidiary where the parent is allowed to fail. However, being able to do that implies not only that the subsidiary is a separately capitalized entity over which the host authority has legal control but that the subsidiary is also free-standing and capable of making a seamless transition to operating on its own. Much of the point of running cross-border banks is to reap economies of one form or another and many systems are likely to be common to parent and subsidiary so the subsidiary cannot continue to operate without the parent. Computer systems are a common link but so are treasury operations. The UK has addressed this in the Banking Act 2009, by requiring the administrator of the failed parent to provide these services until an alternative can be arranged.14 However, this is only readily possible within a single jurisdiction. It would be much more complex to find a way of compelling it across jurisdictions, particularly if it involves costs to the insolvency estate in the home country to the benefit of the host country. While the subsidiary can be charged for the cost of the services it is using, the insolvency estate will have to bear the overheads. It is only in circumstances like New Zealand, where the host authorities can insist that all systemic institutions be locally incorporated and be structured so that they can operate on their own without a material break (Mayes, 2006) that the

13 Brunnermeier et al. (2009) like many authors argue that despite any loss of efficiency for the operation of the cross-border bank, the only system that makes sense for maintaining financial stability in each member state is for responsibility for all significant banking operations and for macroprudential supervision to lie with the host country. However, that is not the current political preference. 14 Likely solutions could be that an acquirer of the subsidiary could implement its own systems or a means of replicating the systems and taking on experienced staff from the parent could be organised by the subsidiary itself.

9 Early and incomplete draft – not for quotation individual countries can make their own decisions over how to handle the parts of the bank that lie in their own jurisdictions. This does not characterize Europe but on the other hand the number of banks that are running systemically important operations in other member states is relatively small, so special arrangements to handle them would only need to cover somewhere between 30 and 60 institutions. However, in the main these are the larger banks so having a system to handle them would cover a large proportion of European banking assets but a small proportion of the number of banks.15 It would thus be a serious political issue, in particular because the banks tend to be headquartered in the larger countries. Small countries are used to having to give up de facto control to other countries over various areas of their affairs but the same is not so true for large countries especially where it is for the benefit or smaller countries rather than other large partners.16 This analysis has simplified the problem by concentrating on the case of bank failures but similar conflicts of view could arise in more normal times when discussing aspects of risk management or the early treatment of problems. In Mayes et al. (2008) we cover the use of Prompt Corrective Action to help handle these cases through technical rules that will take into account all of the countries interests. The problem in normal times is two-fold. First of all any insurer or indeed financial stability agency will want to be fully informed about the risks it faces so that it can manage them. Second, those two authorities would also wish to be able to compel changes in the insured or related entities that could ensure the level of prudence they apply to institutions within their own control. The first is easier to address than the second. Currently there are routes to information sharing, particularly through the supervisory colleges for EU institutions, although the initiative normally rests with provider and there is no effective enforcement mechanism under the soft law of MoUs. Full direct supervision by both parties on a joint and coordinated basis with a legal obligation to share information would solve this problem of information, without altering the unique responsibility for

15 The size of such banks makes their prudent operation all the more important as the failure of just one of them may threaten the viability of the respective deposit insurance scheme. 16 It would be a confident host country in present circumstances that would be prepared to see the deposit insurance payments for subsidiaries in its country going to the deposit insurance fund in the home country so that the home country can handle the whole problem.

10 Early and incomplete draft – not for quotation regulation and enforcement.17 Being able to take action in the light of the information is a very different issue. It would be too confusing to allow both authorities to impose prudential requirements on the same institution. They would either have to agree or one must have precedence over the other even if one acts as the agent. There would need to be a means of handling disagreement expeditiously.18 Thus information can be addressed cooperatively but it is very difficult to devise methods of handling action that do not involve one authority having precedence and going to a higher (EU) level sounds a more persuasive way of doing this than hoping than one country will be willing to subordinate its interests to another. US experience in this regard is by no means reassuring if we look at the disagreements between the Office of Thrift Supervision (OTS) and the FDIC over WaMu (Washington Mutual), which was the largest institution to be resolved in the crisis.19 As the principal regulator the OTS did not grant the FDIC the access it asked for and consistently gave a more optimistic rating of the institution than the FDIC, preventing earlier stronger action.

3 The Problem of Swift Payout

One very obvious feature of the recent crisis is that there is often very little time in which to discuss the actions to be taken. Furthermore unless there has been extensive prepositioning the range of options open to the authorities is small. In the US, where they have had to handle over 200 failures in eighteen months, the principal route has been to sell all or part of the failing bank to another licensed institution including all of the insured deposits. There have been a handful of direct payouts where there has been no suitable bidder and the failing bank has been small. Similarly there have been a couple of examples where the FDIC has used a bridge bank and continued to run the bank itself temporarily until a suitable buyer could be found. The key to avoiding a material break in access to deposits has been that either the existing access system

17 The Canadians appear content to see supervision on an agency basis (LaBrosse and Mayes, 2007). Although the Canadian Deposit Insurance Corporation is actively responsible it has no supervisory rights but can ask the banking supervisor for information and to conduct special reviews and on-site inspections if it has a concern. How it detects the cause for concern is more open. 18 This is a discussion of what happens in normal times. In crisis some one authority must act under a mandate as there is no time to obtain anything other than the most straightforward agreement. 19 The FDIC’s version of the events is set out in their evidence to Congress in April 2010 http://www.fdic.gov/news/news/speeches/chairman/spapr1610.html.

