The Role of Deposit Guarantee Schemes in Preventing and Managing Banking Crises: Governance and Least Cost Principle

Abstract

The Deposit Guarantee Directive enlarges the role of DGSs in supporting and financing with alternative interventions the early research of “market solutions”, that may avoid the failure of a bank. Despite the broad mandate formally set out in the Directive, the feasibility of the failure prevention measures by a DGS is restricted according to the current legal framework. More specifically, constraints to the use of alternative interventions could derive both from State aid rules and the super priority rule coupled with the least cost criterion. As regards the first point, the European Commission ruled that the Italian DGS’s alternative measures in favour of a bank named ‘Tercas’ constituted an illegal State aid, claiming that intervention was attributable to the Italian government and that the resources employed were subject to public control. With reference to the second point, according to the BRRD, within the creditor insolvency hierarchy, depositors are preferred to any of the bank’s other unsecured creditors. As the DGS, after the payout, is subrogated to the preferred claims of covered depositors, it will have a big recovery rate in the bank liquidation. This effect might hamper the DGS’s ability to undertake alternative interventions, since under the least cost criterion these could be more expensive than a depositor payout. Given the importance of the role of DGSs in preventing and minimizing the overall cost of a banking crisis, this paper aims at analysing the two issues above, in order firstly to suggest a governance model which allows a national DGS to intervene in a banking crisis without breaking State aid rules. Secondly, regarding the least cost principle, the paper suggests the adoption of some criteria, extrapolated by the DGSD, which may allow DGSs to overcome the problems arising from the combination of the above criterion with the super priority rule.