The problem with deposit protection

The case of the bankrupt Corporate Commercial Bank (CCB) and the banking panic that hit First Investment Bank give us an opportunity to return to some of the basic problems of the modern form of banking [1]. And especially after the announcement of the idea of paying out all deposits (even amounts exceeding 100,000 euros) in CCB, one cannot help but pay attention to a favorite political-banking scheme – the regulatory mechanism for deposit insurance.

The traditional and fundamentally irrefutable criticism of deposit insurance is that it creates moral hazard. Most depositors have no incentive to check whether a bank is sound or not, if money up to €100,000 in the EU or $250,000 in the US will be returned no matter what. Moreover, in certain places in the world all lost deposits are directly covered, regardless of their size, in order to save political tension - the case of Northern Rock in the UK is a popular example. In such a situation, even state regulators themselves (with all their other problems) are left alone and quietly become closer to the institutions they are supposed to supervise.

As The Economist magazine says, the situation in which the “state guarantees” in the financial sector is well illustrated by the bursting of the 2007-2008 bubble. Having collected the profits from state-guaranteed risky operations, the bankers hand over the bill to the taxpayers at the moment the collapse comes. We all remember the massive “rescues” of banks and other large businesses by the Bush government (with American money) through the TARP program. The scheme is similar with guaranteed deposits, which stimulate risky behavior by seeking high interest rates (like those at Corpbank), without any attention to the stability of the financial institution.

Even more interesting is the position on the subject of the Austrian economist Ludwig von Mises - he says that deposit insurance is in principle inapplicable (regardless of whether it is paid for by private individuals or the state). Mises explains that there are two types of events: "class" and "chance". Chance events are, for example, a football match or a military clash - in them we know a lot about the protagonists, but not what the outcome will be. While in class events, without having information about the participants, we know relatively well what the outcome of the event would be - for example, in the case of a dice roll.

Only class events can be insured, i.e. those that are sufficiently predictable (the chance of two sixes on a dice is 1/36, there is no such statistical probability for a football match), and bank deposits are not included in them. In other words, deposit insurance is not "insurance", but gambling. Moreover, if you buy life insurance, this will hardly make you lead a riskier life in order to die earlier and receive the money, while with a guaranteed bank deposit, the incentive is to put the money in the bank with the lowest fees and highest interest rates, even if it is the riskiest (like Corpbank).

We come to another fundamental problem of deposit protection funds that is currently plaguing us - they can rarely cover all the "insured" funds. Especially when the political apparatus decided that it had to abandon the commitment made (the rule written in the law to pay out deposits up to 100,000 euros) and declared that even the biggest deposit gamblers would be able to take advantage of the fact that the Bulgarian taxpayer and his children (who will be paying off the state debt for years) will reach for their high interest rates.

The way out of the situation is, as usual, to let people take responsibility for their actions. Any kind of “protection” through administrative means simply allows political influencers and other opportunists to strike again.

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