11 Early and incomplete draft – not for quotation including the computer systems, ATMs and branches continue to operate or that a new provider can offer all those facilities to customers with only a brief interruption – normally a matter of hours. In the UK, in the case of the Dunfermline Building Society the interruption was two hours. Strangely, although the European Commission recommended that payouts should be a achieved within 3 days, the European Parliament concluded in favor of 10 days and ECOFIN in favor of 20 (Ayadi and Lastra, 2010). Subsequently the 3 day requirement was approved. Compromises such as 10-20 days will not work. If there is a run confidence will be lost. Ten percent of depositors queuing outside the bank is quite sufficient for a crisis. The UK has set out the range of possibilities that need to be covered if an immediate payout is to be possible in the Banking Act 2009:  simple insolvency where this has no implications for financial stability and represents the least cost outcome;  the ability for the authorities to step in when it is clear that the conditions for registration are no longer being met or will soon not be met20 and transfer shares, assets and liabilities to other registered providers;21  in the event that this cannot be done then taking the whole or part of the bank into a bridge bank under the control of the authorities  the ability to require the residual bank to provide critical services to the parts that have been transferred or bridged.22 The Act also offers the possibility of nationalization if none of the others options appears viable. Not all countries want to consider that option, although it has been the common outcome of large or difficult cases in this crisis and in earlier ones such as the Nordic crises of the early 1990s.

20 A key facet of this ability to step in is that it should occur early, when it is clear that viable private sector solutions are not going to emerge in time, rather than waiting for the point of insolvency. In this case, the extent of the losses is likely to be limited and indeed there may be some residual value for shareholders. 21 Such providers may be created specially for the purpose, say, by a consortium of existing institutions. 22 The residual bank is what is left after the transfers, which will normally be in the hands of the administrator. A bank that loses its license because its capital has been eroded is likely to become insolvent as a result even if it were not so at the time.

12 Early and incomplete draft – not for quotation

There are several technical details that need to be sorted out in facilitating such rapid transfers. For example, it must be possible to identify not just which accounts are eligible but the eligible balance on a daily basis. This means that the system must be straightforward, netting off loans would not be possible and aggregation of accounts for each depositor must be implemented, for instance. There are thus requirements for all banks as well as for the deposit insurer. In some European countries the option of making a direct payout does not readily exist as checks are no longer used. There is an obvious difficulty in making an electronic transfer of funds to someone who has just lost their bank account. Perhaps such a banking facility could be offered say through post offices. However, it might make more sense to discount this option. All such issues need to be solved if the system is to work even for domestic banks. There is however a major drawback in many small European countries. In the US the country and the number of banks are large enough to make the early stages of the bidding process to takeover the deposits and other parts of the failing bank something that can be relatively anonymous. It can take up to two months to put the whole of an orderly closure in place.23 This means that the bulk of the work is undertaken while the bank in question is distressed but has not actually failed. If were to be generally known that the bank was in the process of closure then that window of opportunity would be shut quickly. Junior creditors are likely to suffer some sort of loss in an insolvency hence the sensible action at the first whiff of a failure would be to try to close out the positions as soon as possible, thus denying the bank any access to wholesale funding and cutting off trade credit. Indeed it is this which is the normal direct trigger of failure. There are two obvious ways out of the problem. The first is that the new proposals for ensuring greater liquidity buffers for banks will mean that they can survive for longer without having to access wholesale markets in the event of a shock. The second is to alter the nature of some of the capital so that the recapitalization of the bank is in some sense immediate. One such option is to use contingent capital so

23 This is an estimate by the Bank of England. The Prompt Corrective Action element in FDICIA gives the FDIC 90 days to complete the process once the leverage ratio has fallen so far that it triggers the closure process. However, in many cases the decline will have been obvious for some time before that from capital and other warning signs so the FDIC will already be well advanced in its preparations.

13 Early and incomplete draft – not for quotation that junior debt might have a trigger clause that enables it to be converted into equity. This process is set out in the New Zealand idea of Bank Creditor Recapitalisation (Harrison et al., 2007) and is incorporated in the issue of such contingent convertible bonds (CoCos) issued by Lloyds Banking Group in the UK recently. Denmark already has a clause in subordinated debt contracts that enables them to be written down should the authorities determine that the bank needs to be resolved.24 Ideally there should be no cases where a problem in an individual bank cannot be resolved by normal methods. Stern and Feldman (2004) have argued that no bank in the US should be allowed to continue in its present form unless the authorities can explain how they would resolve it without recourse to the systemic risk exemption (Mayes, 2005). The Bank of England (Tucker, 2010, for example) has been arguing that in the UK all banks should themselves be able to present a credible plan to the authorities for their resolution should they get into difficulty. These plans have been described as ‘living wills’ although they have been referred to as ‘funeral plans’ in the past. The principal characteristic is that they should be ‘going-concern restructurings’ and the recapitalization should come from the creditors. While small banks can be resolved in a simple manner, whereby deposits are transferred and the bank moves into insolvency thereby triggering closure of its other contracts larger banks have to keep their key operations running in order to avoid direct contagion into the rest of the financial system, thereby bringing further banks down with it and generating a major crisis.25 However, there is not agreement over the way this problem is to be handled. Even within the UK the FSA (2009) has argued that the largest banks should expect to be bailed out and that they should pay for this expectation both in terms of higher deposit insurance premia and through having to hold extra buffers against shocks. It will be difficult to cost this as it is not clear what the moral hazard might be. Clearly there is a problem with cross-border banks if one administration favors being able to

