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Session II. Funding and Coverage Limit. Coverage Limits Jorge A. Chávez Presa Board of Directors 18-20 November Amman, Jordan. Overview. Some background The rule of coverage limits Coverage limits and cross border issues Transitioning: Mexico’s case Final remarks. Some background.

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Session II. Funding and Coverage Limit

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Session ii funding and coverage limit

Session II. Funding and Coverage Limit

Coverage Limits

Jorge A. Chávez Presa

Board of Directors

18-20 November

Amman, Jordan


Overview

Overview

  • Some background

  • The rule of coverage limits

  • Coverage limits and cross border issues

  • Transitioning: Mexico’s case

  • Final remarks


Coverage limits

  • Some background

  • Theoretical framework (moral hazard – market discipline)

  • Core principles. Principle 9 – Coverage.

  • Deposit Insurance Coverage Discussion Paper


1 some background

1. Some Background

  • Theoretical framework(moral hazard -market discipline)

    • Limit insurance since:

      • Source of moral hazard

      • A cost for depositors and taxpayers

      • To encourage market discipline

    • Without a limit, depositors would seek the highest return regardless of risk level and banks would invest in financial instruments with higher risk

      • Maximize return by risking the most

    • Moral hazard can be limited by offering partial insurance (align incentives)


1 some background1

1. Some Background

  • Theoretical framework (moral hazard – market discipline)

    • When facing a serious financial crisis, it is common for financial authorities to apply an explicit full coverage or even a blanket guarantee in order to calm down financial markets

    • In the event that a bank has liquidity problems, it represents a high cost for depositors not to access their deposits. Hence, they try to anticipate the behavior of other depositors, withdraw their deposits and seek a better bank or start hoarding cash.

    • Experience has demonstrated that limited insurance is not sufficient to protect banks from runs in a weakened financial system


1 some background2

1. Some Background

  • Core principles. Principle 9 – Coverage

    • examination of relevant data

    • credible and internally consistent

    • cover the large majority of depositors

    • public-policy objectives

    • adjusted periodically


1 some background3

1. Some Background

  • Deposit Insurance CoverageDiscussion Paper

    This paper gives a guidance to:

  • the determination of the level and scope of deposit insurance coverage

  • The setting of coverage level

  • Adjustment of coverage limits

  • Cross border issues

  • Coverage of retirement and pension funds

  • The emergence of new financial instruments, and

  • The importance of effective communication of deposit insurance coverage is also stressed


1 some background4

1. Some Background

  • Deposit Insurance CoverageDiscussion Paper

    Coverage is a fundamental issue in designing a deposit insurance system

    Coverage can be classified in:

Eligibility of deposit instruments

Scope

Amount of deposits to be covered (coverage limit)

Level


Coverage limits

  • The rule of coverage limits

  • Importance of setting the coverage limit right

  • How to set it?

  • What is the optimal coverage?

  • Constraints that Mexico considered to set coverage limits

  • What are the consequences of exceeding the coverage limit?


The rule of coverage limits

The rule of coverage limits

  • Importance of setting the coverage limit right

  • Financial stability

  • Moral hazard

  • Market discipline

Coverage limit


The rule of coverage limits1

The rule of coverage limits

  • How to set it?

Start by considering reality

  • Policymakers must gather data on the financial instruments held by the population

    • Number of accounts, and

    • Size distribution

  • These data will allow policymakers to determine what proportion of accounts and total deposits would be covered at various levels


The rule of coverage limits2

The rule of coverage limits

  • How to set it?

  • One that covers a proportion of depositors and deposits beyond which the benefits accruable to a small number of depositors are negligible

Appropriate coverage limit

  • A limit that covers at least 80% of depositors and 20% – 40% of total deposits*

    • Accounts

    • Amounts

* Rule of thumb accepted at the First Annual Conference of the International Association of Deposit Insuresrs in Basel, Switzerland, May 2002.


The rule of coverage limits3

The rule of coverage limits

  • What is the optimal coverage?

If the objective is:

  • High or relatively generous coverage limits are an attractive option

  • To ensure banking stability

Regulation

and

Oversight

  • To protect small depositors and reduce moral hazard

  • Low or less generous coverage limits are preferred


The rule of coverage limits4

The rule of coverage limits

  • Constraints that Mexico considered to set coverage limits

  • Conditions of the financial system

  • Flow of funds among countries (Mexico – US)

  • Financial - legal framework

  • Political conditions

  • A small number of accounts contain a large amount


The rule of coverage limits5

The rule of coverage limits

  • What are the consequences of exceeding the coverage limit?

Full protection to both depositors and creditors

  • Erodes market discipline

  • Heightens moral hazard

Blanket coverage

Protect all depositors 100%

Fullcoverage


Coverage limits

  • Coverage limits and cross border issues


Coverage limits and cross border issues

Coverage limits and cross border issues

  • In Mexico the definition of coverage limits had to consider:

    • Trading partner and neighbor

    • Convergence of banking and financial markets

  • In 2005, Mexico reached a coverage limit of 400,000 UDIs.


