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[DRAFT] Deposit Insurance Fund

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Imperium Anglorum
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[DRAFT] Deposit Insurance Fund

Postby Imperium Anglorum » Wed May 30, 2018 3:08 pm

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Whereas bank runs can bankrupt a bank, leading to all the depositors' savings disappearing in a flash of mania:

And whereas everyone suddenly no longer having any savings sharply reduces economic activity and poses an extreme hazard to national populations;

And whereas (1) banks are central to modern payments systems and (2) protections for firms or certain asset classes in specific circumstances do not necessarily protect savers from having their life's work wiped out in an instant:

Be it enacted by the World Assembly, as follows:

  1. All member nations are encouraged to establish a deposit insurance scheme that meets or exceeds the protective standards given by the Deposit Insurance Fund. All depository institutions are encouraged to enrol, and all such institutions with demand accounts are required to enrol, in the Deposit Insurance Fund.

  2. There shall be established a Deposit Insurance Fund, hereinafter referred to as the Fund, with the following mandates. "Insured depository institutions" (IDI) refers to those institutions the Fund insures.

    1. Depository institutions enrolled in Fund insurance pay premiums in proportion to the amount and risk of Fund-insured deposits. Extra premiums may be levied against what the Fund believes are systemically important institutions. IDIs receive a certificate and the ability to advertise that their deposits are insured by the Fund. Member nation institutions not insured by the Fund may not make fraudulent claims that they are so insured.

    2. If an IDI declares bankruptcy or is judged by the Fund to be critically undercapitalised, the Fund shall resolve it. The deposits insured by the Fund shall be determined ex ante by an insurance limit for that member nation as a whole, set by the Fund after taking that member nation's advice.

    3. The Fund shall resolve IDIs using one of the following options with the least cost to the Fund: (i) It may pay out to the depositors of such an institution their insured deposits. (ii) It may sell such an institution, or parts thereof, to another IDI, with some proportion of expected losses shared by the Fund, set at the Fund's discretion. (iii) It may advance liquidity support to such an institution if the Fund believes that the institution is systemically important. (iv) It may administer the IDI until such time that it is able to take other action cost-efficiently.

    4. In all cases where the Fund closes an insolvent IDI, it must (i) make reimbursements to depositors forthwith and (ii) liquidate the unsold assets and liabilities under receivership, distributing proceeds to stakeholders per section 3 infra.

    5. The Fund shall collect and supervise the collection of financial and legal information to determine the risk of failure and therefore, appropriate premiums to be levied on IDIs. It may release to the public non-sensitive information that it believes useful in furthering depositor discipline or improving transparency of the banking sector.

    6. The Fund may require IDIs to pre-pay premiums, in exchange for credit against future premiums, within a reasonable time window. When the Fund does not have the money necessary to secure its mandate and is unable to raise the adequate liquidity from IDIs without severely weakening remaining institutions, it may borrow from IDIs or incur amortised non-callable fixed-rate liabilities secured against future General Fund assessments.
  3. The Fund shall distribute monies raised at the liquidation of an IDI in the following order: (a) the Fund itself, in remuneration for expenses incurred in that liquidation, (b) insured depositors if they have not yet been fully reimbursed, (c) uninsured depositors, and (d) all other stakeholders according to the bankruptcy procedures of the relevant jurisdiction. The Fund may issue an advance dividend against the estimated value the receivership.

  4. The Fund shall have the power to create and enforce regulations needed to ensure that it can efficiently, and effectively carry out its mandate. Member nations must enforce and IDIs comply with such regulations; both must provide whatever information is so required. IDIs shall send to the Fund standardised consolidated reports of income and condition at regular intervals on standards specified by the Fund. After considering a cost-benefit analysis, the Fund or superseding institutions shall issue regulations establishing minimum reserve requirements, capital adequacy requirements, liquidity requirements, and corporate governance standards in IDIs. Such regulations must be periodically reevaluated.

