[PASSED] Deposit Insurance Fund

[Kelssek]

Regarding a 'free rider' problem. There isn't one, because the costs of insurance are apportioned not by nation, but by fees for service by each member institution. These fees for service are also adjusted for risk. To identify a free rider issue, one must find a place where costs are being borne disproportionately.

Deposit insurance and weak institutions. On the prohibition of setting up a deposit insurance scheme in a country without institutional capacity, see supra viewtopic.php?p=35156528#p35156528 (specifically, the last highlight in the last paragraph of the blockquote).

Ambassador, I think you are answering a different question. You seem to be trying to address the effectiveness of the deposit guarantee to create depositor confidence that their deposits really are safe. This isn't what I'm questioning, and it doesn't seem like what the Yohannes ambassador is really concerned about either (although they phrased it in terms of "moral hazard"). After all, if I understand this proposal's intent, the idea is to provide a safety net for states which don't have such capacity. That's a worthy goal and our government is totally fine with that.

The free-rider issue I'm concerned with is that states with all the institutional capacity in the world may calculate that they'd rather offload the risk to the WA rather than bear it themselves, and actually abolish existing deposit insurance schemes, thus transferring the risk to the WA. This is what I mean by free-riding. Instead of member states bearing the risk, with this resolution in place the WA DIF would end up bearing the cost of any bank failure, rather than the member state.

Again, the issue I am raising is not about whether depositors would still be confident if that happens. In theory it should make no difference. What I'm questioning is the potential that states will take this opportunity to put the cost of creating depositor confidence through deposit insurance onto the WA rather than bear it themselves. This is also of concern because of a distinct issue, which I think others are also trying to express, that it's the banks in high-capacity, capital-rich states that have engaged in the most risky, systemically dangerous behaviour, not those in weak states.

[Imperium Anglorum]

The free-rider issue I'm concerned with is that states with all the institutional capacity in the world may calculate that they'd rather offload the risk to the WA rather than bear it themselves, and actually abolish existing deposit insurance schemes, thus transferring the risk to the WA. This is what I mean by free-riding. Instead of member states bearing the risk, with this resolution in place the WA DIF would end up bearing the cost of any bank failure, rather than the member state.

Again, the issue I am raising is not about whether depositors would still be confident if that happens. In theory it should make no difference. What I'm questioning is the potential that states will take this opportunity to put the cost of creating depositor confidence through deposit insurance onto the WA rather than bear it themselves. This is also of concern because of a distinct issue, which I think others are also trying to express, that it's the banks in high-capacity, capital-rich states that have engaged in the most risky, systemically dangerous behaviour, not those in weak states.

Regarding a 'free rider' problem. There isn't one, because the costs of insurance are apportioned not by nation, but by fees for service by each member institution. These fees for service are also adjusted for risk. To identify a free rider issue, one must find a place where costs are being borne disproportionately.

[Kelssek]

States would now be able to free ride on the WA's deposit insurance fund. They can abolish their deposit insurance funds and are not on the hook if a bank in their country fails, because the WA deposit insurance scheme will pay out. Meanwhile, they still have the same benefit of maintaining depositor confidence, without assuming the risks. The fact that banks would pay a premium to the WA scheme instead of their state's is irrelevant here.

[Imperium Anglorum]

States would now be able to free ride on the WA's deposit insurance fund. They can abolish their deposit insurance funds and are not on the hook if a bank in their country fails, because the WA deposit insurance scheme will pay out. Meanwhile, they still have the same benefit of maintaining depositor confidence, without assuming the risks. The fact that banks would pay a premium to the WA scheme instead of their state's is irrelevant here.

The DI programme is basically a pass through entity which provide some service at some cost which is a rounding error when you have an actual crisis. If you had 100 million being paid in DI premiums to a state to provide those services, and those 100 million are just moved to some other fund providing those services... nothing changed. As I said in the first response, banks are not subject to an increase in the mis-pricing of risk from status quo.

I don't know how your argument has any impact. And you simply state the warrant for why nothing changed is irrelevant, fundamentally ignoring how the fund gets its money. If you gave me a mechanism as to why this free rider issue exists and an impact as to why its existing is bad, I could actually engage with your claim. Right now, it's a holding pattern where I warrant why your disad doesn't exist and you just assert that the mechanism for why it doesn't exist is irrelevant.

EDIT: Consider this:

In squo, a bank pays 10 credits in risk-adjusted premiums. It fails. Making the insured despoilers whole costs the Maxtopia Deposit Insurance Programme 100 credits.

In affirmative's world, a bank pays 10 credits in risk-adjusted premiums. It fails. Making the insured despoilers whole costs the DIF 100 credits.

The bank's incentives didn't change. The depositor's incentives didn't change, assuming that both funds have the same level of credibility. From a correlated shocks standpoint, one would expect the DIF with a less correlated pattern of shocks to be able to weather localised shocks far better than a national DI programme. The body which pays into the fund, the banks, would have the same risk-adjusted premium (though one would expect that a less correlated pattern of shocks means that the Fund's buffer stock does not need to be as large, so the risk-adjusted premium is probably slightly smaller—the fact that it is smaller is less free riding than it is efficiency).

