Meeting the rationale of deposit protection system

Abstract

Purpose – The purpose of this paper is to explore the full potential of an effective deposit insurance system. The current financial crisis in Europe has arguably casted fresh doubt on the role and need for deposit insurance. In this regard, the deposit insurance system’s rationale is a key starting issue in order to fully understand its design and role within a financial safety net system. Design/methodology/approach – Using the UK regulatory regime as the main reference point, the deposit insurance system’s objectives are divided into two broad categories: depositor protection and financial stability. Findings – It is argued that a deposit insurance system could only be effective if designed to perform key regulatory objectives. Otherwise, authorities will keep resorting to other rescue measures, as this system will never be well equipped to respond to a bank failure. Practical implications – Notwithstanding recent regulatory reforms, there is still a lack of clear objectives and, thus, a clear profile for the Financial Services Compensation Scheme, as the UK deposit compensation scheme. In light of systemic risk and increased demands on prudential banking regulation, the UK deposit insurance system should be reformed to perform significant regulatory objectives. Social implications – The further reform of the UK deposit insurance will enhance depositor protection and financial stability, especially amid the euro-crisis. Originality/value – An effective reform of deposit insurance requires a clear role-setting for deposit insurance. To this end, this paper offers a comprehensive analysis of all regulatory objectives that the post-crisis UK deposit insurance system should serve.