1. Financial crisis and quantitative methods: problems and solutions Are European Deposit Protection Schemes efficient enough? Adamo Uboldi Joint Research Centre European Commission Unit for Econometrics and Applied Statistics Financial Econometrics for a Single Market and Competitiveness Policies

2. 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

3. Financial crisis and quantitative methods: problems and solutions Deposit Protection in the EU 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

4. Financial crisis and quantitative methods: problems and solutions  Protection of depositors’ wealth through the introduction of a minimum threshold (€20,000 till October 08) Directive 94/19/EC (I)  Maintenance of confidence in the EU banking system through protection of stability, avoiding a run on the banks Objectives

5. Financial crisis and quantitative methods: problems and solutions Directive 94/19/EC (II)  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 Key provisions and implementation

6. Financial crisis and quantitative methods: problems and solutions Current financial crisis (I) Quick response to crisis: DG-MARKT asked JRC to perform an early IA on possible changes of coverage level October 9 th : 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…

7. Financial crisis and quantitative methods: problems and solutions Current financial crisis (II)  65% of deposits are currently covered  80% of deposits would be covered under 50K€ limit  90% of deposits would be covered under 100K€ limit

8. Financial crisis and quantitative methods: problems and solutions 50K€ Eligible deposits (m€)Absolute exposure (m€) BE 188,79166,172 CZ 40,854866 DK 106,0299,986 DE 1,615,946530,812 EE 2,590137 IE 143,22643,593 GR 98,92627,816 ES 575,940160,284 FR 839,391- IT 511,527- CY 16,8871,336 LV 5,115284 LT 3,903141 LU 86,73430,486 HU 27,6491,059 MT 4,617365 NL 264,83923,249 AT 158,33866,883 PL 63,9344,588 PT 108,38419,828 SI 10,7603,261 SK 10,1501,120 FI 68,94817,248 SE 113,09428,520 UK 1,728,510- EU 25 total6,795,0821,038,035 Current financial crisis (III) 100K€ Eligible deposits (m€)Absolute exposure (m€) BE 188,79187,313 CZ 40,8541,035 DK 106,02929,620 DE 1,615,946701,172 EE 2,590164 IE 143,22666,820 GR 98,92634,533 ES 575,940193,477 FR 839,39127,070 IT 511,527 - CY 16,8871,494 LV 5,115323 LT 3,903147 LU 86,73440,435 HU 27,6491,228 MT 4,617409 NL 264,83955,906 AT 158,33884,854 PL 63,9345,370 PT 108,38421,873 SI 10,7603,332 SK 10,1501,253 FI 68,94821,541 SE 113,09438,884 UK 1,728,510261,259 EU 25 total6,795,0821,679,510

9. Financial crisis and quantitative methods: problems and solutions DataProblems Deposits/Fund/Premiums Past DGS actions Payout delays Cross-border exposure Quant. Qualit. Triggering event Intervention procedure Authorities involved Dataset incomplete Confidentiality Definitions Late answers (DE missing) Aggregation of data Missing information Heterogeneity of data Overlapping with bankruptcy law Investigating DGS Efficiency

10. Financial crisis and quantitative methods: problems and solutions DGS Actions Types Payout (16 DGS out of 37) 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

11. Financial crisis and quantitative methods: problems and solutions Triggering Event of Payouts  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

12. Financial crisis and quantitative methods: problems and solutions Financial Resources 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

13. Financial crisis and quantitative methods: problems and solutions Payout Delays AmountNumber

14. Financial crisis and quantitative methods: problems and solutions Scenarios Definition Scenario 1: High Scenario 2: Medium Scenario 3: Small Scenario 4: Medium Scenario 5: Very High Payout Preventive Cross-border IR = 3.24, highest in EU-12 IR = 0.81, 2003 failure in EU-12 IR = 0.035, highest in EU-15 IR = 0.16, 2003 failure EU-15 Fictitious, due to lack of data  Intensity Ratio =

15. Financial crisis and quantitative methods: problems and solutions Scenarios Results EU-15 B B

16. Financial crisis and quantitative methods: problems and solutions B B B B B B B B Scenarios Results EU-12

17. Financial crisis and quantitative methods: problems and solutions  Coverage Ratio =  Resource Ratio =  Robustness Indicator = Capability to cover interventions

18. Financial crisis and quantitative methods: problems and solutions Coverage and Resource Ratio

19. Financial crisis and quantitative methods: problems and solutions Intensity Ratio

20. Financial crisis and quantitative methods: problems and solutions Cross-border exposures: branches

21. Financial crisis and quantitative methods: problems and solutions Cross-border exposures: subsidiaries

22. Financial crisis and quantitative methods: problems and solutions Risk-Based Contributions for EU DGS FINLAND FRANCE GERMANY (Cooperative Banks) GERMANY (Saving Banks) ITALY (Banks) PORTUGAL (Banks) PORTUGAL (Cooperative Banks) SWEDEN Risk-Based Contributions AUSTRIA GERMANY (Public Banks) ITALY (Cooperative Banks) POLAND ROMANIA Early-Warning Systems

23. Financial crisis and quantitative methods: problems and solutions Indicators Capital Structure / Solvency Profile Riskiness / Exposure Profitability / Income Maturity transformation / Duration Classes of Indicators 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

24. Financial crisis and quantitative methods: problems and solutions Towards a common Risk-Based System Homogenous Framework: identification of a generalized formula for risk- based contributions c i of the i-th member x i = i-th member’s contribution base (e.g. eligible or covered deposits…)  i = i-th member’s risk-based adjustment  = fixed percentage determining the aggregated contribution (i.e. NOT influenced by single members’ risk, common value for ALL members) IndicatorsScoresRating Class ii

25. Financial crisis and quantitative methods: problems and solutions Contribution OAC ∙ NSR Overall Amount of Contribution (OAC) Net Risk Amount ( x i +  i ) ∙  i Correction  i Contribution base ( x i +  i ) Indicators Scores  i Net Share of Risk (NSR) France

26. Financial crisis and quantitative methods: problems and solutions Contribution Quotas Risk Correction (  i ) Indicators (WAAI) Contribution Regressive Quotas Dimension Correction (  i ) Proportional Quotas Covered Deposits Italy – Commercial banks

27. Financial crisis and quantitative methods: problems and solutions Elasticity analysis

28. Financial crisis and quantitative methods: problems and solutions Reliability and time evolution

29. Financial crisis and quantitative methods: problems and solutions Real mathematical modelling... 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.