  5. The Fund shall release consolidated reports of income and condition at the close of each quarter and liaise with deposit insurance programmes within member nations to provide guidance and assistance in fulfilling mandates concurrent with those of the Fund.
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Frequently asked questions and raised objections

Postby Imperium Anglorum » Wed May 30, 2018 3:08 pm

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I might just happen to know a bit about deposit insurance. :P Also, wow, this thing is currently (as of 30 May 2018) 4663 characters long. We're really pushing against the new character limit. Currently 4919 4868 4884 characters (30 Oct 2019) 4877 (3 Dec 2020).

Why is banking an international issue?
At the start, capital is fungible. It moves easily.

Five reasons.

Deposit insurance is absent in international banking. This means that interbank deposits and other wholesale funding sources are unprotected, which increases the chances of bank runs and causes problems for deposit-holders in banks with international presences.

Second, there are no general binding overseas reserve requirements. No country can generally impose reserve requirements over its own banks' overseas branches because of highly technical and difficult-to-agree-upon internationally uniform regulations. This arises because different nations have different preferences for bank regulations. In the real world, this has become less of an issue after stuff like Basel. Making basic safety regulations universal solves this.

Third, bank examinations are difficult in multiple jurisdictions. Examinations require regulators to keep track of foreign subsidiaries. This is difficult because any one state cannot always compel the production of data in another state.

Fourth, differing regulations between different jurisdictions permit banks to move risky business practices to areas with lax regulations where nobody will say anything. This also makes it unclear which regulators are responsible – especially with strong domestic pressure to ring-fence assets or make whole domestic depositors only – which leads to buckpassing.

Fifth, it's not clear which country should provide liquidity support. If the other proposal of mine passes, this becomes less acute. However, it still has something of a problem insofar as nations may still want to rescue banks which are not in fact solvent in the long run. This can be problematic. I've left it up as a question for another time, but this can be an issue insofar as nations don't want to waste their money rescuing foreigners.

Sixth, (I lied.) countries have to cooperate to resolve a multinational bank's failure. This is difficult and uncertain. These problems create uncertainty in markets on when one can get their money back and imposes costs on depositors. On top of that, the state of being complex incentivises governments to bail banks out instead of descending into a years-long resolution. This creates greater moral hazard.

This relates heavily to the list of safeguards I have under a different thread. This satisfies the deposit insurance and bank examination safeguards.

Broad introductory facts
This section will obviously be massively biased towards the United States, mostly because my expertise is in how deposit insurance works in the United States. However, broadly, because deposit insurance is mostly the same everywhere, this does cross apply substantially.

What is a bank run? Banks do not hold everyone's money in a vault. If they did, they would not make any money and would instead charge you to hold money in the vault. Banks are financial intermediaries. This means that they take the deposits and loan it to other people. These loans are broadly extremely good: credit allows small businesses to borrow to buy new computers, new machines, hire new workers, etc. It also allows people to purchase homes without saving for a lifetime and purchase the things they want more broadly. But when banks run low on money and people find out—or if there is a rumour that this will happen—everyone comes to the bank to take their money out. Such a bank suffers an outflow of liquid cash—a run—and is unable to fulfil its obligations. This causes the bank to go bust and most everyone loses all their money. This is bad. By insuring deposits and guaranteeing that people get some of their money, runs are less likely and people are not scared of their banks going belly up.

What is depositor discipline? If banks know that they lose their main funding source—deposits—if they do risky things and have low capital, they have lower incentives to do those things. This is a reason as to why bank financial information should be released and truthfully audited. The easiest way to do this is to have a government entity do it. Alternatively, in the pre-New Deal era in the United States, many banks would advertise their capital and financials in newspapers. The truthfulness of these adverts is not particularly known to us today (especially as the real internal figures are unknown).

