Deposit Insurance, Blanket Guarantees and Exit Strategies

The World Bank held a discussion yesterday on the role of extraordinary deposit insurance schemes in the crisis. Fred Carns from the FDIC and David Walker from the CDIC (Canada) outlined the lessons learned, measures taken, and future policy recommendations for the world's deposit insurance schemes.

The main crisis driven deposit insurance arrangements include:

• More than one-third of deposit insurance programs around the world have adopted some form of enhanced deposit insurance protection during the crisis.
• Less than 20 percent of deposit insurance jurisdictions have provided blanket guarantees. Yet this minority is significant, and includes the United States. Some schemes apply only to selected categories of deposits, while a handful take the form of political promises as opposed to changes in law or regulations.
• Among jurisdictions that did not provide blanket guarantees but raised their coverage limits, the extent of the increases varies widely.

The topic of exit strategies dominated the discussion:

• In the cases where coverage limits have been raised finitely, the increases appear to be permanent.
• For the temporary increases in coverage and blanket guarantees, in most cases expiration dates have been announced. The general consensus on the effectiveness of these schemes is that they are more effective when expiration dates have been set. 
• Blanket guarantees have been very useful in preventing catastrophe, but they always create problems of moral hazard which can never be mitigated completely.

As we move into the recovery period, the question of when and how to pull back the extraordinary crisis stimulus measures will become more pertinent. Deposit insurance mechanisms provide an interesting case study. How easy will it be to reduce and reform these mechanisms? There is a general consensus that the most dramatic schemes, such as blanket guarantees, need to be winded down as soon as possible. The difficult question becomes, when?