24 In some countries, Norway for example, it is essential that the resolution process take place without a break in payments if the bank is to keep running under its new owners without being closed out of the payments system. If this is not enabled there is a danger that the government will have to recapitalise the bank if its key operations are not to be closed down rather than transferred (Mayes, 2009). 25 Tucker (2010) focuses on the insurmountable barriers that exist at present in applying this approach to cross-border banks because of the incompatibility of insolvency and SRR regimes across the participating countries.

14 Early and incomplete draft – not for quotation resolve using normal methods while another favors bailing out. A host country being asked to contribute to a bail out which it feels is only caused by the failure of the home country to insist on plausible exit arrangements is clearly not going to be enthusiastic. This has a major impact on how a credible deposit insurance regime that will cover cross-border banks can be organized. These incompatibilities cannot be left in the air to be resolved in the (unlikely) event of a failure, they must be resolved in advance or the failure will be disorderly. The new proposals by the Commission (2010) also offer a way forward. They recognize that the costs of handling large banks are likely to overwhelm the deposit insurance fund. Instead of simply using the funds raised by the levy on banks to support the deposit insurance fund or even more simply just to expand the size of the deposit insurance funds they want them to be held simply to handle large banks or other systemic events. The distinction between what these funds cover and what deposit insurance covers is not clear as the items explicitly listed (p.9) are ‘financing a bridge bank’, ‘financing a total or partial transfer of assets and/or liabilities’, ‘financing a good bank/ split’, ‘covering administrative costs, legal and advisory fees’. In the US case where the resolution is to be done at least cost to the FDIC most of these charges would be included. The only issue is where such sums might otherwise be charged to the insolvency estate and hence paid for by the creditors rather than by the deposit insurer (and hence the banks that finance it). The Commission proposal is a clear step forward in cases where the resolution is currently paid for by the taxpayer. However that does not require a new fund but simply a change in the financing of the deposit insurer from ex post public payment to ex ante funding by a levy on the banks. It is also not clear whether these funds would be triggered only for systemic events. Clearly more detail is required before it is possible to judge the fairness of the scheme. It is only the large banks that cannot be handled individually by the existing scheme.26 It is therefore inappropriate to ask the depositors of the small banks to finance it. On the other hand the large banks already

26 Jones and Oshinsky (2009) explore whether the largest banks should be excluded from the insurance fund if they are too big to be covered by it properly. The irony of this arrangement is that then fund would be much smaller and might have difficulty handling some of the smaller banks or certainly a string of failures as in the present crisis.

15 Early and incomplete draft – not for quotation argue that existing deposit insurance schemes are a subsidy by the depositors of the large banks – which are much less likely to fail - to those of the small banks. Moreover a fund of the order of 2-4% of GDP could be seriously inadequate in a crisis. Cross-border arrangements are to come: ‘With regard to arrangements in case of a cross-border resolution, the Commission intends to come forward with proposals to establish clear rules on how coordination will be expected to take place. At the core of these arrangements could be colleges involving authorities in charge of resolution with a view to taking joint decision on the preparation for the resolution of a cross-border banking group under the oversight of an entity such as the future European Banking Authority as proposed by the Commission. Such resolution plans, based on clear principles to be established by law would include discussion about how burdens might be fairly shared and the sharing of costs between privately financed resolution funds.’ (Commission, 2010, p.11) Thus the issues addressed in the present paper remain entirely in the air and now suggestions for a clear EU-level executive authority are made.

4 The Four Models Compared

There is a tendency in the literature to treat the problem cross-border banks as being inherently conflictual among the various countries involved (Holthausen and Rønde, 2005; Hardy and Nieto, 2008). The reasons for this are obvious. In a crisis, each country will rush to minimize the losses for its own jurisdiction. In part this is because it has a duty to do this and also because it can only control what is happening within its own jurisdiction. However, the EU/EEA countries are doing their best to cooperate and their concern is to try to design a system where they can take their joint interest into account. They therefore need to come to an agreement over what constitutes the joint interest and then set up a system for mutual action that tries to ensure that this common interest will be achieved, despite the fact that national interest will continue to exist. They will still be circumscribed by their powers. Furthermore each country’s actions will tend to have implications for the others. In what follows we therefore consider:

