Deposit is the blood of a banking industry. It is the traditional source of funding for banks. A rise in deposits enables banks to effectively perform their primary role of financial intermediation and also create money. As essential as deposits are to banks, it’s worth noting that deposits are hard-earned savings of consumers.
Just like other firms, banks can fail. But a bank failure can have economy-wide effects — bank runs, the collapse of businesses, breakdown of financial systems. To strengthen the financial regulatory environment and boost stability, Deposit Insurance (DI) schemes have been added to the toolkit of financial regulations. The policy of DI dates back to the 1930s of the Great Depression where over 9,000 banks failed. The aftermath of the Great Depression led to the establishment of the Federal Deposit Insurance Corporation (FDIC) in the USA. The purpose was to protect depositor’s money should a bank fail and promote confidence in the financial sector.
In recent times, having a Deposit Insurance scheme is seen as a pillar of modern financial stability. Here in Africa, Kenya, Tanzania, Nigeria, Uganda have all established explicit Deposit Insurance scheme—where the terms of the scheme are stated in a statute— while Cameroon, Ivory Coast, Benin, Burkina Faso, Chad have implicit Deposit Insurance scheme — those with no stated rules but depositors have assurances of government action.
Ghana joined the list of countries with an explicit Deposit Insurance laws by passing the Ghana Deposit ProtectionAct,2016, Act 931. The object of the Act is to protect small depositors from a loss in case a financial institution fails. Although the Act is yet to be implemented, it’s worth considering how fit the policy is for our environment and avoid or possibly manage its potential pitfalls.
Pitfalls to avoid or manage
Issues about insurance-induced risk-taking by banks is a concern to Deposit Insurance schemes. Sheltering of banks from the full consequences of their actions raise their risk appetite. However, the main threat to the scheme is the temptation for the authorities to amass funds and earmark it for insolvency resolution. This would only make the scheme a bail-out entity instead of strengthening financial stability. Prudential regulations and monitoring by the Bank of Ghana should be intensified to eliminate insolvencies and moral hazard behaviours of insured banks.
The coverage of the scheme is a grey area to consider. The Act clearly states that a bank or a specialized deposit-taking institution licensed by the Bank of Ghana shall be a member of the scheme. This purports a mandatory and extensive coverage of the scheme. The extensiveness of the scheme provides a large pool of revenue for the fund. Equally, the extensiveness presents all categories of banks risks to be pooled. The provisions of the Act provide for a differential premium based on risk assessment of individual banks to be implemented. So risky banks will pay an additional premium.
In the event that a differential premium is charged on a bank, that bank would be perceived by the public as “highly risky”. This would negatively impact their operations particularly revenue mobilisation and make them susceptible to shocks. Cognisant of this, authorities would tread cautiously in imposing a differential premium. Yet risky banks would remain in the pool and would subtly undermine the scheme’s stability.
Insolvency procedure in the event of a bank failure is another murky area. In case a bank fails, the scheme has thirty days to compensate depositors. The real challenge lies in either liquidating assets of the bank for compensation or paying immediately from the scheme's reserves.
The first option is often less attractive. Any delay in the sale of assets can fuel the spread of bank panic to other banks, amplifying the initial problem. The latter can also be economically expensive. And the reason is not far-fetched. If the total amount to be released to depositors as compensation exceeds the schemes reserve, the government might be compelled to intervene. This defeats the purpose of the scheme and puts pressure on government’s limited revenue.
Management of the scheme is core to its success. The efficiency of government run organizations has always been questionable in this country. In spite of this, the possibility of the scheme being run by the government is high. To ensure an efficient running of the scheme, private practitioners in the insurance industry must be contracted to handle technicalities within the scheme.
Too much regulation?
There have been concerns from some experts claiming Deposit Insurance is an excess regulation on financial institutions. Could they be right? Data from Bank of Ghana shows that total deposits of commercial banks in Ghana saw a 10.6 percent annual growth between 2016 and 2017. This is a reduction from the 27.6 percent annual growth recorded between 2015 and 2016.
The fall in deposits shows that consumers are putting their funds elsewhere. This hurts the profitability of banks. With the coming into force of the Deposit Insurance which will require banks to pay premiums (between 0.3 -1.5% of deposit), there will be less for banks to carry out their core functions.
At the moment many financial institutions are struggling to meet the new minimum capital requirement.This challenge reiterates the fact that banks/financial institutions are not raking in enough deposits.It can be argued that, if banks are to perform effectively, they would need to hold on to any available deposit for their operations. The likely effect of the Deposit Insurance would be placing further strains on banks in mobilizing deposits.
But, should we sacrifice the ends for the means? Absolutely not. Banks are profit oriented and would take risks that would increase their profits even if it hurts depositors. Evidence from post-financial crises shows how banks desire for profits have led to depositors losing their savings.The DKM scandal, insolvency of UT and Capital Banks tells us depositors are not safe.In fact, no amount of regulation can make banks vault a safe haven for depositor’s savings; hence the more regulation the better.
Industry support for Deposit Insurance
The managing director of Stanbic Bank Ghana, Mr Alhassan Andanihas stated that Deposit Insurance in Ghana was long overdue. He reiterated the need to insure depositor’s funds just as banks insure their physical assets. Again, the Head of Exclusive Banking at Access Bank Ghana, Mrs Matilda Asante-Asiedu has encouraged the Bank of Ghana to expedite the establishment of Deposit Insurance in Ghana. The implied preparedness of banks is a boon to the scheme’s success.In addition to their preparedness, banks should be cautious in their operations as the insurance will only reimburse depositors to a stipulated amount.
Given the advancement in financial engineering and banks' desire for profits, depositors' funds are at risk than ever. The time for deposit insurance is apt. It behoves on the government to carefully design and implement the scheme to avoid falling into its pitfalls.
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