What is an insurance limit? An insurance limit is the amount that one is insured to in the event of failure. If the insurance limit is 100 credits and you have 150 credits, you have 50 credits uninsured and 100 credits insured. If the bank failed, you would receive 100 credits back because they were insured. The other 50 would go poof. This raises another question.

Who are the uninsured depositors? Uninsured depositors are people with money in accounts above the insurance limit. These are normally businesses and rich people. Businesses handle lots of money all the time, factories which take in large orders and ship will need to have money to meet near-term needs. When their banks fail, without very prompt resolution, those businesses too will go under. If they do, the workers get laid off. The customers with whom those firms have relationships have to find new suppliers, and it's a pig's breakfast.

How many uninsured deposits are there and what are current limits? The insurance limit is not specified in the proposal. The authority to make this determination is granted to the Fund because the specific place to put such a limit depends on market structure, a nation's wealth, and the health of that nation's banking system. However, in the US, about 30 per cent of all deposits are believed to not be insured (the US has complicated insurance rules which defy easy determination) and the insurance limit is set by account to a maximum of 250 thousand dollars.


Moral hazard and risk sharing.
Regarding a very similar plan analysed by the EU Commission's European Political Strategy Centre:

1. The costs needed for a nation itself to immunise depositors against risk are reduced compared to the status quo because of increased efficiency from less correlated shocks.
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.

2. Risk-adjusted premiums solve moral hazard problems.
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.

3. DI lowers incentives for state monitoring? Well, that's why the proposal gives the insurer power to monitor and discipline banks. See above; see generally,
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. Asli Demirgüç-Kunt and Edward J. Kane, Deposit Insurance around the Globe: Where Does It Work?, 16 Journal of Economic Perspectives 175 (2002).

Borrowing? Or, "why is a backstop necessary?".

1. EU Internal Think Tank Report
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 ...

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. EU Commission internal think tank report (2015).

2. JEP 2002
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).


"But all my banks are public". Nationalising the banks doesn't eliminate bank runs. They can still happen. When they do, they are worse. See here for explanation. More broadly, at the theoretical level, Diamond-Divbig bank runs are not particularised only to certain types of ownership structures.

Real life analogies? See EU Commission's European Political Strategy Centre: https://op.europa.eu/s/oaeQ; also at https://doi.org/10.2872/512000

Further proposals? Yes. Probably establishing something like a discount window and further details on bank regulations. But given the multitude of currencies, the former would be difficult without an integrated system of monetary exchange or simple delegation of that authority to member nation monetary authorities.
Last edited by Imperium Anglorum on Thu Dec 03, 2020 9:06 am, edited 24 times in total.

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Postby Sierra Lyricalia » Wed May 30, 2018 6:49 pm

"In the event of institutional insolvency which is judged more likely than not to have been caused by misconduct on the part of officers or employees of that institution, the Fund shall have authority to recover the personal assets of such employee(s), notwithstanding any shelters, subsidiary holdings, international borders, or 'corporate veil' that may purportedly shield such assets."
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Imperium Anglorum
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Postby Imperium Anglorum » Wed May 30, 2018 7:43 pm

Regarding the above. I'm not a big fan of such actions to be performed by an insurance company in the case of fraud (which is the usual source of the problems that you are talking about). There really isn't any franchise value in the failed institution, because nobody is willing to buy it. In fact, in the period around 1990 to 2006, of all resolutions, practically all the payout ones were results of fraud (at least in the United States). Payouts take longer and practically destroy the franchise value of the failed institution. Quite simply, there aren't really any assets that can be repossessed by the insurance system.

Rather, I would see this as a matter that could be pursued by the shareholders, creditors, and uninsured depositors (I'm going to use the word stakeholders hereinafter) via the courts. There simply aren't financial assets which can be liquidated to reimburse stakeholders. The main form of deterrence against fraud is basically criminal law.