16 Early and incomplete draft – not for quotation

(1) differences in the prudential supervision and deposit insurance objectives that would be assigned by individual member states in a decentralized system and those assigned by the EU in a centralized system, (2) differences in resources available at the national and EU level (from the point of view of the deposit insurer), and (3) governance arrangements for decentralized and centralized systems

4.1. Differences in objectives Before we can be clear about the relative merits of the four approaches, it is essential to point out that there are some important differences among European deposit insurance schemes that make their joint, or indeed competing, use difficult. To begin with there is no single agreement on what the objective of the deposit insurer is. In the US it is to minimize the loss to itself in the event of problems. In Canada it is a wider concept, which the CDIC tends to refer to as ‘risk minimization’ to take into account the fact that a major portion of the effort needs to go into failure prevention and not simply into speedy and low cost resolution. In most European countries it is inexplicit or, as in the case of the new UK Banking Act of February 2009, it involves a number of criteria that can be inconsistent.27 It would be very difficult for different countries to work together without a shared view of the objective. The common objective cannot be simple minimization of the cost to the insurance funds in aggregate as this eliminates the systemic concerns which are at the heart of the problems. Thus not only is some form of weighting required but some

27 The objectives of the UK scheme are that intervention, ‘the stabilisation powers’, should be invoked in the public interest in

 the stability of the financial systems in the UK

 the maintenance of public confidence in the stability of the financial systems in the UK

 the protection of depositors There is thus no explicit reference to any maximisation or minimisation criteria. Furthermore there are seven criteria which will be borne in mind in choosing which resolution method to use. This makes the process somewhat opaque and would make coordination among countries and ex post assessment of the decisions rather difficult compared with a single simple criterion.

17 Early and incomplete draft – not for quotation wider concept of social loss is required.28 This is precisely the reason why the UK has multiple criteria. While an assessment of the least loss route is difficult enough when it is purely financial as it involves the valuation of assets and liabilities without realizing them, it is an order of magnitude more difficult to try to assess ex post what the knock on costs are to the wider community. Assessing this ex ante and in a hurry is going to be highly impressionistic, which does not bode well for a politically sensitive international agreement. For an international agreement to make sense avoiding systemic consequences for a heavily threatened country should take precedence over extra costs for a country with no systemic worries. If it were the case that the costs to a heavily threatened country exceeded its resources, as in the Icelandic case, then a transfer from other countries would be inevitable, even from the point of view of self-interest. The demands on the deposit insurance schemes from a failed cross-border institution will depend both on the nature of the insolvency and the insolvency regime used to handle it. If the bank can be treated as single entity, as it would if it operated in other countries through branches, then the losses would be aggregated. The deposit insurer in the home country would pay out on all the losses to depositors both at home and abroad up to the limit of its liability. If the bank had purchased top up insurance in some of the host countries from the host country insurance schemes then they would be liable beyond this. There is a small wrinkle here as one might well expect that the insolvency was not so drastic that the deposit insurer had to pay out on 100% of the deposits. The sale value of the bank to the acquirer or rather how much the acquirer had to be paid to take on the assets and liabilities might be sufficient that the depositors and other junior creditors were covered in part. The top up scheme would be drawn on second only if the primary scheme had to pay out in full. If the foreign operations are run through subsidiaries then the position is more complex. Although the group as a whole may be insolvent, some of the subsidiaries might be viable and hence the insurer in some of the subsidiary countries might have no need to pay out if the subsidiary can keep trading. Secondly, where the net position of losses has ended up within the group will depend very much on how it tried to conduct its defense in the final days before its failure. Thus, for example, one of the

28 Goodhart and Schoenmaker (2006) for example suggest that each country should contribute according to the size of its share of total assets (or deposits) in the bank.

18 Early and incomplete draft – not for quotation reasons behind the controversial Landsbanki freezing order in the UK at the time of the bank’s failure was to stop any further repatriation of funds from the UK to Iceland so that the insolvency of the UK operation would not be so deep. There is normally a set of counterclaims among the jurisdictions to try to reverse some of the last minute flows, as only some of them are permissible (see Herring (1993) for the case of BCCI – cases involving the Icelandic banks are currently before the District Court in Reykjavik). There are clearly two issues of equity here: if the losses are to be shared equally among all depositors then there needs to be a single set of proceedings; if the losses are to be borne where they are made then separate but linked proceedings would achieve this objective. Currently the legal position is the second and creditors other than the depositors in each jurisdiction would clearly prefer whichever outcome benefitted them most, i.e. whichever gave them the smaller losses. This of course is bound to be conflictual as the losses to be apportioned are fixed (at least when all the assets have been realized). There is nothing to stop deposit insurers making payments among themselves in the interest of equity outside the insolvency proceedings but they would have to follow the normal legal process up to the point of their redistribution. Whether agencies are to work together or whether there is to be a single agency deciding upon the course of action it is clear that there needs to be agreement on the objective in advance. Otherwise there will be both confusion at the time and recrimination after the event. One way to handle this would be to have a hierarchy of objectives, namely that financial stability in each of the countries concerned should come first and then the cost (to the insurer) should be minimized subject to that. Whether all should be weighted equally is a difficult question to answer if there is any element of blame. The European picture is also complicated by the fact that there is no communality of institutional arrangements for handling bank failures (see Garcia et al. (2009) for a summary of the present arrangements). In some countries, such as Hungary the deposit insurer plays a major role, as in the US. In others the insurer is purely a ‘pay box’ with almost no staff. The Finnish deposit insurer for example has one part time employee, who is otherwise a lawyer with the Bankers Association. In these circumstances the preparation for a speedy resolution has to be undertaken by