If your disad's impact is that nations share costs, the magnitude of the impact would be non-existent after accounting for risk-adjusted premiums. Then, on top of that, any residual impact would be massive outweighed by depositor benefits. If your disad's impact is that nations no longer will invest time and money into building their own DI programmes when the WA one would take centre stage, then warrant why that is more important than the efficiency gains. If your disad is that member nations will no longer regulate as heavily because they no longer assume risk, the impact is non-existent after accounting for the regulatory authority section.

[Kelssek]

A WA member state thinks bank runs are bad. To reassure depositors, it sets up a deposit insurance fund and requires its banks to pay for it. This ultimately has to be backed by a sovereign guarantee for credibility, so the state therefore assumes the risk that it might have to pay out in event of a bank failure.

The WA now sets up an international deposit insurance fund, which banks will be forced to participate in if the member state they are in doesn't have deposit insurance.

Aha, the member state thinks. I can abolish my own deposit insurance fund, eliminate any risk to my own finances, and I still get the benefit of depositors being reassured against bank failures. I make it the World Assembly fund's problem.

Do you believe this is an unrealistic scenario, or one that isn't a problem? If so, why not?

[OOC: Maybe it'll be a bit clearer if I say that I'm thinking of the Icesave and Anglo Irish collapses and the ongoing debates about "national compartments" for the proposed eurozone deposit insurance scheme here. Which I'm happy to assume you would know more about than me.]

Edit response:

Yes, I am saying that some states may engage free-riding because, regardless of efficiency gains, they are now able to offload the risk to the World Assembly fund instead of bearing it themselves. In effect this transfers the risk from one state to all members, while they still enjoy the benefits. I no longer have to bet that my banks won't fail if the WA will do it for me.

[Imperium Anglorum]

A WA member state thinks bank runs are bad. To reassure depositors, it sets up a deposit insurance fund and requires its banks to pay for it. This ultimately has to be backed by a sovereign guarantee for credibility, so the state therefore assumes the risk that it might have to pay out in event of a bank failure.

The WA now sets up an international deposit insurance fund, which banks will be forced to participate in if the member state they are in doesn't have deposit insurance.

Aha, the member state thinks. I can abolish my own deposit insurance fund, eliminate any risk to my own finances, and I still get the benefit of depositors being reassured against bank failures. I make it the World Assembly fund's problem.

Do you believe this is an unrealistic scenario, or one that isn't a problem? If so, why not?

... (reordered by topic) ... Yes, I am saying that some states may engage free-riding because, regardless of efficiency gains, they are now able to offload the risk to the World Assembly fund instead of bearing it themselves. In effect this transfers the risk from one state to all members, while they still enjoy the benefits. I no longer have to bet that my banks won't fail if the WA will do it for me.

It's definitely a realistic scenario. But as I explained earlier, it isn't one that has any impact. What is the impact of the risk being transferred from the national DI programme to the international one? The same money gets paid in by the same firms, which gets paid out to the same people. The programme premiums are still paid to the Fund, and given that squo has risk-based pricing, risk is still properly priced. If squo doesn't have risk-based pricing, my proposal is even further ahead. In general equilibrium, there are some modest efficiency gains from the lack of correlated shocks.

I mean, this line of argumentation is like arguing that a firm being replaced by another firm which provides the exact same service for a lower price is somehow a bad thing. At the argumentative theory level: the warranting is clear now; now there is just no reason to think the claim is a disad. If you have ideas on why there is an impact, see preempts—

If your disad's impact is that nations share costs, the magnitude of the impact would be non-existent after accounting for risk-adjusted premiums. Then, on top of that, any residual impact would be massive outweighed by depositor benefits. If your disad's impact is that nations no longer will invest time and money into building their own DI programmes when the WA one would take centre stage, then warrant why that is more important than the efficiency gains. If your disad is that member nations will no longer regulate as heavily because they no longer assume risk, the impact is non-existent after accounting for the regulatory authority section.

The last one is the most plausible one, I think, along with the strongest impact at the systemic level. In fact, I would say that it would be a very decent opposition argument if the regulatory authority section didn't exist. But more broadly, if you'd like a more broad grant of regulatory authority, then I'll be happy to consider proposals to that effect. I would caution, however, that this proposal is so close to the character limit that an examination of bank regulation would probably best be in a separate resolution.

[OOC: Maybe it'll be a bit clearer if I say that I'm thinking of the Icesave and Anglo Irish collapses and the ongoing debates about "national compartments" for the proposed eurozone deposit insurance scheme here. Which I'm happy to assume you would know more about than me.]

This is one of the major reasons why I thought an international fund is preferable to a national one. The fact that the Icelandic fund was insolvent and that there was a significant lack of clarity as to who was to pay the depositors was very bad for the depositors and (primarily) British consumers.

I think the idea of national compartments is really bad as an economic policy. The better policy option would be to collect risk-based fees from all participating banks, which is the choice that I made at the start of this project.

Also, regarding this topic, from an EU Commission report:

In any of the options above (and just like in the Single Resolution Fund), this common European Deposit Insurance Scheme would be privately funded through ex ante, risk-based fees, paid by all the participating banks and devised in a way that would prevent moral hazard (however, as the existing national Deposit Guarantee Schemes already collect risk-based fees, a euro area system based on the transfer of the national fees would arguably itself be risk-based). In the EDIS context, while the existence of the Single Supervisory Mechanism and the Single Resolution Fund already act as partial deterrents against ‘free riding’ behaviour, the use of risk-based variable fees (therefore higher for riskier banks) set and collected by a central euro area institution (therefore avoiding the ‘institutional capture’ that arguably affected some bank systems in the run-up to the sovereign debt crisis) would likely be the best way to avoid moral hazard.

