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The European Deposit Insurance Scheme

Guntram B. Wolff, (2016), “The European Deposit Insurance Scheme”,Bruegel, 23 May

It is welcome that the European Union and the euro area in particular discuss the topic of a European deposit insurance. In fact, to complete banking union, three pillars are indispensable: banking supervision, bank resolution and deposit insurance. In terms of institution building, I would argue that supervision is now fully in place while the European Resolution Mechanism with its funds is still only a half-way done.  Deposit insurance, in turn, is still national at this stage. There is a further important reason why European deposit insurance is advisable in monetary union: it is about the ability to manage sovereign crisis. The ESM is the main instrument to deal with sovereign debt crisis. Its treaty explicitly allows to bail-out only solvent countries. In case a country is not solvent, however, ESM resources cannot be provided to the country and at least conceptually a bail-in of sovereign bond holders is required. This gives rise to two difficulties: The first one is that is such a situation depositors are likely to panic and since they are in a monetary union they may move deposits to other countries. This, in turn, forces the ECB to provide large amounts of liquidity to the banks of the concerned country. And while central banks should provide liquidity to solvent but illiquid banks, it still increases the exposure of the central bank to banks concentrated in one country. A European deposit insurance, by creating trust, will likely minimize national bank runs and thereby also reduce central bank exposure. The second problem is the concentration of sovereign debt in banks of the same country. This renders a bail-in more difficult as the banking system will be much more affected than if the sovereign debt was spread over the entire euro area banking system. Moreover, the concentration of sovereign debt in national banks also creates a problem for the European deposit insurance in case the potential losses were to be so sizeable that the deposit insurance would have to step-in.

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