The importance of a stable financial sector in a post-pandemic world

This is an opinion article by an external contributor. The views belong to the writer.
The importance of a stable financial sector in a post-pandemic world
Credit: Pixabay

Uncertainty is one of the few things in life that are very certain. The COVID-pandemic is an example thereof and is exceptional in many regards. Hardly ever in modern history has one single event caused so much uncertainty. Not only did it cause uncertainty to countries across the globe.

It also did so very suddenly and with very tangible negative effects on public health. Uncertainty is more than just temporary, as the pandemic is in its second year now and nobody can be certain as regards its likely end. Also, uncertainty has affected (and still is) all economic actors, ranging from central banks, governments, business to ordinary households.

Many questions relating to the COVID-pandemic are still unanswered and this uncertainty continues to complicate planning by economic actors. Simultaneously and in a perhaps less visible, dramatic or outright negative way, other sources of uncertainty are emerging. All these may amount to financial stability concerns, since as opposed to risk, uncertainty is not calculable. In these uncertain times, the role of deposit insurers as key actors in maintaining financial stability is of paramount importance.

Deposit insurers’ main objectives are to contribute to financial stability and to swiftly reimburse depositors where necessary. The past decades have been a global success story for deposit insurance. Up from only 12 some 50 years ago, in 2019, 145 jurisdictions have established explicit deposit insurance, and the number is still rising. Given varying national circumstances, there is a large variety as to the precise mandate of deposit insurers and their institutional set-up.

Yet the core purpose is protecting the savings of depositors and thus removing incentives for bank runs. In doing so, deposit insurers are an important contributor to financial stability.
In the midst of uncertain times, it is important to realise that achievements from the past are no guarantee for success in the future. In fact, deposit insurers around the globe operate in times of unprecedented uncertainty. In the years to come, five challenges will be of paramount interest.

Challenges ahead

The Covid-pandemic is the first and most urgent challenge. So far, massive public policy support, the increase of bank capital buffers after the financial crisis as well as effective deposit insurance schemes have enabled a remarkable financial stability. The main task ahead is to safeguard this stability, as the debate on how to unwind accommodating policy responses without causing turmoil is picking up.

Depending on the future evolution of the pandemic, high levels of indebtedness, a tightening of financial conditions and end to temporary regulatory forbearance may cause signification hikes in corporate bankruptcies, which in turn may translate into higher bank default risks. Deposit insurers are well-prepared to do their utmost – together with other participants in the financial stability net – to contribute to continuing financial stability.

Secondly, deposit insurers face many uncertainties caused by climate change, whose impact may be encompassing and yet cannot be captured in traditional financial risk models. Climate risk may cause risks to general financial stability through physical or transition risks. However, deposit insurers may be affected in other ways as well. This may range from direct operational risks regarding business continuity to more indirect impacts such as higher bank default risks, challenges regarding the risk-adequate investment of funds held by deposit insurers or higher bank resolution costs challenges for that matter.

Managing climate risk is an enormous challenge to deposit insurers. Many of the risks may remain invisible and unrecognised over a long period of time, yet upon materialisation they may cause very high costs. At the same time, this problem is truly global and factors such as climate regulation in other parts of the world may influence the likelihood of problems arising locally.

Thirdly, technological evolution in the financial sector is enhancing competition, efficiency and financial inclusion. However, concerns have risen regarding financial stability and competitive distortions. At times, these policy goals may be in conflict with other ones such as financial inclusion and consumer protection. Fintech affects deposit insurers through numerous direct and indirect channels, which may touch upon the very fundamentals of the banking sector such as payment systems and the role of traditional deposits. Central Banks around the globe are evaluating the merits of Central Bank Digital Currencies. IADI is closely monitoring these developments and their potential implications for deposit insurance.

Bank Resolution

The role of deposit insurers in bank resolution has been developing over time. An increasing share of deposit insurers around the world is involved in the resolution of banks. The nature of this involvement varies significantly and may be subject to financial caps, protecting the deposit insurance fund and thus safeguarding the ability to reimburse depositors without major delay.

Given ample differences in the design of domestic and regional financial safety nets and the legal, political and social particularities surrounding them, there is no optimal approach to deposit insurers’ role in bank resolution. However, looking ahead, it is important that whatever resolution mandate legislators assign to deposit insurers, it is clearly defined, supported by sufficient powers and resources, as well as adequacy of design features, and be well coordinated with the other safety-net participants.

A final challenge for deposit insurers is the inter-connectedness of global financial flows and the increasingly borderless and digital nature of financial services. Cross-border financial considerations are directly affecting deposit insurers’ operations as these pose challenges regarding depositor reimbursement and resolution activities. To reflect this reality, deposit insurers will further intensify cross-border arrangements to ensure effective and efficient depositor reimbursement and resolution.

In reaction to the 2007-2008 global financial crisis and in collaboration with the Basel Committee on Banking Supervision (BCBS), the International Association of Deposit Insurers (IADI) developed the “Core Principles on Effective Deposit Insurance” in 2009 and updated them in 2014. These Core Principles have since been the internationally agreed standard for deposit insurance and are applied also by international financial institutions such as the IMF and World Bank to assess the soundness of financial systems. The upcoming update of the Core Principles will be an occasion to consider the challenges ahead.

Next year, IADI will be celebrating its 20th birthday. As in human life, this age is marked with many uncertainties and current global and technical developments add greatly to these. Yet, at the same time, the relevance of deposit insurance is unchanged and many of the uncertainties can be shaped to become opportunities. Further updating the IADI Core Principles in reflection of the challenges ahead is the best gift to financial stability and depositor reassurance IADI can make.

Dr. Bert Van Roosebeke
IADI Senior Policy and Research Advisor / Head of Research Unit

Latest News

Copyright © 2021 The Brussels Times. All Rights Reserved.