Role and importance of deposit Insurance system (ABSTRACT)

Gogi Kontridze

It is common knowledge that problems of one or several banks can entail systemic bank crisis. Even rumors about this or that bank’s insolvency can turn out to be a provoking factor in such situation.

Evasion of possible social reaction is one of main tasks in the creation of warranty system for depositors. Protection of petty deposits is undoubtedly a direct function and objective of insurance system. A potential depositor finds it much more difficult to estimate the reliability of a certain bank than, for example, a buyer of consumer goods. As a rule, during the estimation of a bank only a small part of necessary information is available to a simple depositor, and even if he had additional information at his disposal, it would still be difficult for him to “process” it and make a right choice. Such drawbacks are compensated by bank supervision and deposits insurance measures.
Creation of deposits security mechanisms in different countries helped to solve several issues simultaneously: growth of trust towards banking system; abatement of worries about bank bankruptcies; depositors’ interest protection; growth of the quality of social interests protection; encouragement of funds attraction to banks; increase of investment resources; strengthening of banking system.
Deposits insurance system does not only provide for direct indemnity in case of occurrence insured but also prophylactic to avoid risk operations. The advantage of deposits protection also consists in the reduction of systemic banking crisis risk that might involve large-scale panic withdrawal of deposits from reliable banks and therefore, destruction of payments system.
Despite the fact that the conception of deposits protection is quite simple, it is very difficult to realize it in practice. Any country that undertakes its realization faces the necessity to take a great deal of decisions. The practice of transition economy countries reveals the fact that payments insurance system has been implemented along with macroeconomic reforms.
Yet, there are also “weak points” of deposits insurance system. Projects of deposits insurance system are directly related to a “moral hazard” that serves to release economic agents from the responsibility for possible consequences of their actions. They no more feel committed to estimating risks connected with paying up of contribution to a certain bank and they choose a bank without considering its financial condition. Banks’ senior management and large shareholders can also contribute to the growth of moral hazard. The fact that depositors will not suffer any damage in case of a bank’s bankruptcy makes it possible for management to implement risk banking operations. It is also important to note the increase in expenses of all banks that as a rule are included in the cost of bank services.
Yet, the influence of the mentioned drawbacks might be reduced by legal norms that will become the grounds of deposits insurance system. It should also be noted that warranty system might prove ineffective in reaching its goals without bank supervision measures that imply precise standards in bank capital as well as without macroeconomic measures for strengthening money turnover. On the contrary, this might turn into an additional burden for a state as well as for banking sector and budget. Approach to the implementation of the system should be of consecutive nature. It should be strengthened by appropriate sources and purposeful actions aimed at the evasion of moral hazards as well as by macroeconomic measures aimed at the strengthening of financial discipline and development of market relations in economy.