19 Early and incomplete draft – not for quotation some other agency. It is likely that there will have to be major changes even in national schemes if they are to meet the requirements of a payout/transfer with no material break. In general it is the supervisory agency that makes these preparations but in the UK this task has been given to the Bank of England. In other cases, such as the Netherlands and Ireland, it is also the central bank because the central bank is the supervisor. There are some clear potential conflicts of interest here. If the central bank is the resolution agency then there is a potential conflict with its role as lender of last resort. As lender of last resort the central bank will be senior creditor but it depends in part on the position of depositors in the creditor priority as to how far these roles might conflict. If the resolution agency is also the supervisor then there is a potential conflict because bank failure will in some sense reflect a supervisory failure in that the problems were not detected early enough to head them off. However, as is common with such conflicts they can be resolved more readily if they are taken to the highest level in the organization by separate divisions reporting to different board members.29

4.1.1 An EU-level deposit insurer

Just in the same way that there is no single design for a national deposit insurer an EU-level insurer could operate in a number of different ways. It could simply be a largely passive organization that responds when the country supervisors or, if there is one, the EU-level supervisor/regulator, require it. On the other hand it could be an FDIC style organization that was able to supervise in order to manage its exposure. Thus far the only proposal that has emerged from the Commission is for ‘resolution funds’ (http://ec.europa.eu/internal_market/bank/docs/crisis-management/funds/com 2010_254_en.pdf). This is a somewhat different idea. Rather than direct insurance per se it envisages that there will be a tax on banks (neither the size of the funds, nor the

29 We already noted the agency problems in Section 2. Where the bank is systemically important in the home country, especially where it is a national icon, there is a strong expectation that the home country authorities will not only find a way of keeping it in being but one that keeps it predominantly in national ownership.

20 Early and incomplete draft – not for quotation possible rate, nor the tax base have been spelt out)30 but the way this might be treated at the EU-level is as yet unclear. In the same way that there is re-insurance in the private sector a European scheme could simply enable European funds to pool risks so that is one country or group of countries facing the failure of major cross-border bank could draw on the resources of the others until such time as repayment could be organized. There are no obvious problems from having different insurance limits, as insurers are used to offering a variety of policies. However, this approach simply views insurance as a passive activity and does not suggest that the insurer should manage the risk. Nor does it address the problem that as insolvency law stands at present coordination of actions across countries would be very difficult and could easily be contradictory in the face of national interest. Hence while a Europe-wide insurance arrangement of pay-box variety might be relatively easy to organize and would spread the risks, thereby making the chance of failure of any individual fund and the need to use public money less likely, it would not address the more difficult and important issues. It therefore appears that what would be needed for cross-border banks that are not readily divisible into their component parts would be a single regulatory and supervisory framework for the bank perhaps along the lines suggested by Wall et al. (2010) in a companion paper, by introducing a European charter for cross-border banks that operates on a 28th regime, which includes single insolvency proceedings and the regulatory ability to organize resolutions at the European level. If the EU deposit insurer were the resolution agency but the supervisory agencies were still national, albeit coordinated through a college, it would be possible to obtain the necessary information through joint supervision, subject to the sorts of problems described in the case of WaMu above, but if regulatory power remains national and insolvency arrangements separate and subject to the decision of the local jurisdiction, the idea of a resolution agency might be somewhat empty.

4.1.2 An EU-level supervisor/regulator

If both prior supervision and resolution are conducted at a European level then many of the difficulties discussed thus far are circumvented. The supervisor would have

30 The Commission (2010) is evaluating the relative merits of assets, liabilities and profits + bonuses as the tax base for the levies.

21 Early and incomplete draft – not for quotation both the information and the power to manage the risks and the tools necessary to conduct a resolution. An obvious item missing is that there is no international equivalent of nationalization should everything else fail, as provided for in the UK legislation. Indeed the tenor of the Commission (2010) proposals is to preclude this or any other use of public funds. Bridge banks financed by the resolution funds would be the ultimate stage but there again the banks would be run by the national authorities. This not only presents a problem of coordination but might make the sale or recapitalization of the bridges difficult if they are not to be sold separately. The present crisis and indeed other national crises illustrates that the scale of the problem might be such that even such a substantial fund might be insufficient even if buttressed by contingent capital provisions and the ability to write down claims. Nevertheless this seems less likely in the case of failure of an individual institution in more normal times. It is under these circumstances that prior preparation, whether in the form of ‘living wills’ or establishment of efficient routes for a rapid payout would come into play. The particular advantage that the EU-level supervisor has is that it can compel a structure for the banking group that is compatible with its ability to resolve possible problems as no part of the group within the EU would be outside its jurisdiction. The problem for cross-border banks that run beyond the EU and are headquartered elsewhere remains, however, there the EU authorities have the ability also to limit the structure of the organization such that it seems prima facie manageable. Nevertheless experience in the present crisis suggests that this may not be enough. In a worst case scenario rescue may prove impossible but more likely the ring fencing problem will remain, this time at the boundary of the EU.

