The Role of Deposit Insurance in Bank Resolution

Abstract

Deposit Insurance Schemes (DIS) are mechanisms that reimburse depositors when banks default; however, they also serve important functions in bank resolution proceedings. Whereas it is evident that DIS should contribute to the rescue of banks’ critical financial functions in such resolution scenarios, the resulting questions of who should benefit from their payments and whether these payments result in any repayment obligations have so far remained unaddressed. In response to these questions, the article suggests distinguishing between scenarios in which banks’ critical financial functions are transferred to other institutions and scenarios in which the critical financial functions remain with recapitalized banks. The latter is the more complex situation because it leads to the survival of the bank in resolution and raises the question of hierarchies among several groups of contributors to recapitalizations. The article argues for a subordinate role for DIS in these hierarchies and suggests that DIS payments should lead to holdings of Tier 2 regulatory capital in recapitalized banks.