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General Overview about Deposit Guarantee System

The banking system is considered as the channel through which money is transferred. As such it highlights the economic activity of nations.
Different criteria are used to measure the size of banking system such as, capital, assets, geographical distribution and deposits. Deposits constitute more than 90% of banks resources. Consequently, monetary authorities set regulatory frameworks to protect depositors and maintain the soundness and stability of the banking system. Deposit guarantee schemes are among the public policy frameworks devised to protect depositors.
‏The idea of deposit insurance was initially developed in the United States of America in New York State in 1829 but the actual beginning was in 1933. However, Checkosolvakia was the first country to implement a deposit insurance system in 1924. Since then countries around the world developed their own schemes to reinforce their financial and banking system.
‏In the Sudan the system was established in 1996

Deposit Guarantee Methodology:

Deposit insurance is a public policy issue. It plays a central role in economic and financial stability. In its simplest form, deposit insurance is intended to protect depositors in case monetary authorities decided to liquidate a bank. However, in reality the case is more complicated.
‏There are a number of principles and foundations upon which deposit insurance systems are based. These principles characterize the public policy features as well as the methodological underpinnings alongside how to exercise their duties and responsibilities.
A number of configurations could be developed to choose from. The principles include:
‏     •   Mandates and powers
‏     •   Coverage
‏     •   Funding, and
‏     •   Calculations of contributions.
Deposit insurance is not a banking business‏.

Mandates and Power:

The mandates and powers of deposit insurance schemes range from a pay box to reimburse depositors to a system with wide authorities that might include monitoring risk, entry and exit control, inspection of banks files or to assume bank administration or even to decide up on bank liquidation.‏

Insurance Coverage:

Coverage is defined in terms of scope and level. Scope of coverage refers to the eligibility of deposits to coverage (i.e., types of deposits to be covered) whereas level of coverage indicates coverage limits.‏

There are three coverage limits:
  • Blanket coverage: blanket coverage provides full and general protection to depositors and creditors and is usually implemented during financial crises that might undermine the nations payments system. Blanket coverage aims to reinforce the depositors and the general public confidence in banking system. Meanwhile, it provides enough time to regulators to implement strategic decisions. Funding blanket coverage is over and above the ability of deposit insurance system, as such monetary authorities undertake financing blanket coverage.

  • Full Coverage: full coverage protects depositors by 100% and hence prevents bank runs. Full coverage minimizes depositors motive to withdraw their deposits from insolvent banks. It also enables banks to successfully pass the crises. Moreover, it facilitates regulators intervention .
    ‏Full coverage is the preferred option if stability is the goal. However, it undermines market discipline and increases moral hazard. Furthermore, it does not prevent bank runs of insolvent banks due to temporary liquidity problems and freezing of deposits.

  • Limited coverage: protects depositors up to a maximum coverage limit. It is the best choice since it protects small depositors. It also prevents bank runs and maintains market discipline by jeopardizing large depositors to potential losses.
    ‏Despite the existence of these three alternatives in deposit insurance literature, however, in reality there is neither full coverage nor blanket coverage in any jurisdiction across the world. Rather limited coverage is dominating almost all deposit insurance schemes in all jurisdictions.
    ‏The level of coverage depends on public policy objectives. If the policy aims to maintain banking stability large maximum coverage is set ( without jeopardizing large depositors role to exercise market discipline). On the contrary, if public policy objective was to protect smaller depositors and minimize moral hazard, smaller maximum limit would be adevised.
    ‏Usually coverage limits are benchmarked by dividing coverage by per capita GDP.

Most deposit insurance schemes do not cover the following deposits:
  • Foreign currency deposits in local banks

  • Inter-bank deposits

  • Local currency deposits in foreign banks

  • Deposits of members of board of directors and general managers and their spouses and children, and
    ‏Deposits of bank's Auditors


To meet their obligations towards depositors, deposit insurance schemes need sufficient funds. these resources are used to cover insured deposits in the event of bank liquidation as well as to cover their administrative expenses.

There are three funding methods:
  • ‏‏Annual contributions: these are amounts paid by member banks either before bank default ( ex   ante) or after bank liquidation ( ex post). Each method has its advantages and disadvantages.
    Annual contribution ( ex ante) is similar to commercial insurance where institutions collect the premiums before default. Whereas in ex-post system banks pay their contributions after the liquidation decision is taken by regulatory authorities.

  •  Annual contribution has the advantage of providing safety and credibility since these are resources  invested to build target fund to meet depositors claims in case of liquidation.
    ‏It is worth mentioning that 80% of deposit insurance schemes use annual contribution funding. Also this method spreads the costs over time since unlike the ex post system which requires all banks pay their contributions once at the same time. Moreover, annual contributions treat all banks equally including the insolvent ones.

Calculation of contributions:

Two methods are available to calculate annual contributions namely: flat rate and risk-based premiums. According to flat rate method a fixed percentage of demand deposits and savings and investments deposits are paid annually to the deposit insurance scheme at the beginning of the fiscal year. All banks pay the same rate. They differ only in terms of size of deposits. One drawback of this method is equating between high risks banks and those who maintain a good risk level.
‏The second method calculates contributions for each bank according to its risk ( i.e., risk- based premiums). This method involves complex procedures for calculating premiums as well as the negative impact it might have on high risk banks.
‏This method requires credit rating assessment such as that of Standards and Poor's or Moody and Fitch. However, these agencies use interest rate as a main vehicle which is prohibited in Islamic banking system. Moreover, the credibility of Credit Rating Agencies was questioned especially after the recent financial crisis. Furthermore, risk-based premiums contradicts the "Takaful" principle which is a core foundation of Islamic banking and Islamic deposit insurance