4.1.3 A general EU level arrangement

We have suggested thus far that it is the combination of the supervisory ability and the resolution agency at the EU level that is key. If deposit insurance were national but supervision and resolution European then the problem would come if deposit insurers disputed the need to pay or indeed if the deposit insurers turned out to be underfunded. Since depositors are identifiable according to the part of the bank they lie in, the liability for paying out would be clear for each insurer.

22 Early and incomplete draft – not for quotation

However, this implies that the deposit insurers are largely passive bodies, which is not the case for some EU countries. We can summarize the concerns as follows: Issues if both the deposit insurer remain national.  Insurers exposed to risk from other countries may have difficulty both in establishing what the risk is in the first place unless there is full joint supervision and doing anything about it if the others are not in agreement, particularly if the country that needs to take action is unwilling  No recourse to adverse actions taken by other authorities in their own interest.  Restrictions on resolution procedures if local activities are a branch or a subsidiary that cannot operate on its own.  Restrictions on ability to payout/transfer rapidly if vital systems are in other countries  Inequity in the burden falling on the individual countries Issues if both deposit insurance and supervision/regulation at the EU level  De-linking of national responsibility for macro-prudential regulation and financial stability from ability to address the problems  Residual national deposit insurance schemes may not be viable without state support as the represent just a few higher risk local banks (in some member states less than 10% of the banking system is locally owned. Issues if just deposit insurance is at the EU level  Information for the deposit insurer to manage the risk has to come from national sources or colleges  insolvency or other resolution procedures will have to go through national authorities providing scope for conflict and difficulty in coordination  moral hazard in supervision as costs may be borne by other countries Issues of just supervision is at the EU level  national funds may be insufficient  insurers may question liability if they believe the EU supervisor is at fault 4.2 Use of Resources

An EU-level deposit insurer for cross-border banks would tend to have a funding advantage over a simple aggregation of national schemes. It would be able to impose

23 Early and incomplete draft – not for quotation a levy on all of the member banks and use those funds to finance the resolution of any bank that got into difficulty. However, nothing precludes the possibility that the individual insurers could enter into reinsurance agreements with each other, which would in effect enable them to draw on the same full set of funds. This would mean that the liability of any one fund would be up to some agreed limit. While having a homogeneous system where each country builds up a fund from its own banks up to an agreed proportion of the deposits in the cross-border banks and where there is a common set of rules for coverage would make it easier to get the agreement to reinsure, this is a commercial transaction and it will be for the reinsurer to assess the risk and hence the premium. If a system preserving the individual deposit insurers but allowing reinsurance is in place, clearly reimbursement from the surviving banks would be on a different basis. The reinsurer would have to have acceptable means of covering its losses. Member banks might well be reluctant to underwrite this form of business so the reinsurer might well not be simply another deposit insurer. The typical ‘reinsurer’ at present is the state. If the deposit insurer runs out of funds then it can appeal to its own state for temporary recapitalization. Some countries already have this as an explicit agreement. However, in this event there would be little or no pooling of the risk among the participating countries. Similarly even if the deposit insurer could borrow from other governments, the inequity and lack of pooled risk would continue if it has to pay the lender back. A joint system would only work if repayment across borders is not required if the demands on any particular country’s deposit insurer exceed the agreed level. Such an agreement seems a rather remote possibility if it has not been possible to control the cross-border exposure in the first place. Thus recompense seems to be one of the areas where anything other than either a joint scheme or a truly separable scheme as in New Zealand and Australia seems unlikely. For this reason, those exploring cooperative approaches among countries have assumed there will have to be payments between governments (Goodhart and Schoenmaker, 2006, for example), which would have to be agreed among the governments in advance. This immediately assumes that taxpayers will pay, rather

24 Early and incomplete draft – not for quotation than depositors paying to have their deposits insured.31 Such prior formulae are related to the structure of assets, liabilities or deposits of the bank and generally do not take into account variation in the risk across countries, as would happen automatically in the case of reinsurance.

4.3 Governance

As mentioned earlier, some body has to be responsible for managing the risks in the banking system. If it is not the deposit insurer itself then it will be the supervisor. Deposit insurers without supervisory authority need not necessarily be payboxes, they can obtain the necessary information from supervisors. Indeed the resolution authority does not necessarily have to be either the supervisor or the deposit insurer. In the case of the UK it is Bank of England. In this case it is the resolution authority that is responsible for managing the risk. Even within countries these relationships can be problematic even if there are clear MoUs. A centralized resolution authority would have a complex relationship with multiple supervisors unless it also had supervisory powers but the ability to call on multiple deposit insurers would be a rather more straightforward matter, depending only on which authority had the power to trigger a payout. It is the resolution authority that has to have the careful prepositioning to be able to transfer deposits, implement a bridge bank etc.

