Will Deposit Insurance Renew Confidence? 

Raising the amount to be covered by deposit insurance was one of the measures taken by some countries against the financial crisis. A few countries even introduced unlimited guarantee to deposits. The issue, which is still being discussed in Turkey, has some negative aspects besides positive ones, however.

  Ceaselessly intensifying, the current financial crisis necessitates change everywhere it hits. Successive measures are adopted in order for the components of financial system to come through the havoc. Some of these measures include; injecting billions of dollars into markets, expanding the borrowing facilities for banks, Troubled Assets Relief Program (TARP), and coordinated interest rate cuts by central banks. While all these “rescue” plans are carried out, at the same time deposit insurance limits are raised in order to strengthen the confidence in financial system. Several countries have already begun to offer unlimited deposit insurance, even. 

The notion of deposit insurance is still unknown to many. Few have detailed knowledge about what kind of protection this system provides to savers. Deposit insurance is a measure to protect deposits of savers. It can be defined as; lending government guarantee to deposits in return for certain premiums that credit institutions pay. While this guarantee may be subject to various limitations, unlimited guarantee may also be extended to deposits. It is aimed through this measure to create confidence in the banking system which assumes a critical role in integrating savings into the economy carrying out credit allocation function. In 1829, New York became the first to adopt a bank-obligation insurance program. Czechoslovakia was the first country to establish a nation-wide deposit scheme in 1924. The Federal Deposit Insurance Corporation (FDIC) was established in the United States in 1933 to guarantee deposits held by commercial banks.

Although heated debates on deposit insurance broke out, after the collapse of many American banks following the Great Depression (1929) and heavy losses suffered with savers losing their confidence in the banking system, it was inevitable to implement this system. Because of the improvements in banks’ structures after the 1929 crisis and increased regulation of banks, deposit insurance practice was not talked much until 1970s. However, transformations in the banking system after 1970s and the resulting crises brought deposit insurance practice to the fore again. 

Pros and Cons of Deposit Insurance

It is said that deposit insurance practice can also have negative effects besides such positive aspects as; protecting the deposits of savers, increasing the confidence in banking system and making it possible for banks to carry out their functions. The problem of moral hazard remains at the center of discussions on whether deposit insurance is “good or bad.” The presence of government insurance may induce banks to take excess risks and to lend to the parties that are not credit-worthy, in their search for profits. Under these conditions, if everything goes well the bank will obtain large profits. In the case of a bankruptcy, on the other hand, since deposits are under guarantee the government pays the deposit holders. The same holds true for deposit holders as well. Savers may prefer risky banks because of high interest rates as government already provides guarantee. Additionally, if premium amounts do not differ according to the risk level of banks, good banks finance bad banks as the premiums they pay are used when bad banks go bankrupt. Deposit insurance practice does not mean that all deposits of savers are under protection. Implementation can differ in various countries. Government guarantee is granted depending on conditions as to what kind of deposits are to be guaranteed, whether interest payment is to be made or according to guarantee limits. Deposits may be given 100% government guarantee, but usually countries limit their guarantees with certain thresholds. In this way, while small deposit holders are protected to a great extent, risk is shared between the bank and the government. 

Current Developments in the World

The ongoing process is defined in various statements as the greatest crisis in recent years. As is known, the U.S.-originated financial crisis has also spread to Europe. Finance sector has incurred huge blows in this process while a lot of banks were taken over by governments and those “labeled as the world’s largest banks” could survive only with government support. Many small-scale banks have gone bankrupt. Trying to draw their money from banks, deposit holders formed long queues in front of banks. Deposit holders have had hard times thinking “Will the next bank be the one at which I placed my money?” A confidence crisis has ensued in financial markets. Since the risk could not be accurately assessed, transactions at the interbank market came to a halt. LIBOR rates saw historic peaks. Banks stopped lending credits as they feared they would not be able to meet the demand if deposit holders wanted to draw their money. While all these developments were taking place, officials produced new solutions in order to restore the confidence and to remove the credit crunch in the markets. One of these steps was to increase the deposit insurance limits. Many other countries extended unlimited guarantee to deposits.  

Ireland, which has received criticism because it followed an independent course within the European Union (EU), increased the deposit guarantee limit from 20 thousand euros to 100 thousand euros. After that, it abolished the 100-thousand-euro limit introducing unlimited guarantee to deposits. Following Ireland, Greece also introduced unlimited guarantee to deposits. Concerns over likely runs on banks by panicked investors have caused countries to take similar steps one after another. Germany, Denmark, Austria and Australia also granted unlimited guarantee to deposits. Before the unlimited guarantee, deposit guarantee limit was 20 thousand euros in Germany, 40 thousand euros in Denmark and 20 thousand euros in Austria. Great Britain increased the deposit guarantee limit from 35 thousand pounds to 50 thousand pounds. The United States, however, increased deposit insurance limits from 100 thousand dollars to 250 thousand dollars. Netherlands and Spain also declared guarantee to deposits up to 100 thousand dollars. Belgium has increased deposit guarantee limits, too. 

Deposit Insurance in Turkey

Turkey has continued unlimited deposit insurance practice for ten years. Unlimited deposit insurance practice was adopted in 1994 after three banks collapsed. The practice has been debated for long years; because 100% deposit guarantee had caused several banks to engage in risky undertakings. During the crisis that broke out in 2001, many banks were seized. In this process radical changes have been made to the banking system. In 2004, unlimited deposit guarantee practice was terminated. Taking the EU criteria as model, deposit insurance was limited to 50 thousand YTL. Recent news on the increase in deposit insurance limits both in Europe and in the U.S. raised questions as to whether a similar move is needed also in Turkey. As other countries have raised the guarantee limits, there arose a risk of deposits’ moving to those countries which offer higher protection. Whereupon it’s decided to grant council of ministers to change the scope and limit of deposit insurance. Minister of Finance Kemal Unakıtan, pointed out this decision wasn’t given with the demand of the banks but to avoid the unfair competition against Turkey.