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Deposit Insurance and Cross-Border Banks A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics e Azevedo, João Valle; Bonfim, Diana Article Deposit Insurance and Cross-Border Banks ifo DICE Report Provided in Cooperation with: Ifo Institute – Leibniz Institute for Economic Research at the University of Munich Suggested Citation: e Azevedo, João Valle; Bonfim, Diana (2019) : Deposit Insurance and Cross-Border Banks, ifo DICE Report, ISSN 2511-7823, ifo Institut – Leibniz-Institut für Wirtschaftsforschung an der Universität München, München, Vol. 17, Iss. 1, pp. 14-20 This Version is available at: http://hdl.handle.net/10419/199053 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu FORUM FORUM João Valle e Azevedo and Diana Bonfim reconcile these opposing perspectives, finding that credibility of the deposit insurance fund backing the One recent example of how the conflicts between before the global financial crisis, ample safety nets claims.3 home and host authorities can shape the outcome of a Deposit Insurance and coming from deposit insurance induced excessive In some cases, host countries of foreign branches financial crisis comes from Iceland (Allen et al. 2011). 1 Cross-Border Banks risk-taking, while during the crisis these schemes were might prefer home country regulation and supervision Immediately after Lehman Brothers collapsed, three a pillar in safeguarding financial stability. if the home country’s deposit insurance scheme is large internationally active Icelandic banks failed. Despite the prevalence of deposit insurance as strong and if the branch is large relative to its banking These banks had adopted aggressive growth strategies an institutional pillar, there is substantial heteroge- group. In this case, the home authorities might be more in the preceding years, relying on the collection of inter- neity in its design (Demirgüç-Kunt and Kane 2001; worried about potential spillovers from the branch into net deposits through foreign branches and subsidiaries Demirgüç-Kunt and Huizinga 2004; Beck and Laeven the banking group that they would be responsible for. (IADI 2011). Depositors in these banks were thus subject Deposit insurance is one of the pillars of trust in the 2006; Demirgüç-Kunt et al. 2015). This has important Still, a banking system where large foreign branches to a wide array of home and host oversight and deposit banking system. This trust is deeply anchored in the implications. For instance, Huizinga and Nicodeme are important might be more exposed to fluctuations in insurance arrangements, which were not easily grasped belief that the sovereign stands ready to reimburse (2002) show that international depositors are sensitive financial intermediation that are not easily dealt with by depositors. The Icelandic insurance fund was not depositors in case of a bank failure. What does this to differences in national deposit insurance policies. by host policymakers. If the home country’s deposit able to immediately reimburse depositors of the failing mean for banks operating across different coun- Eisenbeis and Kaufman (2008) discuss the flaws in insurance scheme is weak, then exposure to large for- banks, requiring the adoption of emergency funding tries? Are differences in the design and protection of decentralized deposit insurance schemes in the US and eign branches is clearly a material risk for the host agreements with institutions from other countries. This deposit insurance behind some banks’ reluctance how these offer important lessons for European poli- authorities. To avoid such risks, supervisors often favor episode made clear the importance of close integration to expand across borders? Can these differences be cymakers. Hardy and Nieto (2008) show that uncoordi- the legal form of a subsidiary. For instance, New Zea- between deposit insurance and resolution authorities, João Valle e Azevedo explored to attract depositors with heterogeneous risk nated deposit insurance policies around the world can land requires foreign banks to be incorporated as sub- most notably when dealing with large internationally Banco de Portugal preferences? lead to insufficient supervision and excessive deposit sidiaries (IADI 2011). active banking groups (IADI 2011). It also showed that and Nova SBE. In this article we discuss these issues, focusing insurance. When financial stability is threatened, the inter- depositors in foreign branches may be unprotected if especially on the current situation in the European ests of stakeholders from the home and host countries the parent bank is unable to protect the branch opera- Union. The euro area sovereign debt crisis, with its BRANCHES VERSUS SUBSIDIARIES: WHAT DOES IT of cross-border banks often come into conflict. The tion (and if the home country deposit insurance scheme onset in the early 2010s, paved the way for a strong MEAN FOR DEPOSIT INSURANCE? agency problems that arise from competition among or, ultimately, the sovereign backing it up, is not strong political consensus on strengthening the financial inte- regulators can have crucial implications for the resolu- or credible enough). gration dimension of the European project. Today there Given the heterogeneity in the design of deposit tion of distressed institutions, the magnitude and dis- is a single banking supervisor and a single resolution insurance around the world, there are key implica- tribution of costs coming from potential failures, and THE CREDIBILITY OF DEPOSIT INSURANCE mechanism. But the banking union will remain incom- tions for cross-border banks. When a bank expands the externalities created (Eisenbeis and Kaufman 2008; plete until an agreement is reached on a common across borders, a crucial decision needs to be made: Dell’Ariccia and Marquez 2006). Schüler (2003) argues While depositors are more likely to react to differences Diana Bonfim deposit insurance scheme. Looking into the current sit- will the bank operate as a branch or as subsidiary? that the conflicts typically arise in two dimensions: a in deposit insurance during a crisis (Bonfim and Santos Banco de Portugal and uation in Europe can thus be an important exercise in For the bank’s day-to-day operations, that decision home country dimension and an international dimen- 2019), these differences may be relevant even in normal Católica Lisbon SBE. better understanding what is special about deposit does not entail major consequences. The customers sion. The home country dimension is related to princi- times, especially for larger depositors with cross-bor- insurance for cross-border banks. of a foreign bank will most likely be unaware of the pal/agent problems between bank supervisors and der operations. Huizinga and Nicodeme (2002) show Of course, the implications of this discussion go legal status of their bank—unless something goes taxpayers. These may be reflected in insufficient capi- that international depositors react to differences in beyond the European debate. That said, heterogene- wrong. In a recent paper, Bonfim and Santos (2019) tal requirements or regulatory forbearance, most nota- national deposit insurance policies. International ous deposit insurance guarantees are possibly even show that during a crisis, bank depositors seem to be bly when financial institutions become distressed. depositors (e.g., large firms) prefer to place their funds more challenging for banks that operate across other well aware of the differences between a branch and a More importantly for the issues we are discussing, in in countries with explicit deposit insurance, most nota- jurisdictions where further legal and financial differ- subsidiary. Indeed, in financial distress, the distinc- the international dimension, Schüler (2003) argues that bly if the deposit insurance schemes have co-insur- ences coexist. tion is not trivial. While a subsidiary is a fully-fledged when foreign banks increase their market share ance, private administration, and a low deposit insur- legal entity in the country where it operates (the host through branches (rather than through subsidiaries), ance premium. These results suggest that countries DEPOSIT INSURANCE AROUND THE WORLD country), a branch does not have legal autonomy from host country regulators are faced with a loss of super- can alter the design of their deposit insurance protec- the parent bank. If a subsidiary fails, the host author- visory and regulatory power over the risks their country tion to capture a larger share of the market
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