Moving toward risk-based deposit insurance premiums in the European Union: the case of Spain

Abstract

This article provides a scenario-based analysis of how the European Union proposal for a new funding model for deposit insurance systems (DISs) would affect the Spanish banking sector. We examine the risk profiles of commercial banks, savings banks and credit cooperatives over the period 2007 to 2011 and compare the contributions to the deposit insurance fund (DIF) under the current flat-rate regime with those that would have occurred under the new risk-sensitive system. We find that a risk-based scheme could provide an incentive for sound management by reducing the premiums for credit institutions with better risk profiles. We also conclude that the proposed reform may help to mitigate the moral hazard associated with larger credit institutions.

Keywords:

• financial safety net
• deposit insurance system
• risk-based premiums
• moral hazard
• European banking system

JEL Classification:

• G21
• G22
• G28

Acknowledgements

We would like to thank the Editor and the two anonymous referees for their helpful comments and suggestions. We also thank Fernando Pampillón for his comments on an earlier version. The usual disclaimer applies.

Funding

Antonio Trujillo-Ponce acknowledges the financial support of Pablo de Olavide University [Research Project APPB813098].

Notes

¹ The financial safety net includes deposit insurance, bank insolvency resolution practices, regulatory forbearance policies and the central bank’s role as a lender of last resort (Yilmaz and Muslumov, 2008).

² The Fund for Orderly Bank Restructuring (FROB) is a public entity created by Royal Decree-law (RDL) 9/2009, dated June 26, concerning bank restructuring and reinforcing the equity of credit institutions.

³ Directive 94/19/EC of the European Parliament and of the Council on Deposit-Guarantee schemes, dated 30 May 1994.

⁴ For detailed information on the European legislative proposal for a revision of the current Directive on Deposit Guarantee Schemes, please see http://ec.europa.eu/internal_market/bank/guarantee.

⁵ To ensure sufficient funding, DISs must have 1.5% of eligible deposits on hand after a transition period of 10 years (this amount is referred to as the ‘target level’). If these assets are found to be insufficient in the event of a bank failure, banks must pay extraordinary (‘ex post’) contributions of up to 0.5% of eligible deposits into the DIS. Consequently, ex ante funds will account for 75% of DISs’ financing and ex post contributions for 25%.

⁶ One of the most contentious provisions of the EU legislative proposal on DIS is the establishment of a mandatory mutual borrowing facility, whereby if a national deposit guarantee scheme is depleted, the programme can borrow from another national fund. This could represent the first step towards a pan-EU deposit guarantee scheme. However, the creation of a pan-European DIS would imply pooling national sovereignty to an extent not acceptable to the MSs, and therefore this idea was temporarily abandoned (Quaglia, 2013).

⁷ CAMEL is an acronym for the following five components of bank safety and soundness: capital adequacy, asset quality, management quality, earning ability and liquidity.

⁸ All existing EU DISs that adjust contributions according to the riskiness of banks use accounting-based indicators.

⁹ Applying the option-pricing model in a cross-country sample, Hovakimian et al. (2003) find that risk shifting is attenuated by risk-sensitive premiums, coverage limits and coinsurance.

¹⁰ However, several studies reveal that this risk-controlling potential of ex ante, risk-based deposit insurance premiums may be limited (Chan et al., 1992; Pennacchi, 2006).

¹¹ At present, the contribution base in most EU MSs is the amount of eligible deposits. However, over time, covered deposits (i.e. eligible deposits not exceeding the coverage level) will become the contribution base in all MSs because they better reflect the risk to which the DIS is exposed.

¹² In 2010, more than 2 years after the onset of the international economic and financial crisis, the Spanish banking sector, and savings banks in particular, faced a major challenge. Capacity in the sector had been adapted to a period of excessive growth marked by extremely high business volumes; thus, the decline in the demand for financial services highlighted an excess capacity, a capacity that needed to be absorbed. Therefore, the banking sector underwent an important restructuring process (Trujillo-Ponce, 2013).

¹³ Under an IPS, also known as a ‘virtual merger’, each savings bank retained its own governing body, balance sheet, legal structure and brand.

¹⁴ The recent reform of the legal regime governing Spanish savings banks (dated July 2010) allows the banks to assign all financial business to a commercial bank controlled by the savings bank, holding at least 50% of its capital, and retaining savings bank status. This option is expected to reinforce market discipline.

¹⁵ This section relies in part on Gómez-Fernández-Aguado et al. (2013).

¹⁶ Given the impossibility of obtaining information on surplus capital for certain banks in the sample and because the financial leverage ratio (Total capital/Total assets) is considered a reliable indicator of financial soundness (International Monetary Found, 2006), we elected to proxy the excess capital ratio by the financial leverage ratio.

¹⁷ Note that the choice of the percentiles reported in Table 3 is arbitrary and could be adjusted in any MS.

¹⁸ Levene’s test is employed to contrast the homogeneity of variances.