On December 17, 2013, the European Parliament and its 28 member states agreed to create a uniform deposit guarantee scheme (DGS) for their banks. It has been in the works for three years. Although the agreed text has yet to be published, an outline of the provisions has been released:

  1. EU banks will provide a uniform guarantee scheme of €100,000 (approximately $135,000) per depositor and per bank. Most countries currently provide this amount, having raising it after the recent financial crisis. Norway is the exception which offers approximately €250,000 (NOK 2,000,000). It will be forced to reduce it under the new agreement.
  2. Each bank will contribute 0.8% of deposit into DGS fund of the country over a ten-year period.  If the fund is insufficient to bail out a bank, additional contributions will be solicited from the remaining banks.
  3. Banks engaged in risky operations will be asked to contribute a higher portion to the fund (similar to the scheme under the FDIC).
  4. Repayment deadlines to depositors will gradually decline from the current 20 days to seven days by 2024.
  5. Better information will be provided to depositors on the extent of the coverage.

The agreement is expected to be finalized in a few months by the European Parliament and the European Council. It has received positive media attention because of the failure of several banks in the recent financial crisis and the uneven compensation received by depositors.  Compensation varied by country and location of the bank.

The most egregious case was Iceland’s Icesave bank (owned by Landsbanki) that failed in 2008. Iceland agreed to compensate only depositors located in Iceland and not those at their branches in the U.K and the Netherlands, citing a lack of funds by Iceland’s Depositors’ and Investors’ Guarantee Fund. Icesave had attracted over 400,000 online depositors from the United Kingdom and the Netherlands through their offer of high interest rates, resulting in a bail-out value of over €4 billion (approximately $5.4 billion).  After years of wrangling, Iceland has agreed to make the payments over a 30-year period.

The failure of two of the largest banks in Cyprus on March 16, 2013 is another case. The European Central Bank, for the first time, endorsed a plan to bail out the banks provided depositors accept a tax on their deposits, 6.7% for deposits under €100,000 and 9.9% for above €100,000.  This led to street protests and eventual withdrawal of the proposal. It was also partially responsible for spurring the negotiations of this agreement.

What has been untold in this announcement is that the original goal of creating a common European fund like the FDIC never materialized, primarily because of objections by Germany. A bank failure in any country would have been bailed out from the common and larger fund. The new agreement would maintain the status quo and payments for bank failures will still come out from a country’s fund, some of which are heavily underfunded. Germany blocked the common DGS fund because it anticipates continuing bank failures in the southern regions of the continent. It is likely that German will accept a common DGS fund and mutualize the various country deposit schemes after a few years when the European banking system is stabilized.  Till then it is not willing to take the risk of subsidizing failures of the current weak banks.

The positive news of this agreement is the deposit guarantees will now be the responsibility of the banks and not the taxpayer. Till recently, a majority of banks remained underfunded and expected to pay as they go with the help of their governments. European officials have also realized that the contingency fund for the banking system has to be in place not for local failures but for regional and global failures in today’s interconnected financial system.

It has taken a major economic crisis for Europe to get its act together to recognize some of its structural problems. Politicians and regulators took too much time at the beginning of the crisis to provide support to their banking system. Perhaps there is hope for a more timely and pragmatic approach to policies and regulations. Making the banks pay for an insurance fund is the right approach to solving potential bank failures in the future.