Deposit insurance aims to safeguard confidence in the financial system while maintaining the critical functions of local payments when credit institutions fail or are likely to fail. It is primarily seen as a paybox function that allows internal stakeholders time to determine the most appropriate resolution for credit institutions in distress while protecting the real economy. Retail deposits, savings and wholesale deposits up to a predefined limit are generally covered under a Deposit Guarantee Scheme (DGS). International standards and domestic matters however may justify alternative terms to protect the stability of the financial system.
Terminology of deposit insurance is somewhat inaccurate. The general public often understands that a DGS repayment is guaranteed for all creditors. Yet not all creditors qualify for DGS repayment. To understand the reasoning behind the applicability of deposit insurance one should consider the fundamental factors of credit creation and the banking system. Banks take deposits from savers and lend these funds to borrowers. They borrow short and lend long. This process is furthered by sophisticated techniques such as securitization and fractional reserve lending. The result is that banks are unable to return savings to all their depositors at the same time. This only works well when there is enough confidence in the system to allows savers and investors retain interest bearing investments at the bank with a long term and fixed maturity.
One of the hazards of the financial system is excessive risk taking. This should not be subsidized by tax payer funded bail outs and deposit insurance. The underlying theory of deposit insurance alleges that in a free market, bank account holders and investors penalize financial institutions for wrongdoing. The challenge of such assertions is that regular account holders are assumed to thoroughly understand banking and finance while acting accordingly when misconduct is unraveled. Regulars customers are almost always too late and may get sucked into a mud fight between the bank and its regulator when markets fail to correct financial institutions.
Deposit insurance is activated when a financial institution fails or is likely to fail. The conditions for DGS claim eligibility are laid down in local regulation. Local regulation often defines and refers to eligibility and exclusions for deposit insurance. In general, public authorities, financial institutions and other account holders that are able to protect themselves against the adverse effects of bank failure are excluded from DGS coverage. So, what does this mean for regular creditors? First of all, the scope of their activities and legal standing must fit with the claim requirements. Second, the DGS claim must be filed so that the administrator instantly sees that there is claim eligibility.