Bolding is in original. See https://ec.europa.eu/epsc/sites/epsc/fi ... e_edis.pdf.

[Aclion]

A WA member state thinks bank runs are bad. To reassure depositors, it sets up a deposit insurance fund and requires its banks to pay for it. This ultimately has to be backed by a sovereign guarantee for credibility, so the state therefore assumes the risk that it might have to pay out in event of a bank failure.

The WA now sets up an international deposit insurance fund, which banks will be forced to participate in if the member state they are in doesn't have deposit insurance.

Aha, the member state thinks. I can abolish my own deposit insurance fund, eliminate any risk to my own finances, and I still get the benefit of depositors being reassured against bank failures. I make it the World Assembly fund's problem.

Do you believe this is an unrealistic scenario, or one that isn't a problem? If so, why not?

... (reordered by topic) ... Yes, I am saying that some states may engage free-riding because, regardless of efficiency gains, they are now able to offload the risk to the World Assembly fund instead of bearing it themselves. In effect this transfers the risk from one state to all members, while they still enjoy the benefits. I no longer have to bet that my banks won't fail if the WA will do it for me.

It's definitely a realistic scenario. But as I explained earlier, it isn't one that has any impact. What is the impact of the risk being transferred from the national DI programme to the international one? The same money gets paid in by the same firms, which gets paid out to the same people. The programme premiums are still paid to the Fund, and given that squo has risk-based pricing, risk is still properly priced. If squo doesn't have risk-based pricing, my proposal is even further ahead. In general equilibrium, there are some modest efficiency gains from the lack of correlated shocks.

Well one impact is that member states no longer have the incentive to prevent bank runs that they would if they were responsible for covering them.

[Bananaistan]

OOC: Irrelevant.

I think it's very important. Transfers made to people who are not in the decision-making process would break the assumed mechanism that the firm-owners do not bear the consequences of their actions. Warrant this claim.

OOC: I'm not talking about firm-owners. But it's all the same anyway. If you bail owed the bank by either paying the bank or its creditors, then you have insulated the owners and managers from the bad decisions of the managers.

I'm somewhat bemused by this line of argument. It's like you do not realise banks collapse IRL and taxpayers end up paying the bill. This is also written into this proposal where you say "the Fund" will "borrow" from the General Fund if it needs to.

A separate point that comes to me is these unknown and woolly regulations. A centrally set one size fits all set of regulations is inappropriate. It may well be in a country's best interests to allow for a greater level risk in its particular economic and social circumstances. EG in Ireland there are special rules for mortgages for first time buyers which allow for the lender to take on greater risk.

... It's definitely a realistic scenario. But as I explained earlier, it isn't one that has any impact. What is the impact of the risk being transferred from the national DI programme to the international one? The same money gets paid in by the same firms, which gets paid out to the same people. The programme premiums are still paid to the Fund, and given that squo has risk-based pricing, risk is still properly priced. If squo doesn't have risk-based pricing, my proposal is even further ahead. In general equilibrium, there are some modest efficiency gains from the lack of correlated shocks...

OOC: Also false. It's there in black and white in this proposal that "the Fund" will "borrow" from the General Fund if it needs to. If things go badly and lots of banks collapse in many different member states, this doesn't end well for the General Fund. Does the fund then strangle all the good banks by increasing their premiums in order to generate funds to repay the General Fund? Perhaps it just waits 100 years? Who knows if "the Fund" will ever be able pay back? Ultimately the taxpayers of each and every member nation is on the hook.

[Imperium Anglorum]

I think it's very important. Transfers made to people who are not in the decision-making process would break the assumed mechanism that the firm-owners do not bear the consequences of their actions. Warrant this claim.

OOC: I'm not talking about firm-owners. But it's all the same anyway. If you bail owed the bank by either paying the bank or its creditors, then you have insulated the owners and managers from the bad decisions of the managers.

I'm somewhat bemused by this line of argument. It's like you do not realise banks collapse IRL and taxpayers end up paying the bill. This is also written into this proposal where you say "the Fund" will "borrow" from the General Fund if it needs to.

It is from responses like these that I question whether you know the difference between liabilities and equity capital; or that limited liability companies are a thing; or that franchise value in failed institutions is low and especially low without adequate management of the assets; Or that under standard bankruptcy law, some kind of demand account would not receive preferential claims in liquidation. That doesn't change anything however: depositors, who are the people immunised, are not actively involved in management decisions. Your claimed endogenous risk-taking mechanism falls apart.

The last sentence is about the backstop. If you read parts of quoted research above (especially the section quoted in length near the bottom of the first page) also in the report linked supra (quoted infra), you'd see the importance of a backstop. If you don't want to acknowledge that, fine.

A separate point that comes to me is these unknown and woolly regulations. A centrally set one size fits all set of regulations is inappropriate. It may well be in a country's best interests to allow for a greater level risk in its particular economic and social circumstances. EG in Ireland there are special rules for mortgages for first time buyers which allow for the lender to take on greater risk.

Liquidity, capital, corporate governance regulations are wholly separate from underwriting standards. If you looked at the literature on bank failure causes, the overwhelming majority have to do with low profitability, low equity capital, and low liquidity. And oh, those are the things which would be regulated by proposed regulations. There are also certainly cases where underwriting standards are too low (construction loans and CRE loans come to mind), which would be reflected in premiums. Moreover, given that uninsured depositors and residual claimants would not be protected, political incentives for bank regulation do not simply go away.

