1 C OMMENTARY ON THE GENERAL GUIDANCE FOR EFFECTIVE DEPOSIT INSURANCE MANDATE The views expressed herein are not necessarily those of the Jamaica Deposit Insurance Corporation or the International Association of Deposit Insurers or any other entity or person and are solely the opinions of the undernamed. Submitted by: Antoinette McKain Legal Counsel/Corporate Secretary Jamaica Deposit Insurance Corporation 30 Grenada Crescent Kingston 5 Jamaica November 1, 2006 AS PREPARED BY THE SUBCOMMITTEE ON GENERAL GUIDANCE FOR EFFECTIVE DEPOSIT INSURANCE MANDATE THE RESEARCH AND GUIDANCE COMMITTEE

2 OVERVIEW ON GENERAL GUIDANCE FOR EFFECTIVE DEPOSIT INSURANCE MANDATE The General Guidance for Effective Deposit Mandate is instructive as it analyses established typologies of Deposit Insurance systems and practices in a number of jurisdictions and properly emphasizes the significance for the Deposit Insurance Mandate being adequately aligned to public policy objectives of the Deposit Insurance System. Recognizing the need for this alignment and that it be publicly disclosed in legislation is fundamental to ensuring an effective Mandate for a Deposit Insurance System.

3 OVERVIEW ON GENERAL GUIDANCE FOR EFFECTIVE DEPOSIT INSURANCE MANDATE Cont’d. Once this fundamental is understood the Guidance appropriately then recognizes the necessarily complementary function of Deposit Insurance in a financial safety net system and that the Deposit Insurers Mandate must be aligned with that of other institutional functions. The Guidance satisfies its objectives in offering guidance in designing an effective Mandate of Deposit Insurance Schemes for countries considering the adoption of deposit insurance or the revision of existing deposit insurance systems. (See General Guidance for Effective Deposit Insurance Mandate Prepared by The Subcommittee on General Guidance for Effective Deposit Insurance Mandate, The Research and Guidance Committee, International Association of Deposit Insurers)

4 DEPOSIT INSURANCE IN THE FINANCIAL SAFETY NET The financial safety net institutions for the deposit taking financial sector are commonly: (i)(ii)(iii) Lender of Last Resort Function of a Central Bank Financial Institution Regulation and Supervision by Government, the Central Bank or other Independent Agency Deposit Insurance in the event of financial institution failure, by an agency of a type carrying out functions of (i) and (ii) or function of (ii) alone. Each financial safety net institution carries out specific functions towards the public policy objective of contributing to financial system safety and soundness notwithstanding, however, with different and potentially conflicting objectives. COMMENTARY

5 TYPES OF DEPOSIT INSURANCE SYSTEMS The General Guidance for Effective Deposit Insurance Mandate finds from the research that there is commonly agreed three types of Deposit Insurance Systems: the paybox, usually by an agency of a type that carries out functions at (i) and (ii); the paybox with extended powers which is usually of a type that carries out some of the functions at (ii) and the risk minimizer which carries out all or most of the functions of (ii). DEPOSIT INSURANCE IN THE FINANCIAL SAFETY NET (CONTINUED):

6 OPTIMAL DEPOSIT INSURANCE MANDATE? The objective of this commentary is to postulate that there may be an optimal Deposit Insurance Mandate within the context of the identified public policy objectives of Deposit Insurance Systems and the specific findings of the research undertaken in the General Guidance for Effective Deposit Insurance Mandate.

7 BROAD PUBLIC POLICY OBJECTIVES OF DEPOSIT INSURANCE SYSTEMS 1.Contributing to Financial-System Stability Minimizing the risk of runs Creating formal mechanisms for resolving failed institutions Contributing to an orderly payments system Resolving a financial crisis 2.Protecting Less-Financially Sophisticated Depositors 3.Redistributing the Cost of Failures 4.Promoting Competition In The Financial Sector By Reducing Competitive Barriers In The Deposit Taking Industry 5.Encouraging Economic Growth 6.Reducing The Effect of A Recession 7.Facilitate The Enactment of Legislation 8.Facilitate the Transition From A Blanket Guarantee To Limited Coverage (See Guidance for Developing Effective Deposit Insurance Systems, Background Documents, Working Group on Deposit Insurance, September 2001)

8 …..WHILE REDUCING MORAL HAZARD The other major consideration for the Deposit Insurer and other financial safety net institutions which assist in the public policy objective of contributing to financial system stability is the reduction of Moral Hazard which is inherent in safety net systems.

