Financial crisis and quantitative methods: problems and solutions

Are European Deposit Protection Schemes efficient enough?

Adamo Uboldi Joint Research Centre European Commission
Financial Econometrics for a Single Market and Competitiveness Policies

Unit for Econometrics and Applied Statistics

Financial crisis and quantitative methods: problems and solutions

Plan of the talk

Deposit Protection Schemes (DPS) in the EU

Reaction to the financial crisis

Efficiency of EU DPS

Quantitative tools and risk-based contributions

Deposit Protection in the EU

Financial crisis and quantitative methods: problems and solutions

AIM: to provide a safety net for depositors so that, if a credit institution fails, they will be able to recover their bank deposits up to a certain limit

HOW: Directive 94/19/EC on Deposit Guarantee Schemes (DGS)

and current amendment proposal

Directive 94/19/EC (I)

Financial crisis and quantitative methods: problems and solutions

Objectives Protection of depositors wealth through the introduction of a minimum threshold (20,000 till October 08) Maintenance of confidence in the EU banking system through protection of stability, avoiding a run on the banks

Directive 94/19/EC (II)

Financial crisis and quantitative methods: problems and solutions

Key provisions and implementation Member States have to ensure one or more officially recognised DGS and ALL deposit-taking credit institutions must join DGS
EU has a total of 39 DGS (some MS have more than one DGS)

Minimum coverage level set at 20,000

MS apply different coverage levels from min. 20,000 to max. 103,000

Obligation for DGS to repay depositors claims within three months

from triggering event (possible extension up to nine months)

90% of deposits and 70% of depositors have been repaid within 3 months

Current financial crisis (I)

Financial crisis and quantitative methods: problems and solutions

Quick response to crisis: DG-MARKT asked JRC to perform an early IA

on possible changes of coverage level

October 9th: delivery of a confidential Impact Assessment to feed the amendment proposal of Directive 94/19/EC as the situation of financial markets was requiring immediate actions, no detailed IA was possible at that time

Current financial crisis (II)

Financial crisis and quantitative methods: problems and solutions

65% of deposits are currently covered

Total amount of deposits (b)

Distribution of deposits
300

250

80% of deposits would be covered under 50K limit 90% of deposits would be covered under 100K limit

200

Not covered Covered under 100K Covered under 50K Covered under 20K

150

100

50

0-10

10-20

20-30

30-40

40-50

50-60

60-70

70-80

80-90 90-100 100-110 110-120 120-130 >130

Size of deposits (K)

Current financial crisis (III)

Financial crisis and quantitative methods: problems and solutions

50K
BE CZ DK DE EE IE GR ES

Eligible deposits (m)

188,791 40,854 106,029 1,615,946 2,590 143,226 98,926 575,940

Absolute exposure (m)

66,172 866 9,986 530,812 137 43,593 27,816 160,284 BE CZ DK DE EE IE GR ES FR

100K

Eligible deposits (m)

188,791 40,854 106,029 1,615,946 2,590 143,226 98,926 575,940 839,391

Absolute exposure (m)

87,313 1,035 29,620 701,172 164 66,820 34,533 193,477 27,070

FR IT
CY LV LT LU HU MT NL AT PL PT SI SK FI SE

839,391 511,527
16,887 5,115 3,903 86,734 27,649 4,617 264,839 158,338 63,934 108,384 10,760 10,150 68,948 113,094

1,336 284

IT
CY LV LT

511,527
16,887 5,115 3,903 86,734 27,649 4,617 264,839 158,338 63,934 108,384 10,760 10,150 68,948 113,094 1,728,510

1,494 323 147 40,435 1,228 409 55,906 84,854 5,370 21,873 3,332 1,253 21,541 38,884 261,259

141 LU 30,486 HU 1,059 MT 365 NL 23,249 AT 66,883 PL 4,588 PT 19,828 SI 3,261 SK 1,120 FI 17,248 SE 28,520 UK

UK

1,728,510

EU 25 total

6,795,082

1,679,510

EU 25 total

6,795,082

1,038,035

Investigating DGS Financial crisis and quantitative methods: problems and solutions Efficiency
Data Triggering event Intervention procedure Authorities involved Problems Aggregation of data Missing information Heterogeneity of data Overlapping with bankruptcy law Dataset incomplete Confidentiality Definitions Late answers (DE missing)

Qualit.