EDIT: If you're not talking about fraud, I have no idea what you mean by misconduct. Insofar as misconduct is completely undefined and extremely ambiguous, I'm unwilling to put it in the proposal. There are a lot of actions, for example, ignoring your risk management team, that some would consider misconduct in hindsight, but should not actually be illegal due to issues with universalisability of such a rule.
Last edited by Imperium Anglorum on Thu May 31, 2018 5:48 am, edited 4 times in total.

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Jarish Inyo
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Postby Jarish Inyo » Thu May 31, 2018 9:31 pm

Opposed. The Empire is not responsible for individuals or companies finances. We do not insure so called banks or lending institutions. Nor will we be forced to do so.
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Postby Kenmoria » Fri Jun 01, 2018 3:46 am

Jarish Inyo wrote:Opposed. The Empire is not responsible for individuals or companies finances. We do not insure so called banks or lending institutions. Nor will we be forced to do so.

"We are opposed for the same reason as the Jarish Inyo delagation. A large percentage of banks are completely privatised in Kenmoria, and recieve little to no help. This is an excessive violation of national sovereignty."
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Postby Imperium Anglorum » Fri Jun 01, 2018 1:59 pm

ELSIE MORTIMER WELLESLEY: The only response I can think of to the delegation who seemingly can only respond with We shall not X is You shall. Simply because their ability to actualise their preferences in the Assembly has no credibility. They have opposed practically every resolution in the past few years, and that has not stopped anyone.

The question of whether it is a violation of national sovereignty is neither here nor there. The purpose of the Assembly is to restrict sovereignty. If you really believe that it is a step too far, resign.

Nevertheless, there are considerable advantages to increasing the breadth of premiums. Insurance companies have the same kinds of issues in procuring liquidity as financial institutions have, just in different sectors. Decreasing correlation by broadening income sources helps to get around that. Furthermore, banks receive practically no assistance under this scheme. The vast majority of banks which fail would either be liquidated with assets paid to depositors and stakeholders or merged into another bank. The main objective of this scheme is to protect depositors.

Nor would this proposal restrict the ability for nations to determine their own depositor schemes, insofar as they provide the same level of protection as the main scheme. Ceteris paribus, that should be more expensive due to a nation's necessarily smaller and more highly correlated cash flows, increasing the amplitude of exogenous shocks to any national fund, but that is really your problem.

If you don't care about depositors, then that's really just your problem. Strengthening transmission mechanisms between capital markets and the real economy isn't a good idea when capital markets are considerably more pro-cyclical than real output. Have fun with your comparatively worse recessions. And when consumers are less trustworthy of their deposits, they move primarily to larger banks with more capital that are more likely to weather any shocks. Godspeed with your higher level of financial consolidation and lower capital productivity.
Last edited by Imperium Anglorum on Fri Jun 01, 2018 2:09 pm, edited 3 times in total.

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Postby Imperium Anglorum » Thu Jun 14, 2018 7:25 am

I came across an interesting statistic in an NYU Stern working paper’s introduction that I think is quite relevant here at establishing the level of harm that we’re talking about in this topic. In the period 1921 to 1933, in the United States, more than 13 000 banks failed. In 1933 alone, more than 4 000 banks failed. And in that same year, the US government introduced the Banking Act of 1933, which created a deposit insurance scheme. From 1933 to 2014, there have been 4 057 failures in total. That’s an astonishing discontinuity.

It also isn’t something that that goes away when you weigh by asset levels. Bank runs in a world absent depositor insurance do not scale non-linearly with depositor account numbers. The real question effectively becomes on of convertibility and information transmission. And even in one that is reasonably interconnected like the 1930s, the size of this discontinuity is only slightly different when weighted by bank asset levels.
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Postby Desmosthenes and Burke » Thu Jun 14, 2018 8:48 am

Kenmoria wrote:
Jarish Inyo wrote:Opposed. The Empire is not responsible for individuals or companies finances. We do not insure so called banks or lending institutions. Nor will we be forced to do so.

