Question

Explain why government deposit insurance is a desirable and effective policy in some countries, but not in others.

Answer 1

Firstly we need to understand the meaning of Deposit Insurance Schemes. These schemes insures the deposits which are made by the public into the banks for safeguarding their interests and money by providing a safety net to the banks. These schemes in some countries are offered by private corporations backed by govt., therefore it may or may not be a scheme provided by the central bank of any country.

Banks get money through public deposits. They lend the same to borrowers as loans. Some loans become non performing assets for the banks leading to financial crisis. Due to the non performance of bank's assets, they fail to payback the public money because of the financial inability of their debtors. This may lead to bankruptcy of the banks itself.

To provide a safety net for this kind of situation deposit insurance schemes came into place. Many countries all over the globe implemented the policy.

EFFICIENCY OF THE POLICY IN SOME COUNTRIES

Countries where the bad loans number is huge should mandatorily implement this scheme to safeguards the financial system and public money. Due to bad loans Banks become incapable to payback the public deposits and to provide loans to actually potential businesses. This leads to financial crisis.

In simple words we deposit our earnings to the banks to get interest but eventually end up losing our earned money of a few bad loans aka the financial burglars. This leads to losing of public confidence ultimately crunching the financial stability of the economy.

History is evident to prove that having this scheme does not eliminate the chances of financial crisis in the country. However Government intervenes to payback public money up to some extent(coverage) to win the public confidence. We shall understand the situation through Deposit Insurance Scheme of the US. The coverage amount increased year by year from nearly 2500$ in earlier years to 250000$ currently, but bank failures still occur.

Same was the case with Japan Deposit insurance scheme even when regularly amended. The scheme did not help during the 1995 Crisis.

Moreover this scheme provides the Managers opportunity and room to invest money in the risky sectors in order to earn more interests because they know that the deposit funds are insured by the policy. This is called as Moral Hazard.

The Difference in the efficiency of the implementation of the policy is there because of different financial structures of the countries. This majorly depends up on the financial regulation of the country. Some countries see the policy as mere appreciation of Bank's operational costs (because of premium), but some countries see this policy as a safety net for their financial stability.

Countries with already stringent financial regulations take care of the movement of their funds. This may be the case with those countries which have limited population, limited businesses, limited growth or small old rich countries. These countries might see these policies as an inefficient or useless costs or burden to the financial entities.

But Countries which have dynamic economic environment give birth to infinite opportunities which leads to requirement of finance. All of these movements are connected and the funds eventually are rotated through a common point called as Banks. These countries may be developed or developing or underdeveloped. These countries with such dynamicity may find these schemes as financial stabilizer.

The deposit insurance scheme is a popular concept and is being implemented at the tripling rate from the past few years.