Deposit insurance is the term used for the statutory and voluntary measures taken to protect the deposits of bank customers in the event of insolvency.
Like any investment of funds deposits bear counterparty risk, ie, the risk that the bank may not repay the deposit. The instruments of deposit insurance may reduce this risk, but not completely. The risk exposure of a guarantee of deposits is reduced to the level of default risk of the guarantor.
It is intended to compensate customers in case of failure of their bank or financial institution to dispense the funds. It includes the deposit guarantee, known as cash guarantee, warranty of title, (guaranteed securities), guarantee of bonds (security guarantees).
Measures taken to guarantee security pertain to capital requirements, mutual responsibility within banking groups, statutory deposit insurance, as well as voluntary deposit by the deposit insurance fund.
The elementary protection of customers’ deposits involves preventing the insolvency of the bank. These are implemented through a number of provisions of the Banking Act, in particular the capital requirements order. These rules will ensure that in case of problems sufficient bank assets exist to pay the deposits of customers.
In some jurisdictions life insurance is guaranteed by the guarantee fund and health insurance. The guaranteed amount is set at a predetermined maximum per insurer.
Those receiving invalidity pension or disability benefits (and beneficiaries of a contract following a death) are entitled to a given amount. As regards guarantee insurance in general there are many restrictions and the law sets a comprehensive multi-year intervention fund to limit compensation.
Banks are often part of formal (ie legally binding) or informal (ie voluntary) mutual liability schemes. Legally binding liability rules often exist between parent and subsidiary companies. Such a group of savings banks or cooperative banks are referred to as backup formations. Not only deposits are protected but also the stock of the institutions, to such an extent that debt by the cooperative banks and savings banks is fully secured.
The history of banking is closely connected with the history of banking crises, and thus the loss of investors’ money. Protection promised to the investor, is largely perceived to be reflected in the choice of a bank with a long track record and good reputation.
In many countries, banks offer additional backups, in Europe there are numerous deposit insurance funds of the respective banking associations, which protect more than the statutory requirements, and the deposits of customers. The voluntary deposit insurance takes into account the base rate of the statutory deposit.