"We are opposed for the same reason as the Jarish Inyo delagation. A large percentage of banks are completely privatised in Kenmoria, and recieve little to no help. This is an excessive violation of national sovereignty."


Given the way this is currently worded, our suggestion would be to decline to set up a national scheme pursuant to clause 1, and refuse to require your institutions to join the WA scheme also pursuant the clause 1. Some of them may still choose to do so, but at that point longue vie au marché libre and your government, at least, is not insuring anything.
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Postby Imperium Anglorum » Thu Jun 14, 2018 12:54 pm

Whoops. I guess that grammatical construction was ambiguous.

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Postby Christian Democrats » Thu Jun 14, 2018 1:21 pm

This proposal has our full support.

In subsection 2(d), the "3" should be changed to a "iii."
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Postby Imperium Anglorum » Thu Jun 14, 2018 1:36 pm

My thanks to CD.

The ‘under section 3’ is a reference to section 3, not a continuation of the list.

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Postby Christian Democrats » Thu Jun 14, 2018 1:46 pm

Ah, yes, I was reading the proposal too quickly.
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Postby Imperium Anglorum » Wed Jan 09, 2019 4:47 pm

So I'm also resurrecting this.

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Postby Naboompu » Wed Jan 09, 2019 7:58 pm

Personally, I support. Financial regulations are conspicuously absent from current WA legislation.

But why the current category? I suspect the category of regulation and area of effect of consumer protection would do the trick better than social justice. It is certainly significant enough in strength to be categorised as a regulation, no?

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Postby Imperium Anglorum » Wed Jan 09, 2019 10:21 pm

Bank runs affect all depositors and borrowers (as well as increasing pressure on all banks which might be linked to that bank). Social justice has general welfare implications, rather than simply consumer protections. If the area of effect "Increas[es] consumer rights, product standards, accurate labelling, and legal recourse for consumer David against the corporate Goliath", this probably doesn't do that, because not only does it impute market regulatory power from depositors to a regulatory organisation, but also defers general creditor claims against failed institutions to that regulatory agency. There also isn't really anything having to do with product standards or accurate labelling.

Of course, the real reason why this isn't marked as anything to do with consumer protection is because the draft predates the category.

Whether it fits into consumer protection, a new category with unknown boundaries, is a topic on which I would welcome the Secretariat to advise.

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Postby Tinfect » Wed Jan 09, 2019 10:22 pm

OOC:
Aside from the fact that this is another draft that seems to be almost deliberately made nearly incomprehensible, let me get this straight; you're basically making a WA FDIC?

And, the last clause, surely you can't actually mean to give a WA committee direct legislative power in Member States?
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Postby Aclion » Wed Jan 09, 2019 10:31 pm

The term insured depository institutions is rather deceptive. It implies that deposits in institutions which are not part of the WA deposit insurance scheme are not insured. We would prefer the term World Assembly insured depository institution. Also why are clauses 3 and 4 not subclauses of 2? I believe that by "the fund" they refer to the World Assembly's Deposit Insurance Fund

Tinfect wrote:OOC:
Aside from the fact that this is another draft that seems to be almost deliberately made nearly incomprehensible, let me get this straight; you're basically making a WA FDIC?

And, the last clause, surely you can't actually mean to give a WA committee direct legislative power in Member States?

This is legible enough. He's still bloviating but it's not so full of jargon that some clauses are meaningless.
Last edited by Aclion on Wed Jan 09, 2019 10:37 pm, edited 2 times in total.
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Postby Imperium Anglorum » Wed Jan 09, 2019 10:44 pm

Tinfect wrote:OOC: Aside from the fact that this is another draft that seems to be almost deliberately made nearly incomprehensible,

If this were in character, I'd write something like:

Appleby: (Shoves a New Sterling note into Wellesley's hand, visibly frowning)
Wellesley: You lose.