... It's definitely a realistic scenario. But as I explained earlier, it isn't one that has any impact. What is the impact of the risk being transferred from the national DI programme to the international one? The same money gets paid in by the same firms, which gets paid out to the same people. The programme premiums are still paid to the Fund, and given that squo has risk-based pricing, risk is still properly priced. If squo doesn't have risk-based pricing, my proposal is even further ahead. In general equilibrium, there are some modest efficiency gains from the lack of correlated shocks...

OOC: Also false. It's there in black and white in this proposal that "the Fund" will "borrow" from the General Fund if it needs to. If things go badly and lots of banks collapse in many different member states, this doesn't end well for the General Fund. Does the fund then strangle all the good banks by increasing their premiums in order to generate funds to repay the General Fund? Perhaps it just waits 100 years? Who knows if "the Fund" will ever be able pay back? Ultimately the taxpayers of each and every member nation is on the hook.

During the last financial crisis, the FDIC charged higher premiums and permitted prepayment of those premiums. The US still has banks. The FDIC Deposit Insurance Fund was replenished, taxpayer dollars were not borrowed. Even if they were, taxpayers could easily be repaid from the hundreds of billions of dollars in it. This kind of unwarranted exaggeration is not credible.

But on the backstop (and not The Backstop™ from May and Johnson: Adventures in Brexit), from the report supra—

Additionally, historical experience (See Annex 1 on The US and German Deposit Guarantee Schemes) also shows that a Deposit Guarantee Scheme at some point in time needs a formal, pre-agreed and transparent backstop framework, given that the accumulated amounts in even fully-funded Deposit Guarantee Schemes are unlikely to be sufficient in case of systemic crises. At least in the euro area case, the backstop function could be achieved through a credit line to the Single Resolution Board by the European Stability Mechanism (ESM). This would, however, demand a change in the ESM treaty.

Bolding is original. Why is this important? Oh, because the credibility of an insurance scheme matters insofar as depositors are not static automatons, but instead, will react to news (primarily macroeconomic news, according to recent research from Southern Europe) and may do a bank run. Such a bank run would be disastrous for a nation's economy and impose undue hardship on the general population whose savings get wiped out.

Similarly, if you seriously want to engage in the hyperbolic hypothetical of 'what if every bank fails?!?!?', at that point, a nation ought to spend public money to solve that. At that point, doing so would prevent most the entire population from losing their life savings and doing severe harm to the national economy. The impacts like Great Depression-level unemployment are broadly bad and massively outweigh costs on the order of a few tens of billions dollars.

However, on costs, compared to a national DI status quo, also note from that same report's first page "A common euro area scheme is more likely to be fiscally neutral over time than national Deposit Guarantee Schemes, because risks are spread more widely between different countries and because the private bank fees that pay for the guarantee funds are raised over a much larger pool of financial institutions". Relative to squo these worst-case impacts are similarly comparatively better in the proposal's world.

[Bananaistan]

OOC: You're talking about deposit guarantee schemes. Per 2.c(iii) & 2.f (2nd sentence) this proposal is not merely a deposit guarantee scheme. It would help if you'd debate the proposal that you have actually written.

Edit: Even if it was just a deposit guarantee scheme, I'd still oppose ICly because it risks taxpayers in fiscally prudent and regulatory sound countries paying for the excesses of other countries.

[Imperium Anglorum]

OOC: You're talking about deposit guarantee schemes. Per 2.c(iii) & 2.f (2nd sentence) this proposal is not merely a deposit guarantee scheme. It would help if you'd debate the proposal that you have actually written.

Apparently what the EU wants to do and what the FDIC does is not a deposit insurance scheme. Curiously, then, you'd be surprised to know that the FDIC, which is a deposit guarantee scheme, has all of that authority. For reference, the noted clauses are—

The Fund may resolve an IDI in one of the following manners with the least cost to the Fund: ... (iii) It may advance liquidity support to such an institution if the Fund believes that the institution is a systemically important. ...

The Fund may require IDIs to pre-pay premiums, in exchange for credit against future premiums, within a reasonable time window. Where the Fund is unable to adequately insure depositors, it may borrow from the World Assembly General Fund the necessary money to achieve its mandate.

For supra para 1, see Crisis and Response chapter 3. For supra para 2, see that same chapter and also https://www.fdic.gov/regulations/laws/r ... -1600.html. Then, one might find that the EU Commission also believes that having a financial backstop is integral to having a credible deposit insurance scheme. I quoted the portion above already, talking about a backstop. But the conclusion to the report also says—

Finally, experience shows that Deposit Guarantee Schemes and resolution bodies need a backstop. The European Stability Mechanism, after treaty changes, could perform this function, once corresponding legal questions are addressed. This integrated setup will be both more functional and effective in reducing moral hazard, free-riding behaviour and institutional capture.

Or also consider that the JEP article I quoted in January says—

The liquidity of an unfunded deposit insurance enterprise can derive instead from an unfettered line of credit with the national treasury, from reinsurance contracts written with reliable outside insurers and from the power to collect special assessments from its client base.

