The European Commission has proposed changes to existing European rules to further improve protection for bank account holders and retail investors. Since 1994, Directive (94/19/EC) ensures that all EU Member States have in place a safety net for bank account holders. If a bank is closed down, national Deposit Guarantee Schemes are to reimburse account holders of the bank up to a certain coverage level.
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1) What is a Deposit Guarantee Scheme?
A Deposit Guarantee Scheme acts as a safety net for bank account holders in case of bank failure. If a bank is closed down, the scheme is to reimburse account holders of the bank up to a certain coverage level. A 1994 Directive ensures that all EU Member States have Deposit Guarantee Schemes in place.
2) Why is the revision of the Directive on Deposit Guarantee Schemes necessary?
The Directive on Deposit Guarantee Schemes has not been changed substantially for about 16 years although financial markets have significantly changed since then.
The 1994 Directive introduced minimum harmonisation for Deposit Guarantee Schemes; this meant that there were only a few basic requirements for Member states to follow up. As a result, Deposit Guarantee Schemes between countries vary significantly on the level of coverage, the scope of covered depositors and products and the payout delay. Also, the financing of schemes has been left entirely to Member States. This has turned out to be disruptive for financial stability and the proper functioning of the Internal Market. For example, when the crisis deteriorated, many depositors shifted money in the UK from British banks to branches of Irish banks in the UK, since Ireland had unilaterally introduced unlimited deposit guarantees. This led to a severe and abrupt draining of liquidity from the British banks, making them very vulnerable.
Therefore, the Commission aims at harmonising and simplifying the Directive in order to confirm the required level of deposit protection, reimburse account holders more quickly and ensure schemes are properly funded. These new funding requirements will improve the confidence of savers and ensure long-term financial stability.
3) What is the current level of deposit protection in the EU? How is this going to change in the future?
When the financial crisis hit in autumn 2008, Member States decided that the level of deposit protection should be gradually but quickly increased in the EU. A Directive adopted in March 2009 required coverage to be increased from a minimum of 20 000 to at least 50 000 by June 2010 and to a uniform level of 100 000 by the end of 2010. Today’s proposal following an impact assessment on the move to 100 000 confirm the 100 000 figure.
On the basis of a coverage of 100 000, 95% of eligible accounts will be fully covered, 7% more than before the crisis.
4) Which deposits and depositors will be protected?
Deposits are covered per depositor per bank. This means that the limit of 100 000 applies to all aggregated accounts of one account holder at the same bank. So this will include his or her current account, savings account and other accounts he or she might have in any one bank.
Deposit Guarantee Schemes will protect all deposits held by individuals and small, medium-sized and large businesses. However, deposits of financial institutions and public authorities will not be covered. The former do not need protection since they are professional market actors and the latter would have easy access to other sources of financing.
Deposits in non-EU currencies will also be covered, which is important for small and medium-sized businesses acting globally. Some more complex products similar to bonds will not be covered. Structured products whose principal is not repayable in full will not be protected (e.g. products whose value is dependent on a share price index).
This simplification and harmonisation will contribute to more transparency for savers and to quicker reimbursement in the event of a bank failure.
5) How quickly will bank account holders get their money back after a bank failure?
Currently, account holders must be paid within three months after a bank failure. By the end of 2010, this delay has to be reduced to between four and six weeks. Today’s proposal shortens the pay out delay to one week. This is important as account holders can face important financial difficulties within a few days for example when they must pay bills.
6) Is a 7 day payout of deposits feasible?
Yes. This already happens in the United States and will happen soon in the UK.
To make this 7 day deadline work, managers of Deposit Guarantee Schemes will be informed at an early stage by supervisory authorities if a bank failure looks likely. Banks will be required to mark eligible deposits in their books and to maintain up-to-date records. If a bank fails, no application from bank account holders will be needed; the scheme will pay out automatically.
7) Will Deposit Guarantee Schemes have enough funds to pay out in case banks fail?
There have been shortcomings in some countries in the past. It is not feasible or necessary to provide schemes with an amount of money equivalent to all deposits. But banks will have to pay on a regular basis to the schemes, in advance, so a pot of money can be built up, and not only after a bank failure. Such ‘ex-ante funds’ will make up 75% of the overall funds in DGS.
If it becomes necessary, banks will have to pay additional contributions, which will contribute a further 25% of the target funds. If this is still insufficient, Deposit Guarantee Schemes could borrow from each other (“mutual borrowing facility”) up to a certain limit (again 25% of target funds) or use additional funding sources such as borrowing on the financial market, e.g. by issuing bonds.
The new financing requirements will ensure that each scheme has enough funds in place to deal with a medium-size bank failure. This level is comparable to the existing well-financed schemes in the EU. These levels of funding will have to be achieved in all Member States by 2020.
Banks having a riskier business model than others will pay higher contributions to Deposit Guarantee Schemes – up to about 3 times more.
8) Will the improved funding of Deposit Guarantee Schemes make taxpayers’ involvement and bank resolution funds obsolete?
Deposit Guarantee Schemes are part of the measures being taken to create a stronger crisis prevention and crisis management system so that taxpayers are no longer the first to pay out. Soundly financed Deposit Guarantee Schemes will mean that in case of bank failure, funds are there to pay out account holders without needing to have recourse to taxpayers. Furthermore, a scheme’s funds can be used for certain resolution purposes – those that involve the transfer of deposits to another bank and are therefore equivalent to a payout.