9 PUBLIC POLICY OBJECTIVES: THE ALIGNMENT OF MANDATES, ROLES AND RESPONSIBILITES AND POWERS AND AUTHORITIES Once the public policy objectives are agreed by the proper authorities, then the Mandate can be determined accordingly and the specific roles and responsibilities and powers and authorities publicly disclosed. P UBLIC P OLICY O BJECTIVES M ANDATES R OLES AND R ESPONSIBILITIES P OWERS AND A UTHORITIES

10 PRIMARY MANDATE OF DEPOSIT INSURANCE SYSTEMS: REIMBURSEMENT OF DEPOSITORS (PAYOUT) All Deposit Insurance Systems (PAYBOX, PAYBOX WITH EXTENDED POWERS AND RISK MINIMIZER) reimburse depositors where financial institutions become insolvent and are unable to do so. This is within a context of the overarching public policy objective for contribution to financial system stability.

11 SOME IMPLICATIONS OF THE OBLIGATION FOR REIMBURSEMENT OF DEPOSITORS I.The Deposit Insurer Must Have The Power To Reimburse Depositors In The Event of The Insolvency of A Financial Institution, Taking into Account Moral Hazard Issues. II.The Deposit Insurer Must Be Able To Fund The Reimbursement of Depositors. III.The Deposit Insurer Must Have The Means To Ensure That Its Funding Source Is Adequate. IV.The Deposit Insurer Should Have The Power To Make A Determination That The Reimbursement Is Necessary And The Least Costly Course of Resolution V.The Deposit Insurer Must Have The Power To Recover As Far As Is Possible The Monies That It Has Paid Out. VI.The Deposit Insurer should be Autonomous.

12 (I) THE DEPOSIT INSURER MUST HAVE THE POWER TO REIMBURSE DEPOSITORS IN THE EVENT OF THE INSOLVENCY OF A FINANCIAL INSTITUTION TAKING INTO ACCOUNT MORAL HAZARD ISSUES  The payment guaranteed to depositors should be limited so as to foster market discipline and help to reduce moral hazard.  The payment should be to those depositors at greatest risk and with least information.  The Deposit Insurer must have access to the depositor records sufficiently before a reimbursement so that the reimbursement can be carried out efficiently and speedily.  The Deposit Insurer should have no obligation to reimburse depositors who have contributed to the insolvency of a financial institution.

13 (II)THE DEPOSIT INSURER MUST BE ABLE FUND THE REIMBURSEMENT OF DEPOSITORS  The Deposit Insurer should be responsible for the establishment and management of a Fund for the reimbursement of depositors.  The Deposit Insurer should be able to invest its funds in marketable securities, preferable risk free.  The Deposit Insurer should have the power to borrow and to issue debt.  The Deposit Insurer should be able to obtain the guarantee of the Government  All deposit taking financial institutions should compulsorily be members of the Deposit Insurance Scheme

14 (III)THE DEPOSIT INSURER MUST HAVE THE MEANS TO ENSURE THAT ITS FUNDING SOURCE IS ADEQUATE -The Deposit Insurer should have the power to levy premium from member institutions preferable consequent on the risk that the institution poses to the Fund managed by the Deposit Insurer. -The Deposit Insurer must have the means, either by information obtained from the Supervisor or on its own or a combination of both methods, for assessing the risk of the member financial institutions whose deposits it insures.

15 (IV)THE DEPOSIT INSURER SHOULD HAVE THE POWER TO MAKE A DETERMINATION THAT THE REIMBURSEMENT IS NECESSARY AND THE LEAST COSTLY COURSE OF RESOLUTION  The Deposit Insurer should be in close collaboration with the Supervisory/Regulatory authorities during the period prior to and during crisis resolutions so that their respective positions can be assessed as a whole to determine the best course of resolution in the interest of financial system stability and the least cost to the Deposit Insurance Fund.  The Deposit Insurer should have the power to provide financial assistance to its member institutions in prescribed circumstances and on prescribed conditions, in pursuit of least cost resolution.  The Deposit Insurer should have the power to make a preliminary assessment of the costs of a reimbursement vis a vis other resolution strategies.

16 (V)THE DEPOSIT INSURER MUST HAVE THE POWER TO RECOVER AS FAR AS IS POSSIBLE THE MONIES THAT IT HAS PAID OUT  The Deposit Insurer should be subrogated to the rights of the depositor where it has made a payment.  The Deposit Insurer should have control over the liquidation of the financial institutions, either acting as liquidator or receiver to ensure the speedy realization of assets and maximum recovery for itself.

17 (VI)THE DEPOSIT INSURER SHOULD BE AUTONOMOUS The roles of the financial safety net institutions are potentially conflicting and which conflicts are more likely to be patent and costly when a financial institution crisis becomes imminent or occurs. The autonomy of the various safety net institutions then allows for the synergies that results in the best resolution strategy within the context of the overreaching public policy objective of contributing to financial system safety and soundness.

18 CONCLUSION THE OPTIMAL DEPOSIT INSURANCE MANDATE? Is the optimal deposit insurance Mandate one that is achieved with a PAYBOX WITH EXTENDED POWERS?