Coverage limits and cross border issues1

Coverage limits and cross border issues

  • Your neighbor matters


Coverage limits

  • Transitioning: Mexico’s case

  • Antecedents

  • Transition Program of the coverage of guaranteed obligations

  • Types of banking guaranteed deposits in Mexico

  • Data of banking guaranteed deposits in Mexico

  • Number of accounts, amounts for coverage and accumulated percentages

  • Number of accounts and deposits (Mexican Financial System)


Coverage limits

  • Transitioning: Mexico’s case

  • Number of accounts and amounts for coverage (Banks A and B)

  • Accumulated percentages number of accounts and amounts for coverage (Banks A and B)

  • Sight and time accounts (Banks A and B)

  • Sight and Time deposits (Banks A and B)

  • Annually average total current income per household by deciles of households (2008)

  • Deposit Insurance Coverage 2008-2009


Transitioning mexico s case

Transitioning: Mexico’s case

  • Antecedents

  • Meltdown of the financial system

  • Re-privatization of the banking system (in order to capitalize banks)

  • Government assumed banks’ losses(toxic assets)

  • Updating the financial regulatory framework

    • Early corrective measures (first stage)

    • Bank liquidation (second stage)

    • Bankruptcy (third stage)


Transitioning mexico s case1

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Derivatives on

Shares and

metals

Derivatives in well-known

Stock exchanges and

capitalization instruments

Guarantee deposits, tax collection,

payments to the TESOFE and securities

liquidation accounts

Coverage

Obligations held by full service banking institutions,

except: subordinate obligations, interbank loans,

Obligations on behalf of intermediaries of their own financial

groups, unlawful transactions, and obligations with related parties

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

I


Transitioning mexico s case2

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Derivatives in well-known

Stock exchanges and

capitalization instruments

Guarantee deposits, tax collection,

payments to the TESOFE and securities

liquidation accounts

Coverage

Obligations held by full service banking institutions,

except: subordinate obligations, interbank loans,

Obligations on behalf of intermediaries of their own financial

groups, unlawful transactions, and obligations with related parties

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

II

I


Transitioning mexico s case3

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Guarantee deposits, tax collection,

payments to the TESOFE and securities

liquidation accounts

Coverage

Obligations held by full service banking institutions,

except: subordinate obligations, interbank loans,

Obligations on behalf of intermediaries of their own financial

groups, unlawful transactions, and obligations with related parties

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

1-January-01

II

III

I


Transitioning mexico s case4

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Coverage

Obligations held by full service banking institutions,

except: subordinate obligations, interbank loans,

Obligations on behalf of intermediaries of their own financial

groups, unlawful transactions, and obligations with related parties

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

1-January-01

1-January-02

II

III

IV

I


Transitioning mexico s case5

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Coverage

Up to

10 million

UDIS

Obligations held by full service banking institutions,

except: subordinate obligations, interbank loans,

Obligations on behalf of intermediaries of their own financial

groups, unlawful transactions, and obligations with related parties

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

1-January-01

1-January-02

1-January-03

II

III

IV

V

I


Transitioning mexico s case6

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Coverage

Up to

5 million

UDIS

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

1-January-01

1-January-02

1-January-03

1-January-04

II

III

IV

V

VI

I


Transitioning mexico s case7

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Coverage

Up to

5 million

UDIS

Up to

400,000

UDIS 3_/

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

1-January-01

1-January-02

1-January-03

1-January-04

1-January-05


Transitioning mexico s case8

Transitioning: Mexico’s case

  • Transition Program of the coverage of guaranteed obligations1_/

Derivatives on

Shares and

metals

Derivatives in well-known

Stock exchanges and

capitalization instruments

Guarantee deposits, tax collection,

payments to the TESOFE and securities

liquidation accounts

Coverage

Up to

10 million

UDIS

Obligations held by full service banking institutions,

except: subordinate obligations, interbank loans,

Obligations on behalf of intermediaries of their own financial

groups, unlawful transactions, and obligations with related parties

Up to

5 million

UDIS

Up to

400,000

UDIS 3_/

Deposits, loans and credits mentioned in Article 46, Sections I and

II of the Law of Credit Institutions

1-June-99

1-January-00

1-January-01

1-January-02

1-January-03

1-January-04

1-January-05


Transitioning mexico s case9

Transitioning: Mexico’s case

  • Types of banking guaranteed deposits in Mexico

  • Banking monetary sight deposits, such as checking accounts;

  • Saving accounts;

  • Term deposits or deposits that can be withdrawn with prior notice, such as certificates of deposits

  • Deposits that can be withdrawn on predefined days

  • Current account deposits associated with debit cards


Transitioning mexico s case10

Transitioning: Mexico’s case

  • Data of banking guaranteed deposits in Mexico

    (September, 2009)