Deposits/Fund/Premiums Quant. Past DGS actions Payout delays Cross-border exposure

DGS Actions
Financial crisis and quantitative methods: problems and solutions

Payout (16 DGS out of 37) Types Preventive (21 DGS out of 37)

Since 1994 only 22/37 DGS

have intervened 67 payouts (37 EU-15, 22 UK)

27 preventive (26 EU-15)

No cross-border cases

Triggering Event of Payouts

Financial crisis and quantitative methods: problems and solutions

Following the Directive the event triggering the payout in all EU MS is the unavailability of deposits The DGS intervenes only after the declaration by the competent authority

No common rules

Financial Resources
Financial crisis and quantitative methods: problems and solutions

Funds Size known for all MS but DE Most of the ex-ante DGS

manage resources investing in

low-risk, liquid instruments Borrowing Allowed in 30/37 DGS In 24 cases no explicit limit set by law/regulation

Payout Delays
Financial crisis and quantitative methods: problems and solutions

Number

Amount

Scenarios Definition
Financial crisis and quantitative methods: problems and solutions

Intensity Ratio =

Total Cost of Interventi on Total Amount of Eligible Deposits

Scenario 1: High IR = 3.24, highest in EU-12

Payout

Scenario 2: Medium Scenario 3: Small

IR = 0.81, 2003 failure in EU-12

IR = 0.035, highest in EU-15

Preventive

Scenario 4: Medium
Scenario 5: Very High

IR = 0.16, 2003 failure EU-15

Cross-border

Fictitious, due to lack of data

Scenarios Results EU-15

Financial crisis and quantitative methods: problems and solutions

Scenarios Results EU-12

Financial crisis and quantitative methods: problems and solutions

BB B B

Capability to cover interventions

Financial crisis and quantitative methods: problems and solutions

Coverage Ratio =

Size of Fund Total Amount of Eligible Deposits

Maximum Amount of Available Resources Total Amount of Eligible Deposits

Resource Ratio =

Robustness Indicator =

1 1
i i

Depi RR

Coverage and Resource Ratio

Financial crisis and quantitative methods: problems and solutions

Intensity Ratio
Financial crisis and quantitative methods: problems and solutions

Cross-border exposures: branches

Financial crisis and quantitative methods: problems and solutions

Cross-border exposures: subsidiaries

Financial crisis and quantitative methods: problems and solutions

Risk-Based Contributions for EU DGS

Financial crisis and quantitative methods: problems and solutions

FINLAND FRANCE GERMANY GERMANY ITALY PORTUGAL PORTUGAL SWEDEN

(Cooperative Banks) (Saving Banks) (Banks) (Banks) (Cooperative Banks)

Risk-Based Contributions

AUSTRIA GERMANY (Public Banks) ITALY (Cooperative Banks) POLAND ROMANIA

Early-Warning Systems

Indicators
Financial crisis and quantitative methods: problems and solutions

The risk is assessed using indicators The indicators are built using financial ratios based on balance-sheet data, financial statement data or other types of accounting data

Current ratios are quite heterogeneous

Capital Structure / Solvency Profile Classes of Indicators Riskiness / Exposure Profitability / Income Maturity transformation / Duration

Towards a common Risk-Based System

Financial crisis and quantitative methods: problems and solutions

Homogenous Framework: identification of a generalized formula for riskbased contributions ci of the i-th member

ci i x i
xi = i-th members contribution base (e.g. eligible or covered deposits) i = i-th members risk-based adjustment = fixed percentage determining the aggregated contribution (i.e. NOT
influenced by single members risk, common value for ALL members) Scores Rating Class

Indicators

France
Financial crisis and quantitative methods: problems and solutions

Indicators Overall Amount of Contribution (OAC) Correction i Net Risk Amount (xi + gi) i Contribution base (xi + gi) Net Share of Risk (NSR) Contribution OAC NSR

Scores ri

Italy Commercial banks

Financial crisis and quantitative methods: problems and solutions

Proportional Quotas

Regressive Quotas

Contribution Quotas

Contribution

Covered Deposits

Dimension Correction (ti)

Risk Correction (i)

Indicators (WAAI)

Elasticity analysis
Financial crisis and quantitative methods: problems and solutions

Reliability and time evolution

Financial crisis and quantitative methods: problems and solutions

Real mathematical modelling...

Financial crisis and quantitative methods: problems and solutions

Merton framework: it assesses the credit risk of a bank by characterizing the bank's equity as a call option on its assets. The bank has a certain amount of zero-coupon debt that will become due at a future time T. The bank defaults if the value of its assets is less than the promised debt repayment at time T. The equity of the bank is a European call option on the assets of the bank with maturity T and a strike price equal to the face value of the debt. The model can be used to estimate the risk-neutral probability of the bank.