Whether or not substantial reserves are held, it must be made clear that funds that ultimately cover bank losses will come principally from surviving banks. Tax- payer assistance should be expected only in the special case of a verifiable systemic crisis. Convincing the banking industry that it cannot routinely dump insurance losses on taxpayers will encourage healthy banks to support high-quality regulation and to monitor other banks. Conversely, to the extent that emergency funding is expected to be provided from government revenues, market discipline is compro- mised and financial fragility increased. Asli Demirgüç-Kunt and Edward J. Kane, Deposit Insurance around the Globe: Where Does It Work?, 16 Journal of Economic Perspectives 175, 193 (2002).

One may also note that I designed the mechanism in this proposal informed by survey of the literature: that's why the funds are borrowed and not transferred.

Edit: Even if it was just a deposit guarantee scheme, I'd still oppose ICly because it risks taxpayers in fiscally prudent and regulatory sound countries paying for the excesses of other countries.

Regarding the risk concerns. If on regulatory incentives, asked and answered. viewtopic.php?p=35156528#p35156528

This is the problem of moral hazard: when insurance exists against negative outcomes, parties will take more risk. To control the exposure of taxpayers to moral hazard, the insurer must involve itself or surrogate parties in monitoring and disciplining banks. The balance of benefits and costs engendered by individual deposit insurance will vary with the ability of the insurer to reduce the chance of risk taking and with how the actions of the insurer interact with the informational and contracting environments of individual countries.

And that is why the insurer is given the authority to involve itself in monitoring and disciplining banks.

If on cost-sharing, preempted. "If your disad's impact is that nations share costs, the magnitude of the impact would be non-existent after accounting for risk-adjusted premiums. Then, on top of that, any residual impact would be massive outweighed by depositor benefits."

---

Well one impact is that member states no longer have the incentive to prevent bank runs that they would if they were responsible for covering them.

Didn't see this before Banana's post. But, however that is, that impact was already answered before it was raised. See viewtopic.php?p=36396652#p36396652:

If your disad's impact is that nations share costs, the magnitude of the impact would be non-existent after accounting for risk-adjusted premiums. Then, on top of that, any residual impact would be massive outweighed by depositor benefits. If your disad's impact is that nations no longer will invest time and money into building their own DI programmes when the WA one would take centre stage, then warrant why that is more important than the efficiency gains. If your disad is that member nations will no longer regulate as heavily because they no longer assume risk, the impact is non-existent after accounting for the regulatory authority section.

Then in my next response to Kelssek:

The last one is the most plausible one, I think, along with the strongest impact at the systemic level. In fact, I would say that it would be a very decent opposition argument if the regulatory authority section didn't exist. But more broadly, if you'd like a more broad grant of regulatory authority, then I'll be happy to consider proposals to that effect. I would caution, however, that this proposal is so close to the character limit that an examination of bank regulation would probably best be in a separate resolution.

Also, "given that uninsured depositors and residual claimants would not be protected, political incentives for bank regulation do not simply go away" (viewtopic.php?p=36397147#p36397147).

[Blueflarst]

My nation does not have this problems the banks are publics and their funds can not be touched for nothing unless the client request it

[Imperium Anglorum]

My nation does not have this problems the banks are publics and their funds can not be touched for nothing unless the client request it

Imagine you had a bank with only 5 dollars in it and 10 people whose balances all say 5 dollars, all of whom are clients. You lose.

---

"But all my banks are public!". And regarding this repeated "but all my banks are public" assertion, that doesn't actually solve the problem, as I told Ara in January 2019. In fact, it makes it worse. First, you have greater incentives to take risks because the managerial staff are fully insulated, unless you also caveat highly restrictive banking regulations. Second, just searching would find that India, which is dominated by state run banks (many of which are also ailing and inefficient because of politics) has ... a deposit insurance corporation. Third, deposit insurance still makes sense in such a case because, as Demirgüç-Kunt and Kane argue, the implicit state guarantee is unlimited relative to a capped deposit insurance limit under this policy.

Then, also consider the benefits to efficiency. Borrowing from one of my posts above,

From a correlated shocks standpoint, one would expect the DIF with a less correlated pattern of shocks to be able to weather localised shocks far better than a national DI programme. The body which pays into the fund, the banks, would have the same risk-adjusted premium (though one would expect that a less correlated pattern of shocks means that the Fund's buffer stock does not need to be as large, so the risk-adjusted premium is probably slightly smaller—the fact that it is smaller is less free riding than it is efficiency).

Proposal's world would have increased risk pricing efficiency (from Third) as well as higher efficiency because of the lower buffer stock because if these public banks were truly safe, they would pay low risk premiums. So entirely ignoring the inefficiency of public sector credit intermediation, a nationalised banking system doesn't solve the bank run problem (see Diamond-Divbig 1987 [year might be wrong]) and proposal's world is ahead on efficiency.

[Kelssek]

So what prevents the proposed DIF from becoming insolvent, and the burden falling on all member states via the General Fund? I remain unclear about this because you clearly recognize the possibility, but appear to be saying that no problem exists because the banks are charged premiums based on their risk-taking. Yet this does not rule out crises of a magnitude that could also render an international fund insolvent, since after all it also insures more banks. The reason crises occur is because they are not predictable - if they were, then insurers whose job it is to assess those probabilities would have charged the premium for it, paid out, and we win again.

[OOC: Plus, isn't a major reason "the US still has banks" because the government and the central bank stepped outside the deposit insurance mechanism to provide public funds? This suggests insolvency for the US deposit insurance fund was quite possible too.]