Transitioning mexico s case11

Transitioning: Mexico’s case

  • Data of banking guaranteed deposits in Mexico

    (September, 2009)

i) Accounts


Transitioning mexico s case12

Transitioning: Mexico’s case

  • Data of banking guaranteed deposits in Mexico

    (September, 2009)

ii) Balances


Transitioning mexico s case13

Transitioning: Mexico’s case

  • Number of accounts, amounts for coverage and

  • accumulated percentages

70’313,488

Accumulated percentages

Number of accounts

3’158,732

498,166

273,207

143,191

111,688

Range

Up to 10

10 to 50

50 to 100

100 to 200

200 to 400

More of 400

Note 1: Data to September, 2009


Transitioning mexico s case14

Transitioning: Mexico’s case

  • Number of accounts, amounts for coverage and

  • accumulated percentages

100.00%

99.85%

70’313,488

99.66%

99.29%

98.62%

Accumulated percentage

Number of accounts

3’158,732

498,166

94.38%

273,207

143,191

111,688

Range

Up to 10

10 to 50

50 to 100

100 to 200

200 to 400

More of 400

Note 1: Data to September, 2009


Transitioning mexico s case15

Transitioning: Mexico’s case

  • Number of accounts, amounts for coverage and

  • accumulated percentages

100.00%

99.85%

70’313,488

99.66%

99.29%

98.62%

Accumulated percentage

Number of accounts

3’158,732

498,166

94.38%

273,207

143,191

111,688

Range

Up to 10

10 to 50

50 to 100

100 to 200

200 to 400

More of 400

32,876

Accumulated percentage

34,868

Amounts

36,581

40,327

65,586

219,499

Note 1: Amounts in millions of UDIs

Note 2: Data to September, 2009


Transitioning mexico s case16

Transitioning: Mexico’s case

  • Number of accounts, amounts for coverage and

  • accumulated percentages

100.00%

99.85%

70’313,488

99.66%

99.29%

98.62%

Accumulated percentage

Number of accounts

3’158,732

498,166

94.38%

273,207

143,191

111,688

Range

Up to 10

10 to 50

50 to 100

100 to 200

200 to 400

More of 400

32.30%

9.38%

40.41%

24.65%

32,876

48.92%

Accumulated percentage

34,868

Amounts

36,581

40,327

65,586

219,499

Note 1: Amounts in millions of UDIs

Note 2: Data to September, 2009

100.00%


Transitioning mexico s case17

Transitioning: Mexico’s case

  • Number of accounts and deposits (Mexican Financial System)

Deposits

(millions of UDIs)

Number of accounts

Note 1: Data to September, 2009


Transitioning mexico s case18

Transitioning: Mexico’s case

  • Number of accounts and amounts for coverage (Banks A and B)

Number of accounts

13’995,821

13’921,684

114,983

714,607

841,213

106,297

61,985

31,808

55,155

25,183

26,717

17,772

Range

Up to 10

10 to 50

50 to 100

100 to 200

200 to 400

More of 400

6,492

7,099

7,456

7,145

7,903

8,262

8,790

11,337

35,669

59,471

14,865

16,826

Amounts

Bank A

Bank B

Note 1: Amounts in millions of UDIs

Note 2: Data to September, 2009


Transitioning mexico s case19

Transitioning: Mexico’s case

  • Accumulated percentages: number of accounts and coverage amounts (Banks A and B)

100.0%

99.88%

99.71%

99.34%

98.63%

Accounts accumulated percentage

93.84%

99.82%

99.61%

99.20%

98.43%

92.82%

Range

Up to 10

10 to 50

50 to 100

100 to 200

200 to 400

More of 400

10.2%

25.3%

32.0%

Amounts accumulated percentage

39.1%

46.5%

11.0%

29.5%

38.4%

47.3%

55.4%

Bank A

Bank B

Note: Data to September, 2009

100.0%


Transitioning mexico s case20

Transitioning: Mexico’s case

  • Number of accounts and amount of deposits in the Mexican banking system)

Deposits

(millions of UDIs)

Number of accounts

Note 1: Data to September, 2009


Transitioning mexico s case21

Transitioning: Mexico’s case

  • Sight and time accounts (banks A and B)

Note 1: Number of accounts

Note 2: Data to September, 2009


Transitioning mexico s case22

Transitioning: Mexico’s case

  • Sight and time deposits (Banks A and B)

Note 1: Data in millions of UDIs

Note 2: Data to September, 2009


Transitioning mexico s case23

Transitioning: Mexico’s case

  • Annually average total current income per household

  • by deciles of households(2008)

100.0

127,188

63.8

47.6

36.0

UDIs

26.8

Accumulated percentage

56,576

19.4

40,964

13.4

8.5

4.6

32,244

25,820

1.7

-

20,984

17,184

13,760

10,216

5,848

I

II

III

IV

V

VI

VII

VIII

IX

X

Note: Gini coefficient = 0.457


Transitioning mexico s case24

Transitioning: Mexico’s case

  • Deposit Insurance Coverage 2008-2009


Coverage limits

  • Final remarks


Final remarks

Final remarks

  • The establishment of coverage limits an important action for deposit insurance.

  • Setting coverage limits is not an easy job

  • There is no recipe

  • The banking authorities should establish coverage limits of deposit insurance system according to its sensitivity, avoiding incentives to moral hazard and by encouraging market discipline

  • We should investigate the relationship between the coverage limits and premiums or levies, as well as institutions too big to fail.


Coverage limits

Jorge A. Chávez Presa

Thank you


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