Breakdown: what went wrong with deposit insurance in Russia

ABSTRACT

The paper examines the Russian experience with explicit deposit guarantee. Some of its effects, such as moral hazard, adverse selection, and erosion of discipline, are typical and well-researched by previous authors. The social cost of having this institution in Russia turned out to be abnormally high, while the results in terms of bank stability are questionable. More than half of the insurance system members have gone out of business in a matter of just fifteen years. I examine the inception of deposit insurance in Russia, its design, implementation and political economy, using various theoretical approaches and combining qualitative with quantitative evidence. I argue that explicit deposit guarantee by a government agency was a priori redundant, in view of the extraordinary role of state-owned banks. The new institution was used as a tool for structural change and competition enhancement, which I regard as misuse. Deposit guarantee was enacted prematurely, before other essential institutions of bank regulation were in place. The political economy of deposit insurance reveals the political system’s vulnerability to uncontained pressure from private special interests demanding public protection. The new institution was captured by interest groups and exploited for private benefit. The evidence from Russia might be relevant to other emerging market countries.

KEYWORDS:

• Deposit insurance
• banking
• misuse of institution
• political economy
• institutional change
• special interests
• bank stability
• opportunism
• moral hazard
• regulatory capture

JEL:

• D02
• E53
• G21
• G28

Acknowledgments

The author would like to thank, without implication, Nikolay Krotov, Henry Penikas, Timothy Spence, an anonymous reviewer, and the Editor of Post-Communist Economies. Various versions of this paper were presented at the Institute of Economics RAS, HSE University, Southern Federal University, WINIR conference (2019), SASE conference (2020), and EBES conference (2022).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. The ‘generosity’ of a deposit insurance scheme is expressed via a ‘moral hazard index’ (Demirgüç-Kunt et al., 2008), later rebranded as ‘safety net index’ (Demirgüç-Kunt et al., 2015). It captures moral hazard stemming from the financial safety net at large, not only from deposit insurance.

2. Undisclosed conflict of interest may partly explain this phenomenon. Russian bank lobbyists often hold academic degrees and are proliferous authors, without declaring potential biases. Coincidentally, deposit guarantee is often praised by authors affiliated with the DIA, regulatory agencies or banking associations.

3. https://ria.ru/20191125/1561126844.html?

4. Deposit insurance scheme maintains membership of banks which are no longer permitted to accept retail deposits and/or are under resolution after licence revocation. There were 355 such banks by end-2020, as compared to 334 active ones.

5. https://1prime.ru/finance/20210916/834717823.html.

6. In 2016, the amount disbursed by the Deposit Insurance Fund to affected depositors (RUB 667bn) exceeded the expenditure of the federal budget on essential social items such as education or health care (RUB 599bn and 506bn, respectively).

7. https://www.asv.org.ru/agency/for_press/pr/613325/.

8. There may be double counting, because an individual can claim compensation more than once.

9. According to Eugene White, ”deposit insurance was the peculiar creation of the U.S. banking experience generated by some of that system’s worst features. It is inappropriate for developing or transition economies” (White, 1997, p. 85).

10. Banking Supervision Report 2003. Moscow: Bank of Russia, 2004, p. 12.