EDIT:

If your disad's impact is that nations no longer will invest time and money into building their own DI programmes when the WA one would take centre stage, then warrant why that is more important than the efficiency gains.

So why do you encourage member states to have their own deposit insurance schemes at all? It seems like this would actually detract from what you're trying to do. Yet it still seems much more preferable to make sure states are doing their part before imposing risks and potential losses to the WA membership as a whole.

[Imperium Anglorum]

So what prevents the proposed DIF from becoming insolvent, and the burden falling on all member states via the General Fund? I remain unclear about this because you clearly recognize the possibility, but appear to be saying that no problem exists because the banks are charged premiums based on their risk-taking. Yet this does not rule out crises of a magnitude that could also render an international fund insolvent, since after all it also insures more banks. The reason crises occur is because they are not predictable - if they were, then insurers whose job it is to assess those probabilities would have charged the premium for it, paid out, and we win again.

[OOC: Plus, isn't a major reason "the US still has banks" because the government and the central bank stepped outside the deposit insurance mechanism to provide public funds? This suggests insolvency for the US deposit insurance fund was quite possible too.]

If your objection is wholly to the idea that depositors get money from the government when the Fund is insolvent, then you should see posts above where I already addressed the need for a backstop. If your objection is to the idea that depositors get money from other nations when the Fund is insolvent, then you should see below.

So I wholly recognise the fact that Funds can become insolvent when systemic crises emerge. However, in the comparative, between a national status quo with deposit insurance with a government backstop and this proposal's world, that chance is lower and the costs to national inhabitants are smaller. See posts above. In the comparative, between a national status quo without deposit insurance—or national deposit insurance sans backstop—and proposal's world, the massive gains to stability clearly outweigh losses. The size of losses has not been historically large relative to the total amount of assets in the banking system. Any such funds sourced from the General Fund are also borrowed and repaid rather than unilaterally transferred.

In the comparative, between a national status quo with deposit insurance and proposal's world, where the level of deposit insurance is the same, the use of risk-based fees would effect this compartmentalisation of ex ante idiosyncratic risk. The scheme that I propose is the best way to prevent the kind of moral hazard between banks. As I already quoted:

... this common European Deposit Insurance Scheme would be privately funded through ex ante, risk-based fees, paid by all the participating banks and devised in a way that would prevent moral hazard (however, as the existing national Deposit Guarantee Schemes already collect risk-based fees, a euro area system based on the transfer of the national fees would arguably itself be risk-based). In the EDIS context, while the existence of the Single Supervisory Mechanism and the Single Resolution Fund already act as partial deterrents against ‘free riding’ behaviour, the use of risk-based variable fees (therefore higher for riskier banks) set and collected by a central euro area institution (therefore avoiding the ‘institutional capture’ that arguably affected some bank systems in the run-up to the sovereign debt crisis) would likely be the best way to avoid moral hazard.

About the 2008 bailouts. The shadow banking system is separate from banks which were insured by deposit insurance. Moreover, the United States government did not unilaterally transfer funds to ailing financial institutions during the crisis. Then, even if shadow banks were given insurance, this is why proposal uses a borrowing mechanism rather than sourcing funds directly.

If your disad's impact is that nations no longer will invest time and money into building their own DI programmes when the WA one would take centre stage, then warrant why that is more important than the efficiency gains.

So why do you encourage member states to have their own deposit insurance schemes at all? It seems like this would actually detract from what you're trying to do. Yet it still seems much more preferable to make sure states are doing their part before imposing risks and potential losses to the WA membership as a whole.

Because nations might want to insure deposits to a higher degree than the WA Fund would be willing to?... Doing so has clear benefits, as it would keep liquidity open to firms and businesses while having a defined maximum benefit. Broadly, see Massachusetts:

https://en.wikipedia.org/wiki/Depositors_Insurance_Fund
About above, also see: http://archive.boston.com/business/pers ... pos_3.html

The idea of having states wholly involved in the issue is similar to what the EU report talks about regarding all the options other than option (a). Broadly, while those options can be feasible, the EU report rejects those alternatives for variety of EU specific reasons. I would reject it for the main reason that cross-border buckpassing would still be highly problematic (e.g. Icesave). A reinsurance scheme would have the same moral hazard problems without a reliable arbiter. A system of organised bilateral transfers would be far too fragile in a systemic crisis.

[Kelssek]

So I wholly recognise the fact that Funds can become insolvent when systemic crises emerge. However, in the comparative, between a national status quo with deposit insurance with a government backstop and this proposal's world, that chance is lower and the costs to national inhabitants are smaller.

But while the chance of a catastrophic event may become lower, it is not (and cannot possibly be) zero. So the institution must still be designed for that contingency. Otherwise it's like saying we don't need lifeboats on a ship because it's so well-constructed.

It strikes me that this would turn the WA General Fund into a lender of last resort which does not have money-creation power and is legally forbidden from running a deficit (as that resolution states). Which is a really bad idea; it wouldn't be able to make a "whatever it takes" type of commitment because its limited resources are there for all to see. Furthermore, each WA member state is now on the hook to replenish the fund in case of a catastrophic economic event which they may not have had any involvement in.

This is indeed a big sticking point for my government, hence the concern about other states which may opt to offload their own deposit insurance onto the WA.

