On March 12, 1933, in his first fireside chat, U.S. President Franklin D. Roosevelt said, “there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the confidence of the people.” As FDR understood over eight decades ago, safeguarding the public’s confidence is one of the basic requirements for financial stability. Banking systems ultimately rely on the public’s willingness to deposit their hard-earned money in banks. As exporters across the globe experience reduced revenues and as the European Union’s financial troubles continue, governments are growing worried that confidence levels in their banking systems will deteriorate. This would have not only immediate financial consequences, but could also have far-reaching geopolitical implications as the ability of governments to manage growing crises diminishes.
Deposit insurance is at the core of government efforts to maintain public confidence in banking systems. What sets deposit guarantees apart from other government tools for stabilizing financial systems is that these schemes are a direct pledge to each deposit holder to safeguard some of their assets. In fact, the safety of funds in banks has informally become a part of the social contract in many countries. The massive crisis facing the U.S. financial system in the early 1930s led to the creation of the Federal Deposit Insurance Corporation (FDIC), which protects deposits if an FDIC-insured bank or savings association fails. The FDIC is backed by the U.S. government, and can insure up to $250,000 in deposits for individuals. Deposit insurance schemes around the globe differ in their design and coverage, but fundamentally these schemes are designed to maintain public confidence in the system.
The economic crisis facing exporters, as well as the eurozone’s ongoing economic difficulties, are increasing the significance of deposit insurance. Azerbaijan’s government announced on Jan. 28 that the country’s Central Bank may provide financial assistance to the Azerbaijan Deposit Insurance Fund (ADIF) if it is unable to pay compensations to depositors. The statement came after the Central Bank revoked licenses of six Azerbaijani banks and was likely intended to alleviate fears following the closure of those banks. Azerbaijan is a major energy exporter, and deteriorating economic conditions have already led to protests throughout the country. The Central Bank’s pledge to provide extra funding for the ADIF signals that the regime is worried that public confidence in the banking sector could be undermined. Should confidence erode, the outcome could be not only a run on the banks and significant disruptions to the country’s financial system, but also an erosion of the regime’s own position.
Azerbaijan is not alone in its concerns about the public’s confidence levels. It is no coincidence that, in December 2014, at a time when low world oil prices and sanctions were beginning to have a significant impact on Russia’s economy, and particularly on the value of its currency, the Russian government took initiatives to help insure bank deposits. It moved to allocate extra funds to the country’s Deposit Insurance Agency (DIA) and increased the deposit insurance coverage limit for individuals to 1.4 million rubles, the equivalent of about $18,300 under the current exchange rate. Russia’s DIA is a busy entity: over the past two and a half years, the country’s Central Bank has shut down over 150 banks, with many others under crisis watch. With reduced energy revenues intensifying Russia’s economic problems, the importance of deposit insurance as a tool for maintaining public confidence, and therefore limiting social unrest, will grow.
Concern over internal stability also played a role in China’s decision, in May 2015, to introduce deposit insurance for the country’s banking system. Large bank failures are mostly unheard of in China, as the government in Beijing generally steps in to assist banks and investors and implicitly guarantees deposits, especially at bigger banks. Politically, Chinese decision-makers feel that they cannot allow banks to fail, as such a move would undermine confidence in the leadership and China’s economic system as a whole. Nevertheless, the Chinese government recognized that by implicitly making guarantees, they are also failing to discourage banks and investors from making risky choices. China’s decision to introduce deposit insurance, therefore, was designed in part to highlight that there is a limit to government assistance and to encourage better investment decisions. While China’s system differs greatly from its Western counterparts, the Chinese leadership is also aiming to use deposit insurance ultimately to boost confidence and stability in their banking sector.
In Europe, as in the U.S., deposit guarantees have become a part of the social contract between the people and the authorities, but the question of which authorities are ultimately responsible for guaranteeing the deposits — and thus for safeguarding financial stability — has become significant. In the European Union, the future of deposit guarantees is one of the main points of contention between Germany and the eurozone’s other members. Currently in Europe, there are EU-wide regulations on deposit insurance, but those are implemented on a national level. In November 2015, the European Commission officially presented its proposal for a European Deposit Insurance Scheme (EDIS). Under the plan, a European fund would be created and it would be financed directly by bank contributions, adjusted for risk. At first, the European fund would only be used if national-level deposit insurance funds exhausted their own resources, but over time it would take on a greater role, fully insuring all national deposit guarantees by 2024.
Germany opposes the scheme on the grounds that risk within the eurozone has to be reduced before such a risk-sharing plan could be viable. Fundamentally, for Berlin, the EDIS would represent a financial obligation to assist eurozone countries with troubled financial systems. Countries such as Italy, which is currently experiencing banking challenges as a result of high levels of non-performing loans, support the plan because it would provide a much stronger layer of security for depositors than simply relying on national-level insurance schemes. Deposit insurance is thus one of the elements of Germany’s geopolitical dilemma: on the one hand, Berlin wishes to safeguard the stability of the eurozone, but on the other hand, it would like to minimize its own financial contributions to other eurozone countries.
As the exporters’ crises deepens, the ability to maintain comprehensive deposit guarantee schemes and ensure continued public confidence in the financial system is key for countries like Azerbaijan and Russia. Two factors to watch are deposit levels and capital flight. Russia in particular has struggled with high levels of capital flight, and further outflows could indicate that efforts to promote confidence in the system as a whole are failing. At the same time, negotiations over the future of the planned EDIS will be a key indicator, both for the stability of Southern European banking systems and the relationship between Germany and the rest of the eurozone. From Russia to China and the European Union, public confidence in banking systems is a factor that impacts not only financial stability, but the survival of regimes and political institutions.