Tinfect wrote:let me get this straight; you're basically making a WA FDIC?

Yea. If you look in #eggnog you'll know why.

Tinfect wrote:And, the last clause, surely you can't actually mean to give a WA committee direct legislative power in Member States?

Definitely. We already do that in some cases and there are large enforcement/credibility issues if you can't. There are also limitations to make sure that regulations in fact have to do with being able to credibly carry out its mandate. So, if you think something absurd like "The Fund can ban capital punishment", it can't.

Aclion wrote:The term insured depository institutions is rather deceptive. It implies that deposits in institutions which are not part of the WA deposit insurance scheme are not insured. We would prefer the term World Assembly insured depository institution. Also why are clauses 3 and 4 not subclauses of 2? I believe that by "the fund" they refer to the World Assembly's Deposit Insurance Fund

I've changed the language there to simply use IDI within the resolution. Also, banks insured by the FDIC are termed IDIs in the Federal Deposit Insurance Act, even when state deposit insurance networks exist (or existed, as in the case of the Ohio Deposit Guarantee Fund).
Last edited by Imperium Anglorum on Wed Jan 09, 2019 10:56 pm, edited 2 times in total.

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Re: [DRAFT] Insurance Against Bank Runs

Postby Yohannes » Thu Jan 10, 2019 6:23 am

Naboompu wrote:Personally, I support. Financial regulations are conspicuously absent from current WA legislation.


Some questions I have, but I support this too!

Naboompu wrote:But why the current category? I suspect the category of regulation and area of effect of consumer protection would do the trick better than social justice. It is certainly significant enough in strength to be categorised as a regulation, no?


I can see why Imperium Anglorum has chosen the "Social Justice" category. In the middle of a nationwide panic where multiple bank failures are happening (I can especially see this happening in my fictional roleplayed nation on NationStates), there will inevitably be huge disruption on one's monetary system - and this will severely reduce production (thus affecting people's welfare)

That is, from a macroeconomic perspective, bank runs are costly and will impact a fictional roleplayed nation's welfare (the people) by disrupting production

Hi Imperium Anglorum,

My apologies if this has been asked before! I have a few questions concerning this proposal

1.) "The Fund shall collect information and supervise the collection of such information to determine the risk of failure and therefore, appropriate premiums to be levied on IDIs. The Fund is empowered to release such information to the public that it believes useful in furthering depositor discipline."

Just a wee bit concerned about the underlined part. By "information", I'm guessing sensitive fictional information (of my fictional banks or institutions) will be included there? How far will the power of the Deposit Insurance Fund go? Can my fictional bank in my fictional nation refuse to give information (and internal reports) they believe are too sensitive to be released?

2.) In some nations out there, realistically government deposit insurance schemes already add on the existing allocations that markets of the citizen sector can provide. I'm guessing that the purpose of this WA-wide Deposit Insurance Fund is to create an even stronger/more comprehensive scheme (i.e. more resources/security power with more participants involved) to protect those WA nations which have agreed to register themselves under this WA-wide fund?

3.) Government deposit insurance ensures that the promised return will be given to those who withdraw. If this guarantee is of real value, however, the government must then impose tax to fulfill the promise of the deposit guarantee (or inflation tax on nominal assets caused by money creation for nominal guarantee). I'm guessing that the WA Fund will also do something similar ("levied against what the Fund believes are systemically important institutions") imposed on member nations/registered nations' funds?

4.) In real life, some governments (and opposition parties) and (national) monetary authorities have opposed deposit insurance schemes because they believe that the moral hazard presented is too high. What is your opinion on this?

In the case where managers are given the ability to select portfolios relatively free (though of course not completely) from outside interference, moral hazard issues would become a problem (affecting bank managers' optimal risk sharing versus portfolio incentives decision-making)

What would you tell those critics of a WA-backed deposit insurance scheme who worry about moral hazard problems and believe that multinational private bank managers will exploit the whole thing knowing that there's a WA-wide bailout fund ready to protect them?

