Evaluation of European Deposit Insurance Scheme Funding Based on Risk Analysis

Abstract

In this paper, we carry out a quantitative analysis of the financing measures proposed for the European Deposit Insurance Scheme (EDIS) regarding the target level of the fund and the contribution scheme of member entities. We estimate the loss distribution of the EDIS considering different sources of systemic risk associated with the correlations between bank assets inside and outside the eurozone countries, and we analyse the sensitivity of the results to bank portfolio risk. We determine the variations in the cost of insurance due to the relative risk profile of banks in the Banking Union and the loss-absorbing capacity of the contribution made by countries with the methodologies proposed by the European Banking Authority (2015). Our findings show how the interconnection between banks of different countries has an important influence on accumulated losses in the tail of the distribution, although the correlation within a country exerts a stronger effect. Both aspects must be considered in the calibration of the target level of the fund to avoid underestimating financing needs. Likewise, deterioration in the quality of bank portfolios produces a significant reduction in the fund's loss-absorbing capacity, which calls into question its soundness in times of economic recession. Finally, we assess the impact of the new contribution scheme on moral hazard and the possibility of cross-border subsidies between the countries of the Banking Union.