The Role for Deposit Insurance Funds in Dealing with Failing Banks in the European Union

IMF Working Papers, January 7, 2022

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The paper argues that in the European Union (EU) deposit insurance funds are too difficult to use in bank resolution and too easy to use outside resolution.
It proposes reforms in three areas for the effective management of bank failures of small and medium-sized banks in the European Union:
- making resolution the norm for dealing with failing banks;
- establishing a common DIS for the European Union;
- increasing funding and backstops for deposit insurance while removing constraints on their use for resolution measures.
The paper warns that without these changes, the European Union will continue to be challenged by banks that are too small for resolution and too large for liquidation.

Deposit insurance funds in the EU face legal and operational constraints that make their use within formal resolution processes difficult.
Deposit insurance is relatively easier to deploy outside of resolution, which can undermine comprehensive resolution frameworks.
The current setup creates a structural problem where some banks fall into an intermediate zone: too small for resolution yet too large for straightforward liquidation.

Make resolution the default approach for dealing with failing banks, including small and medium-sized banks, to preserve financial stability and consistent treatment.
Establish a common Deposit Insurance Scheme (DIS) for the European Union to harmonize tools and incentives across jurisdictions.
Increase funding and backstops for deposit insurance and remove constraints on the use of deposit insurance funds for resolution measures to enhance flexibility and effectiveness.

Subject: Bank resolution, Bank resolution framework, Deposit insurance, Distressed institutions, Financial crises, Financial institutions, Financial safety nets
Keywords: aid rule, authorities in host jurisdiction, Bank resolution, Bank Resolution, Bank resolution framework, Banking Union, Crisis Management, Crisis Preparedness, deposit insurance, Deposit insurance, Deposit Insurance, Distressed institutions, EU response, Euro Area, European Union, Financial Crisis, Financial safety nets, Financial Stability, fiscal authorities, Global, host authorities' concern, liquidation regime, single market