Edit: Thank u for your time! And apologies for the random questions (probably it was a bad idea to just ask what was in my mind without drafting my post first!)
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Postby Imperium Anglorum » Thu Jan 10, 2019 7:28 am

(1) seems to just say ' add non sensitive '. The rest has to do with some interesting econ theory about moral hazard. There's a paper I was reading some months ago which has to do with this exact topic, which I can expound upon at length when I get home from work.

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Postby Imperium Anglorum » Thu Jan 10, 2019 4:48 pm

Yohannes wrote:1.) "The Fund shall collect information and supervise the collection of such information to determine the risk of failure and therefore, appropriate premiums to be levied on IDIs. The Fund is empowered to release such information to the public that it believes useful in furthering depositor discipline."

Just a wee bit concerned about the underlined part. By "information", I'm guessing sensitive fictional information (of my fictional banks or institutions) will be included there? How far will the power of the Deposit Insurance Fund go? Can my fictional bank in my fictional nation refuse to give information (and internal reports) they believe are too sensitive to be released?

No. Or, it would suffer fines and penalties which the Fund can create such to exert enough coercive force to require the presentation of truthful information. I've changed the language to require law-related and financial information. The transparent release of such information, I think, is also going to be definitely preferable: depositors should be able to tell if their banks will go under and so should the people who would be on the hook for it.

Yohannes wrote:2.) In some nations out there, realistically government deposit insurance schemes already add on the existing allocations that markets of the citizen sector can provide. I'm guessing that the purpose of this WA-wide Deposit Insurance Fund is to create an even stronger/more comprehensive scheme (i.e. more resources/security power with more participants involved) to protect those WA nations which have agreed to register themselves under this WA-wide fund?

There have been attempts to create a private deposit insurance scheme in the past. Cf 19th century Massachusetts. But most of them fail because of severe bank runs. The lack of an ability to credibly secure those funds means that people don't believe the insurance. In fact, this happened in an even greater extent: in the 1980s, the savings and loan crisis led to the collapse of the Federal Home Loan Bank Board, which was in charge of insuring the deposits of savings and loan institutions. An important thing to remember is that many times, these things are in fact implicitly guaranteed. People will still do the bank run because of uncertainty over whether it applies or not, and then the government will step in when the public outcry becomes too loud. See Asli Demirgüç-Kunt and Edward J. Kane, Deposit Insurance around the Globe: Where Does It Work?, 16 Journal of Economic Perspectives 175, 176 (2002) (explaining that "shifting from implicit to explicit deposit insurance, with explicit limits on coverage, may serve as a way to limit the government's commitment to depositors").

Yohannes wrote:3.) Government deposit insurance ensures that the promised return will be given to those who withdraw. If this guarantee is of real value, however, the government must then impose tax to fulfill the promise of the deposit guarantee (or inflation tax on nominal assets caused by money creation for nominal guarantee). I'm guessing that the WA Fund will also do something similar ("levied against what the Fund believes are systemically important institutions") imposed on member nations/registered nations' funds?

Not necessarily. The Federal Deposit Insurance Corporation funds its DIF (deposit insurance fund, formerly known as the BIF, the bank insurance fund) from dues paid by FDIC members. Dues should be levied, in my view, on three things: (1) the number of deposits under insurance, (2) the probability of payment, and (3) the systematic harm caused to the banking system by failure. What you quoted has to do with the third point supra.

Yohannes wrote:4.) In real life, some governments (and opposition parties) and (national) monetary authorities have opposed deposit insurance schemes because they believe that the moral hazard presented is too high. What is your opinion on this?