5 A Reflection

The first question to answer is whether in fact we are dealing with something that is no longer a problem. If the banking system has been structured in such a way that no failure in an individual bank should represent a systemic event in any country then technical solutions to insolvency if all the prepositioning has been put in place should be possible. This would imply that something akin to the living will proposals was in place, for example. There would then be no need to discuss how public money is to be used across borders as the case does not arise unless the only solution would be more permanent public ownership. Although in some senses a bridge bank is a form of

31 It is of course difficult to assess where the incidence of the levy on banks will fall. It could be spread across much of the customer base through charges, or on the shareholders through reduced profits. Since all banks have to pay it, the chance of it falling on the customer is high, although not specifically on depositors.

25 Early and incomplete draft – not for quotation public ownership it is by the resolution authority while the transition is taking place and is not on the books of the government in a strict sense. This presupposes however that the deposit insurer is properly funded by the banking industry and that the taxpayer does not pay directly or temporarily for rescues. In any case the risk of failures should have fallen, in part simply from the shock to experience that the present crisis has induced and second through the raft of regulatory reactions: tightening capital and liquidity requirements, restricting leverage, extending the regulatory net across the financial sector, improving risk management and supervisory systems and enhancing macro-prudential monitoring, for example. However, it seems unlikely that restructuring of the system will be as comprehensive and some banks will still be large relative to small countries and the potential for conflicts of interest will continue if resolution powers remain national or if branches are of systemic importance. Moreover it is likely that the main EU banks will still be ‘too big to fail’ so that they need to be addressed by a form of ‘going- concern reorganization’ where funding through deposit insurance may not be the route and direct taxpayer support is required with all of the difficulties of burden sharing this entails. Clearly the simplest solution for the EU is to follow the US example and have an EU level resolution authority for cross-border banks that is required to ensure that the systemic concerns of all countries involved with a bank are addressed. Given that requirement it could seek to minimize the cost of the resolution to itself or the insolvency estate. It cannot simply add together the losses of all jurisdictions as this would ignore the issue of maintaining financial stability in each country. No redistributive mechanisms exist in the EU that would match those that can be provided in say the US or Canada to offset a highly concentrated regional impact. However, the effectiveness of an EU level resolution authority depends on the nature of the insolvency regime. Current arrangements involve separate proceedings in each country. Furthermore the intervention powers vary by country. If the EU-wide authority is to be able to act it will need to have replaced the national authority in the case of cross-border banks. It might seem less likely that such authority would be created without an EU-level insolvency regime for banks. Additionally the authority could also ensure that issues of equity are addressed, if last minute movements of

26 Early and incomplete draft – not for quotation funds before failure affect depositors in the different countries unfairly. The problem would apply for other creditors but there the outcome would depend upon the actions of the various receivers/administrators involved. There would still be some advantages from having an EU-level deposit insurer even if resolution authorities remained national. It could pool funds and enable countries with large banks relative to their own resources to cope, thereby removing the fear that a failure might bankrupt the national fund. However, it would have to rely on others both for supervision and for ensuring an efficient resolution. Clearly the simplest solution is to have all agencies at the EU-level, with cross- border banks that have a systemic implication for any country chartered by an EU authority which is then responsible for supervision (even if that supervision is effectively contracted out to national supervisors). We explore the case of the EU- level chartering of banks in Wall et al. (2010). EU-level supervision at least means that it is easier to form a clear picture of the organization, while having a single jurisdiction for the group means that a more coherent approach to both correcting problems and handling failure can be applied. Taken together, therefore there are obvious attractions for EU level supervision, resolution and deposit insurance.

References

Arner, D W and Taylor, M W (2009) ‘The global financial crisis and the Financial Stability Board: Hardening the soft law of international financial regulation?’ Asian Institute of International Financial Law Working Paper 6. Ayadi, R and Lastra, R (2010) ‘Proposals for reforming deposit guarantee schemes in Europe’, Journal of Banking Regulation, vol.11(3),pp.210-222. Brunnermeier, M, Crockett, A, Goodhart, C, Persaud, A and Shin H S (2009) The Fundamental Principles of Financial Regulation, 11th Geneva Papers on the World Economy, http://voxeu.org/index.Php?q=node/2796. Campbell, A, LaBrosse, R. Mayes, D and Singh, D. (2009) A New Standard for Deposit Insurance and Government Guarantees After the Crisis’ Journal of Financial Regulation and Compliance, vol.17(3), pp.210-239.

