Is deposit insurance inevitable? Lessons from Argentina

Abstract

This paper explores the decision by the Argentine government to abolish deposit insurance, and its subsequent decision to re-establish a form of deposit insurance. Before 1991, the Argentine banking system operated under a regime of optional, explicit deposit insurance, coupled with extensive implicit deposit insurance in the form of central bank assistance to failing banks. In 1991 and 1992, Argentina reversed this policy by repealing the country's deposit insurance program and attempting to convince financial markets that it would not under any circumstances rescue a failing bank. In 1995, in the face of a forthcoming election and a severe economic crisis sparked by the Mexicon peso devaluation of December 1994, the Argentine government reinstituted a form of deposit insurance in an effort to stave off an all out bank panic. The decision to re-establish deposit insurance appears inconsistent with repeated assurances from high-level officials that the Argentine government would not under any circumstances bail out depositors in a failing bank. These events are of interest to U.S. deposit insurance reform because they allow the investigation of a real-world case in which a significant economic system repealed its program of deposit insurance. It is often said in the United States that cutbacks in the deposit insurance guarantee are politically impossible. Yet such reforms were implemented in Argentina. How those reforms came to pass is a question of some interest for the analysis of U.S. deposit insurance reform. At the same time, the government's subsequent retreat from its commitment to allow troubled banks to fail, without protecting depositors, counsels caution about the efficacy of attempts to eliminate deposit insurance. Argentina's deposit insurance reform could not withstand the political and economic pressures attending a severe crisis that threatened the viability of the overall package of economic change. To what extent can any country reliably commit not to protect bank depositors, given the possibility of a banking crisis and the extraordinary political pressures that attend it? While fundamental reform of deposit insurance does appear possible, the experience in Argentina suggests caution about the durability of such reforms, especially in economic systems characterized by historical instability in banking markets.