Because nations might want to insure deposits to a higher degree than the WA Fund would be willing to?...

I think what I'm saying is this proposal seems to be of two minds on whether it wants states to have their own deposit insurance or not. On one hand it actually bans states judged as incompetent from insuring their own deposits, and if I understand your points correctly, there is more efficiency and less risk if the pool is as wide as possible. Yet it "encourages" states to have their own schemes, which seems to run counter to that.

A system of organised bilateral transfers would be far too fragile in a systemic crisis.

[A very OOC point - Federal Reserve swaps were arguably the most important part of handling the worst systemic crisis IRL.]

[Imperium Anglorum]

But while the chance of a catastrophic event may become lower, it is not (and cannot possibly be) zero. So the institution must still be designed for that contingency. Otherwise it's like saying we don't need lifeboats on a ship because it's so well-constructed.

I don't see how the institution is not designed for this contingency. The backstop mechanism is right there in the text.

It strikes me that this would turn the WA General Fund into a lender of last resort which does not have money-creation power and is legally forbidden from running a deficit (as that resolution states). Which is a really bad idea; it wouldn't be able to make a "whatever it takes" type of commitment because its limited resources are there for all to see. Furthermore, each WA member state is now on the hook to replenish the fund in case of a catastrophic economic event which they may not have had any involvement in.

Historically, the magnitude of depositor losses has not required actually drawing upon the backstop. The FDIC considered, but decided against, drawing on monies from the Treasury during the last financial crisis. I am not particularly, however, familiar with the national EU systems. Importantly, the size of the United States' depositor market is a better metric for understanding the funding at the size of the EU or that of the World Assembly. In addition, the presumption of effectiveness in GA bureaucratic agencies, to me, would imply a broadly lower chance of Fund depletion.

Given, however, drawing on the backstop, regarding the deficit specifically, the General Fund is large and diverse enough to satisfy these constraints, under the historical interpretation of the General Fund's size given by Frisbeeteria. Moreover, the authority to create money is not necessary. The backstop in the United States is to the Treasury, which does not control the money supply, and the proposed one in the European Union would not be to the European Central Bank.

This is indeed a big sticking point for my government, hence the concern about other states which may opt to offload their own deposit insurance onto the WA.

I've been OOC the entire time. I'm not sure to whom your IC ambassador, if it is in fact IC, is responding.

Because nations might want to insure deposits to a higher degree than the WA Fund would be willing to?...

I think what I'm saying is this proposal seems to be of two minds on whether it wants states to have their own deposit insurance or not. On one hand it actually bans states judged as incompetent from insuring their own deposits, and if I understand your points correctly, there is more efficiency and less risk if the pool is as wide as possible. Yet it "encourages" states to have their own schemes, which seems to run counter to that.

The latter clause should be interpreted, in light of the first clause, to encourage only those nations which are permitted to set up deposit insurance schemes to do so. The specific portion that I used to justify this was already highlighted and brought to attention in January and then repeated in the FAQ and the last post. EDIT:

While perfect transparency, deterrency and accountability are of course un- likely, each country's institutional environment can perform better or worse along these dimensions. High readings on these dimensions assure that parties in the private and public sectors can be expected to enforce appropriate bank behavior by evaluating bank activities, disciplining bank risk taking and resolving financial difficulties promptly. Around the globe, large differences exist in each of these contracting features. Across countries and cultures, proxies for transparency, de- terrency and accountability tend to increase with per capita GDP (Kane, 2000)- but other elements of social capital play a role as well.

Deposit insurance arrangements-and other elements of the regulatory safety net-must address the weaknesses that exist in the institutional environment of individual countries. In broad terms, institutional environments for financial mar- kets are fairly similar in high-income countries of the world. But as per capita income falls, the contracting environments tend to become more diverse. This diversity of institutional circumstances suggests that any proposed combination of "best-practice" design features for deposit insurance may generate counterproduc- tive consequences in more than a few developing countries. Indeed, for countries in which transparency, deterrency and accountability are very weak, implementing an efficient explicit deposit insurance scheme may be impossible (Id. at 182).

A system of organised bilateral transfers would be far too fragile in a systemic crisis.

[A very OOC point - Federal Reserve swaps were arguably the most important part of handling the worst systemic crisis IRL.]

Could you clarify what you mean with this? What is the warrant and what is the impact?

[Kelssek]

I don't see how the institution is not designed for this contingency. The backstop mechanism is right there in the text.

Maybe I should rephrase. The backstop mechanism involves borrowing from the WA General Fund, and this has the potential to impose a massive cost on all member states in event of a crisis that overwhelms the deposit insurance fund insolvent. Our government, and I imagine some other member states, finds this unacceptable. Historically, the autopilot does not override the pilot's attempt to not to crash into the sea. I think I see that the concern is with optimizing. But it is increasingly looking like that introduces a huge uncertain cost for everyone.

[OOC] If we can handwave perfect information and that the General Fund always has enough money... Then I guess it's moot, but wholly unsatisfying.

Could you clarify what you mean with this? What is the warrant and what is the impact?

I guess by pointing out this factoid I mean that all those things you mentioned as tools to deal with financial problems are part of a healthy breakfast and shouldn't just be casually dismissed, but this is a side issue which isn't all that important here.

