Deposit insurance in developing countries

About a dozen developing countries have deposit insurance systems and several others are considering establishing them. These systems are typically created to prevent contagious bank runs, to provide a formal national mechanism for handling failing banks, and to protect small depositors from losses when banks fail. Without a deposit insurance system, many developing nations in recent years have extended implicit deposit protection to depositors on a discretionary, ad hoc basis. Deposit insurance systems have several advantages over these implicit protection schemes. Deposit insurance probably gives the banking system more protection against bank runs, provides more protection for small depositors, and provides a faster, smoother administrative process. On the other hand, deposit insurance probably creates more moral hazard for depositors, thereby contributing to the erosion of market discipline and increased bank risk-taking. Deposit insurance also tends to be a more expensive mechanism for protecting depositors because it offers less freedom of action to policymakers than an implicit scheme. Finally, developing countries often do not adequately fund their deposit insurance schemes. As a result, the systems often lack credibility in the marketplace and bank supervisors may be unable to close insolvent banks because the insurer would be unable to pay off insured depositors.