Andreas Wesemann argues that the government must stop insuring bank deposits – a practice that has only resulted in an increase in the probability and severity of banking crises.
The abolition of deposit insurance could counter-intuitively lead to;
Deposit insurance has already been rejected in a number of sizable western economies – in particular New Zealand where a temporary scheme was ended in 2011 due to concerns that it was creating damaging risk incentives and thereby increasing the chance of bank failure. Deposit insurance was replaced with a rapid resolution system to deal with bank failures, the “Open Bank Resolution” – a policy ensuring that customers would be able to gain access to their accounts and other bank services, whilst an appropriate long-term solution to a bank’s failure was identified.
Andreas Wesemann explains:
“The existence of almost complete loss protection on a significant part of banks’ liabilities has distorted deposit pricing, retail investors’ willingness to use banks, and banks’ ability to grow & assume risk. The macro-economic cost of this subsidy has been very significant.
The abolition of deposit insurance, supported by legislation outlawing such compensation payments, combined with the establishment of NS&I as a bank offering a full range of current account and savings products would trigger a significant strengthening and improvement of the UK banking sector. It could pave the way towards a world with less leverage, fewer recessions and a more functional involvement of the state making better use of its balance sheet.
In this world, the Basel 3 regulatory regime is unnecessary and can be abolished. It would be replaced by one or mutual guarantee schemes between eligible banks. Industry, rather than sovereign, protection of this kind is a better way of managing banks and managing risk.”
While the abolition of deposit insurance would require either a UK opt-out from EU regulations – or for the policy to be adopted across the EU – it would be a simple initiative to implement and would stabilise the banking sector by reducing its leverage substantially in a way that involves minimal regulatory intervention and, therefore, the transgression of state authority into private commercial relationships.