(© Project Syndicate) – While existing European Union institutions were always unlikely to implement a common deposit-guarantee system (DGS) on their own, the formation of a European banking union will naturally lead to such a scheme. Europe’s leaders should begin to prepare for this eventual outcome – and the political leap that will be needed if it is to succeed.
To this end, countries should go further in harmonizing national DGSs, including areas that have been neglected so far. For example, optional deposit insurance is not needed, nor is any other optional element that induces divergences in national DGSs.
Moreover, absolute protection for all deposits up to an ex ante threshold – say, €100,000 ($133,000) – should be firmly anchored within EU legislation. In order to avoid a repeat of recent events in Cyprus, where a one-time tax on both large and small savers was put on the table as a means to help fund a bailout of the country’s financial system, the rigidity of this guarantee should be communicated clearly to countries.
To be sure, this does not mean that deposit protection should be unlimited. Rather, it should apply only to small deposits, with the specific scale defined according to the richest participating country. The EU’s current €100,000 threshold could be reduced to half, or even less. This approach would also improve the credibility and stability of the DGSs, since small claims would be given priority.
This would pave the way for the EU to create a common DGS in the longer term – a political decision with far-reaching consequences, owing to the fiscal burden-sharing that it implies. But, while European Central Bank Vice President Vitor Constâncio was correct to emphasize recently the appropriateness of taking a gradual approach to implementing a common DGS (which is not essential in the short term), it is important that policymakers view a common DGS as the ultimate goal.
When a common DGS does become feasible, it should be combined with a new European Resolution Authority (ERA), an independent supervisory entity that follows, to some degree, the example of the Federal Deposit Insurance Corporation in the United States and Japan’s Deposit Insurance Corporation. Such a system would ensure that the EU’s DGS remains independent from the European Commission, the European Council, and the ECB.
Separating the DGS from the “lender of last resort” function is necessary in order to prevent conflicts of interest from arising. So, while the ECB, in its capacity as the micro-prudential supervisor, would share information with the ERA, each institution’s decision-making would have to occur independently, based on clearly delineated responsibilities and objectives. (The future distribution of tasks between the ECB, European Systemic Risk Board, ERA and common DGS is depicted in the picture)
Recent events in Cyprus have put DGSs back on the EU’s agenda. This is the ideal opportunity to begin the long and difficult process of drumming up the political will and public support for a common DGS, while laying the foundations for its eventual creation.
Sylvester Eijffinger is Professor of Financial Economics at Tilburg University in the Netherlands.