In the case where managers are given the ability to select portfolios relatively free (though of course not completely) from outside interference, moral hazard issues would become a problem (affecting bank managers' optimal risk sharing versus portfolio incentives decision-making)

What would you tell those critics of a WA-backed deposit insurance scheme who worry about moral hazard problems and believe that multinational private bank managers will exploit the whole thing knowing that there's a WA-wide bailout fund ready to protect them?

I'll quote at length. Apologies on some pseudo-line breaks. I highlighted what I think are some of the important points in this section.

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.

Controlling bank risk taking requires three characteristics: transparency, de- terrency and accountability (Kane, 2000). Complete transparency is obtained when institutions disclose information that perfectly and costlessly informs either bank creditors or supervisors about changes in a bank's financial condition and risk taking. Perfect deterrency describes a situation where individual creditors or su- pervisors can immediately understand the implications of information flows and can protect themselves completely and costlessly from any adverse consequences. Perfect accountability occurs when taxpayers can identify the actions of govern- ment officials and hold them fully responsible for the outcomes their actions engender.

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).

The mechanisms explicitly here to deal with this issue are three-fold:
  1. I prohibit the formation of deposit insurance schemes in nations with little capacity to do anything with them. This helps to deal with the institutional capacity argument.
  2. Premiums are risk-adjusted, i.e. if you do risky shit, then your premiums go up. So don't.
  3. Information is explicitly released to the public to further depositor discipline. In the status quo, at least in NationStates, you cannot be assured of information from these depository institutions. This (a) fixes that and (b) makes it more publicly accessible. Tempered depositor withdrawal, especially in the light of deposit insurance limits, helps to punish bad actors.
Moreover, on a moral point, while there is research clearly showing that depositors exercise discipline (see id. at 187), I don't believe that (a) most normal depositors exercise that discipline because they have informational acquisition barriers vis-à-vis bank financials and (b) those normal depositors should not be punished for other people's risk-taking of which they were unaware or of which they unable to be fully cognisant (see at a general level, a Millian paternalism framework). This is especially important when considering that one would expect that normal depositors are not financially sophisticated and have lower deposit levels. And considering that marginal propensities to consume are higher amongst poorer people than rich ones (see Tullio Jappelli and Luigi Pistaferri, The Consumption Response to Income Changes, 2 Annual Review of Economics 476 (2010)), the impact and celerity of such negative wealth shocks on aggregate demand and the real economy should definitely be mollified to the greatest degree possible.

Yohannes wrote:Edit: Thank u for your time! And apologies for the random questions (probably it was a bad idea to just ask what was in my mind without drafting my post first!)

These are excellent questions.
Last edited by Imperium Anglorum on Sat Jan 12, 2019 11:45 am, edited 1 time in total.

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Postby Karteria » Thu Jan 10, 2019 6:52 pm

"We support. Financial institutions – in this case, insured depository institutions – need protection against runaway consumers that can threaten the entire system. This proposal provides the necessary safety net for these institutions to keep operating so externalities do not hurt individuals to the extent where the entire system collapses."
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Postby Wallenburg » Fri Jan 11, 2019 1:39 am

I'm aware that this tackles things in a different manner than "Preventing Financial Crises", but are the two really simultaneously necessary? Seems like a whole lot of overkill.
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Postby Sierra Lyricalia » Fri Jan 11, 2019 11:40 am

Wallenburg wrote:I'm aware that this tackles things in a different manner than "Preventing Financial Crises", but are the two really simultaneously necessary? Seems like a whole lot of overkill.


OOC: IA can correct me if I'm misunderstanding these proposals, but here's my take in plain language:

To the extent that the WA has any business regulating international finance, the two proposals are regulating very different things. This one prevents and cures savings bank (i.e. "I have to go to the bank" banks) insolvency (which affects people's savings and wealth), while the other prevents and cures central or investment bank (i.e. banks that lend to your bank) insolvency, which is a proximate cause of savings bank insolvency. The problems and solutions faced by the different types of institutions are not identical, necessitating two different resolutions.
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