Bank resolution funds, as the Commission’s Communication of 26th May advocated (IP/10/610), serve a different purpose to Deposit Guarantee Schemes. The latter ensures that savers will be reimbursed up to the coverage level whilst resolution funds ensure that the bank can be wound up and cover different costs (paying for continuity of certain key services, covering administrative costs, fees, etc.), for the benefit of all creditors of a bank and not only to the benefit of insured depositors.
Half of the target size of DGS funds can also be used for early intervention measures, i.e. measures aimed at helping a bank when it faces difficulties and avoiding it needs to be wound up, for example temporary liquidity support. The table below illustrates how the funds of Deposit Guarantee Schemes could be used for early intervention measures. It should be noted though that the necessary funds always remains ring-fenced for paying out depositors.
9) Should we have a pan-European Deposit Guarantee Scheme?
A single pan-European scheme would have two main advantages:
* First, the impact assessment estimates that 40 million administrative costs per year could be saved.
* Second, it could better deal with bank failures. The impact of a single bank failure on a large scheme is lower than on a scheme only covering the banking sector of one Member State.
However, there are complicated legal issues which would need to be examined. The idea of a pan-EU Deposit Guarantee Scheme remains a potential longer-term project. A more detailed report examining the options will be presented by 2014.
Under the new supervisory structure, the European Banking Authority will facilitate the functioning of Deposit Guarantee Schemes. The authority will be involved in stress tests and peer reviews of schemes, help settle any disagreements (for example in a cross-border case when two schemes have to coordinate their actions) and will ensure the consistent determination of contributions based on the risk of each bank.
10) Why set a maximum level for deposits protected? Why not leave Member States choose their own levels?
Coverage can remain unlimited if it is linked to real estate transactions (for example selling your house) or to specific life events such as marriage and divorce. So, if you sell your house, the money from the sale is transferred to your account, and the bank fails the next day, Member States can ensure that you are covered for more than 100 000. In this scenario, depositors enjoy such coverage for up to 12 months after such an event if their Member State opts for such regime.
But an unlimited higher coverage in general would jeopardise financial stability. When the crisis deteriorated, account holders shifted deposits to banks in Member States whose coverage was higher. This led to banks being stripped of liquidity in times of stress and made the crisis worse as it led to a near-liquidity crunch. Moreover, one scheme offering general unlimited coverage needed state aid because of the demands made on it.
11) What are the benefits for consumers and business under the new rules?
Consumers will benefit from the Commission’s proposal: interest will now be taken into account when reimbursing deposits, credits and instalments can no longer be deducted from the amount to be reimbursed and savers at branches of banks in other Member States will not be referred to a scheme in a country they don’t live in. Depositors will be informed about the coverage on their statement of account.
Businesses will also benefit. First, as explained above, the new proposal will extend coverage to all currencies, including, for example, US dollars, Swiss francs and yen, which is beneficial for business operating globally. Second, all businesses, whatever their size, will be now covered under the Deposit Guarantee Scheme. This is new as until now, some EU Member States exempted medium-sized and large enterprises from the existing rules on Deposit Guarantee Schemes.
12) How does the proposal cater for the needs of Mutual Guarantee Schemes? Will their stabilising function not be reduced?
Mutual Guarantee Schemes are schemes where banks support each other so they do not fail. By doing so, they contribute to financial stability in some Member States. On the contrary, Deposit Guarantee Schemes pay if a bank fails.
The new proposals do not ask Mutual Guarantees Schemes to close down. On the contrary, the new proposal acknowledges the stabilising function of Mutual Guarantee Schemes and offers a lot of flexibility to them.
Nevertheless, Mutual Guarantee Schemes are intended in the first place to save a bank as such and not the bank account holders. The Commission believes that it is important that all banks participate in a Deposit Guarantee Scheme so as to give bank account holders the same level of protection – no matter where they are based in Europe. This would be an improvement for bank account holders, as under the current system account holders cannot make a claim if a Mutual Guarantee Scheme fails.
Under the Commission’s new proposal, Mutual Guarantee Schemes can continue to exist. However, participating banks would be required to participate in a Deposit Guarantee Scheme or to establish a separate deposit scheme for themselves. Their lower risk factor can be taken into account when determining contributions.
13) More burdensome rules on banks will these proposals not choke the recovery?
The crisis has made clear that banks must take more responsibility and measures to strengthen financial stability are essential.
But the Commission is also very aware of the cumulative effects of new rules on banks which is why each proposal is accompanied by in-depth impact assessments.
The calibration of measures is essential which is why banks will have 10 years to reach the target funding levels set out in the proposal.
14) Will these new rules not lead to higher banking fees for clients?
This is unlikely. Since the market on financial products is quite competitive, banks are unlikely to transmit their costs completely to their customers. But even if they did so, it would not exceed a 0.1% reduction in interest rates on saving accounts or an increase of bank fees on current accounts by about 7-12 per account per year.
15) How will the mutual borrowing facility work?
This is illustrated by the graph below. The amount of funds being lent is equal to the ex-post funds at the scheme borrowing from the others. The borrowing scheme has to pay back to the lending schemes within 5 years (see also question 7).
16) When will all the changes come into effect?
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Due by |
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General implementation deadline |
31.12.2012 |
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Simplification and harmonisation of scope and eligibility |
31.12.2012 |
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One-week payout delay |
31.12.2013 |
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Report on pan-EU schemes |
31.12.2014 |
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Reaching the target funding level |
31.12.2020 |
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Mutual borrowing facility functioning |
31.12.2020 |
Source: European Commission
