EDITORIAL: A buffer against bank failure
The benefits of deposit insurance outweigh the moral hazard that could be raised
Years in the making, the deposit insurance scheme aimed at protecting the most vulnerable bank customers and shoring up the stability of the SA financial system is moving a step closer to become part of banking regulation. That’s good news.
Endorsed by the Bretton Woods institutions such as the IMF and World Bank as best practice for developing countries, the scheme is already a ubiquitous feature in dozens of countries in the West, and its importance was reinforced during the financial crisis. It gave banking clients confidence that their money was safe, preventing bank runs that could have tipped lenders with already lopsided capital structures into insolvency despite largely being healthy.
Crucially, the schemes helped keep the financial system intact since big banks are deeply interconnected. The failure of one bank — either through customers withdrawing their money en masse or through a build-up of inherent vulnerabilities — can easily spread into contagion, sweeping otherwise solvent companies into bankruptcy.
The Reserve Bank is credited with helping the local banking industry escape largely unscathed from the global financial crisis more than a decade ago thanks to its tough regulations, which prevented the banking industry from buying toxic mortgage assets in the US. Maintaining that public and investor confidence in the sector is central to the team led by Kuben Naidoo, a deputy governor and head of the Prudential Authority, to ensure that these short-term deposits continue to fund long-term investments such as building homes and expanding factories.
It’s for these noble reasons that the Bank and the Treasury came up with the Financial Sector Laws Amendment Bill, tabled in parliament earlier in June. Under the draft law, which also makes important changes to how the Bank handles the collapse of a large financial institution, depositors are covered for up to R100,000 of their money, enough to give 97% of all depositors peace of mind in the event of bank failure.
Details on the funding of the scheme have yet to be fleshed out but the Bank has signalled that it is willing to consider lowering the amount of cash that banks must have in line with deposits made by their customers. To alleviate the initial funding costs banks could also be forced to cough up roughly 21c on every R100 deposit to fund the operational costs of the scheme.
It’s true that the scheme will not warm the hearts of laissez faire purists, who argue that the safety net weakens depositors’ incentive to exert discipline on an otherwise underperforming bank manager just as a sell-off in shares of a company on a stock exchange can nudge managers to adjust their growth strategies.
This ironclad guarantee could create a moral hazard, giving a bank’s managers a reason to take on riskier investments because it does not bear the full costs of the risk, the free-market fundamentalists say.
Still, the benefits of deposit insurance outweigh the moral hazard that could be raised in the system. For one, it’s hard to imagine that millions of consumers actually do any due diligence on banks before they deposit their money. It is fair if these vulnerable depositors do not lose their money when a bank fails.
Also, given that corporate clients — which have dedicated Treasury teams to perform due diligence and monitor their banks’ financial health — effectively fall outside the safety net, it ensures that they, with unsecured creditors and shareholders, play a big role in curbing excessive risk-taking at banks.
From a consumer point of view, if all banks can wave this assurance at potential clients, it could help level the playing field for newcomer banks as the top six banks already benefit from an implicit too-big-to-fail economic theory.