27 Early and incomplete draft – not for quotation

Commission (2010) Bank Resolution Funds, Brussels, 26.5.2010, COM(2010) 254 final (http://ec.europa.eu/internal_market/bank/docs/crisis- management/funds/com 2010_254_en.pdf). Dell’Ariccia, G and Marquez, R (2001). ‘Competition among regulators’, IMF Working Paper 01/73. Eisenbeis, R and Kaufman, G (2008). ‘Cross-border banking and financial stability in the EU’, Journal of Financial Stability, vol. 4(3), pp. 168-204, Authority (2009) ‘Turner Review Conference Discussion Paper’, Discussion Paper 09/4, October. Garcia, G.H. (2009). ‘Ignoring the lessons for effective prudential supervision, failed bank resolution and depositor protection’ Journal of Financial Regulation and Compliance, vol.17(3), pp. 186 – 209. Garcia, G., Lastra, R and Nieto, M (2009) ‘Bankruptcy and reorganization procedures for cross-border banks in the EU: Toward an integrated approach to the reform of the EU safety net’, Journal of Financial Regulation and Compliance, vol.17(3), pp.240-276. Goodhart, C and Schoenmaker, D (2006). ‘Burden sharing in a banking crisis in Europe’, Sveriges Riksbank Economic Review, 2/2006, pp.34-57. Hardy, D and Nieto, M (2008) ‘Cross-Border Coordination of Prudential Supervision and Deposit Guarantees” IMF Working Paper 08/283. Harrison, I.G, Anderson, A. and Twaddle, J. (2007). ‘Pre-positioning for Effective Resolution of Bank Failures’, Journal of Financial Stability, vol.3(4), pp.324- 341. Herring, R (1993) BCCI & Barings: Bank Resolutions Complicated by Fraud and Global Corporate Structure, Wharton School. Holthausen, C and Rønde, T (2005). ‘Cooperation in International Banking Supervision’, CEPR Discussion Paper 4990. IADI and BIS (2008) Core Principles for Effective Deposit Insurance Systems, Basel: BIS, http://www.iadi.org/NewsRelease/JWGDI%20CBRG%20core%20 principles_18_June.pdf Jones, K.D. and Nguyen, C. (2005). ‘Increased concentration in banking: megabanks and their implications for deposit insurance’, Financial Market, Institutions and Instruments, vol.14(1), pp.1-42.

28 Early and incomplete draft – not for quotation

Jones, K.D. and Oshinsky, R C (2009) ‘The effect of industry consolidation and deposit insurance reform on the resiliency of the US bank insurance fund’, Journal of Financial Stability, vol. 5(1), pp. 57-88. LaBrosse, R and Mayes, D (2008) ‘Promoting financial stability through effective depositor protection: the case for explicit limited deposit insurance’, in A Campbell, R Labrosse, D Mayes and D Singh, eds., Deposit Insurance, pp.1- 39, Basingstoke: Palgrave-Macmillan. Mayes, D G (2005) 'The Role of the Safety Net in Resolving Large Financial Institutions', in D Evanoff and G Kaufman eds., Systemic Bank Crises: Resolving Large Bank Insolvencies, pp.275-306, Amsterdam: Elsevier. Mayes, D G. (2006) ‘Financial Stability in a World of Cross-Border Banking: Nordic and Antipodean Solutions to the Problem of Responsibility Without Power’, Journal of Banking Regulation, vol.8, pp.20-39 Mayes, D G (2009) ‘Resolution Methods for Cross-Border Banks in the Present Crisis’, in J R LaBrosse, R Olivare-Caminal and D Singh, eds., Financial Crisis Management and Bank Resolution, pp.302-327. Mayes, D G (2010) ‘The future for deposit insurance’ 15th Melbourne Money and Finance conference, 31 May, forthcoming, Journal of Applied Finance. Mayes, D, Nieto, M and Wall, L (2008) Multiple safety net regulators and agency problems in the EU: Is Prompt Corrective Action partly the solution?’, vol. 4(3) pp 232-57. Mayes, D G and Wood, G E (2008)‘Lessons from the Episode’, Economie Internationale, vol.114, pp.5-27. Squam Lake Group (2009) Tucker, P (2010), Resolution of Large and Complex Financial Institutions: The Big Issues, available at http://www.bankofengland.co.uk/publications/speeches/2010/speech431.pdf Wall, L.D. (1993) ‘Too-big-to-fail after FDICIA’, Economic Review, Federal Reserve Bank of Atlanta, January, pp. 1-14. Wall, L D (2009). ‘Prudential Discipline for Financial Firms: Micro, Macro, and Market Regimes’, paper presented at the Conference on Global Financial Crisis: Financial Sector Reform and Regulation, ADBI, Tokyo, 21–23 July.

29 Early and incomplete draft – not for quotation

Wall, L, Nieto, M and Mayes, D G (2010) ‘Creating an EU Level Supervisor for Cross-Border Banking Groups: Issues Raised by the U.S. Experience with Dual Banking’, Symposium on Managing Systemic Risk, University of Warwick. revised, Federal Reserve Bank of Atlanta, May

30 Early and incomplete draft – not for quotation

Table 1. Interests in the Event of Banking Problems (an entry in the table indicates which authorities want to avoid an insolvency)

Host

Systemic Non-systemic

Systemic Home, Host Home Home Non-systemic Host neither

31 Early and incomplete draft – not for quotation

Table 2 Structures of Supervisory and Deposit Insurance Systems

decentralized EU supervisor EU deposit Both EU insurance Lack of yes Depends on Depends on no information flow to insurer relationship with supervisors Power to act in no yes Depends on yes other relationship jurisdiction with supervisors Rapid payout

32