[Imperium Anglorum]

Maybe I should rephrase. The backstop mechanism involves borrowing from the WA General Fund, and this has the potential to impose a massive cost on all member states in event of a crisis that overwhelms the deposit insurance fund insolvent. Our government, and I imagine some other member states, finds this unacceptable. Historically, the autopilot does not override the pilot's attempt to not to crash into the sea. I think I see that the concern is with optimizing. But it is increasingly looking like that introduces a huge uncertain cost for everyone.

Before I respond, I want to clarify these claims. First, I think you are objecting to the sharing of costs. Is this correct? Second, do you mean that the autopilot doesn't override an attempt to crash into the sea? Or, rather, could you explain this metaphor/analogy? Third, what specifically about optimisation do you have objection or comment to?

[Araraukar]

"Given that the main opposition is the fear of giving irresponsible banks the freedom to not care about their responsibilities, because the WA will always bail them out, and the author's repeated reassurances that that's not what is intended to happen, would not that be easiest achieved by simply decoupling this new fund entirely from the General Fund by removing the last part of 2.f.? If the author is unwilling to do that for some reason, then they should perhaps ensure that the member nation - or nations, in the case of multinational banks - in which the bank operates, would be the first and foremost payer if the insurance fund didn't have sufficient funding. That way nations that haven't allowed short-sighted capitalists to fuck up everyone's finances wouldn't have to pay for the follies of nations that have. If the author is truly sincere in their attempts to force banks to shoulder their responsibilities, then those are the two easiest ways to do so. I would suggest removing all mentions of the General Fund. Let those that want to play the game, pay for the consequences."

[Kelssek]

It is indeed the sharing of costs, the potential cost to all member states of bailing out the deposit insurance fund, if it were to be overwhelmed by a future crisis. Especially because it does not require all states have their own deposit insurance, or to have committed their own resources first.

And am I right in saying that even in normal circumstances where the fund successfully handles a major bank failure, premiums for all customers would typically rise?

A big reason we seem to be talking past each other is that your objective seems to be about more efficiency for banks and pooling as much risk as possible, but our position has to do with ensuring that bank collapses in some countries will not become the burden of all WA member states.

As for the parable of the 737Max Maneuvering Characteristics Augmentation System, I guess it is quite culturally specific. I will defer to our Spiritual Attaché (Visiting), Rev. Bieber Carlson of the Church of the Volatile Beta, to explain:

The Profane Scriptures tell of an aviation industry where one-in-a-million chances are too risky because that means a deadly disaster every 10 or so days. In banking, one is more willing to take risks, of course.

One of the airplane makers created an autopilot system designed to improve safety by overriding the pilots in certain circumstances. This allowed the plane to use efficient new engines without having to re-train pilots qualified to fly the older model. Such systems had worked fine in the past. But in practice these features created an unanticipated, catastrophic flaw, one that was only obvious after it had caused crashes that killed hundreds of people.

One does not design a safety system expecting it to fail. It is right to be concerned with creating a system that is beneficial “usually” and “historically”, yet rare catastrophic events are unusual, precisely because they are not expected. For it is written, “past performance is no guarantee of future results”.

Thank you, Reverend. The point being that the probability of a catastrophic bank failure that renders this deposit insurance fund insolvent cannot be zero, and historically has been severely underestimated by the most competent experts with the biggest incentives to get it right. And in seeking out efficiencies, we shouldn't magnify the potential impact by forcing all WA states to be on the hook for the next financial disaster.

[Imperium Anglorum]

Especially because it does not require all states have their own deposit insurance, or to have committed their own resources first.

Would you support a mandate to have deposit insurance? A mandate to commit state resources first?

[Kelssek]

It would greatly increase the chances. Here are suggestions on how to make room:

In the preamble:

Whereas bank runs can bankrupt a bank, leading to all the depositors' savings disappearing in a flash of mania, sharply reducing economic activity, making everyone poorer, and harming all workers and consumers;

This saves 79 characters.

I suggest also swapping sections 1 and 2. This way you save on spelling out “DIF” in section 1. It also flows better because we know what the Fund does before you tell states what they have to do in relation to it.

Section 4 becomes this, with a clearly defined scope that prevents mission creep:

The Fund shall have the power to create regulations on minimum reserve requirements, capital adequacy requirements, liquidity requirements, and corporate governance in IDIs, and other matters directly related to its mandate. Member nations shall enforce these regulations.

The old section 1 becomes:

All member nations shall establish a deposit insurance scheme that meets or exceeds the protective standards given by the Fund. The Fund shall provide technical assistance to enable member states to build the necessary institutional capacity to credible insure deposits, where this is lacking.

This is 571 instead of 911 characters, give or take. Hope this is helpful.

[Kelssek]

simply decoupling this new fund entirely from the General Fund by removing the last part of 2.f.? If the author is truly sincere in their attempts to force banks to shoulder their responsibilities, then those are the two easiest ways to do so. I would suggest removing all mentions of the General Fund. Let those that want to play the game, pay for the consequences."

I thank the hon. ambassador for this intervention. A further point is that although a deposit insurance fund does help to reduce the chances of a financial disaster, once it happens it can't really be handled by a deposit insurance fund alone. Better to have every incentive for those governments and central banks with something at stake to act, and remove the thought that loans from the WA General Fund can be a source of liquidity.

[Imperium Anglorum]

So you think nations ought to have Deposit insurance. So how would you solve the problem of banks which operate across borders? Banks in the modern era are highly interconnected. How would you reconcile differences in regulatory criteria between those nations?