It is not always clear how a Deposit Guarantee Scheme generates the funds available for payout and how a payout has an effect on the liquidity of a bank. Deposit Guarantee Schemes (DGS) are funded by participating banks and branches of domestic banks that are established in the country. Participation in the DGS is often mandatory for financial institutions with a (branch) license in a country.
Participating banks pay a periodic premium to the domestic DGS, that is most often managed by the central bank. This premium is based on a combination of the qualitative and quantitative deposits, as well as the size of these deposits a bank holds on behalf of its depositors and the risk factor that corresponds with these deposits. E.g. FBME Bank has a high risk profile because its customer base is almost complete foreign and the deposits are in general higher than deposits made in other banks.
The central bank or court can activate the DGS. They do so when they have evidence that customer deposits are at risk and a bank run is expected. In the case of FBME Bank Cyprus, it is a certainty that the bank will have difficulties to return customer deposits. The bank has no license, no active payment system, no card services and the majority of its cash position is blocked on nostro accounts at corresponding banks. Reason enough for the Central Bank of Cyprus to establish and inform the Committee that FBME Bank Ltd – Cyprus Branch for reasons relating to its financial condition does not appear for the time being able to repay deposits to its clients and also deems that FBME Bank Ltd – Cyprus Branch will not be able to do so in future.
After a payout of the DGS funds to a customer, a maximum of 100.000 Euro is protected under the DGS, the account of the customer at FBME Bank is reduced with the DGS payout amount. These funds are added to the banks liquidity since the premiums that cover the customers funds are already paid in the past.
If during the contract term no banks in the country fail, the premiums are added to the reserve of the DGS. This can be helpful when a bank panic results in bank failure of more banks at the same time.