“A policy of unlimited deposit insurance may have significantly supported system growth and membership confidence. But it is unknown outside of Western Canada, may cause moral hazard, and may be increasingly expensive to credit unions in terms of earnings, capital and compliance.”
SERIES OVERVIEW
This article is the first part of a two-part series related to deposit insurance applicable to Canadian credit unions.
Overview, History & Pros/Cons: Policy in B.C. & Canada. Unlimited vs limited
Implications & Options: Benefits, cost & regulatory impact. Three policy choices
This series was authored earlier in 2017 to aid an executive search process. A formatted PDF of the article series is available on request and will be published in due course. Several system veterans kindly volunteered technical expertise, system memory, and professional guidance. Thank you. Their wisdom, perspective and encouragement were invaluable.
This article has five sections - Executive summary; Deposit insurance; Canadian provincial credit unions; B.C. credit unions; Unlimited vs limited coverage.
Given subject matter complexity, subjectivity and sensitivity then the author has leveraged significant graphical analysis in efforts to enhance explanation and to aid assessment.
This document may be easier to read in PDF format. Download per http://bit.ly/dep-ins-pdf
EXECUTIVE SUMMARY
“Deposit insurance policy may gain prominence due to emergent federal credit unions and a current B.C. legislative review.”
Most credit unions, banks and other deposit taking institutions are legally obligated to maintain deposit insurance. Such insurance refunds depositors in the event of institutional insolvency. An ‘ex-ante’ policy involves the establishment of a fund to subsequently settle claims. Canada has multiple deposit insurers that collectively manage approximately C$5 billion of investment funds. Deposits in B.C. credit unions are covered by Credit Union Deposit Insurance Corporation (CUDIC) and by Stabilization Central Credit Union (SCCU) that collectively manage approximately C$600 million of investment funds.
The coverage terms and resultant cost of deposit insurance vary materially across Canadian deposit taking institutions. Deposi- tors in some institutions, including B.C. credit unions, currently receive insurance to an unlimited amount.
Individual credit unions can mitigate assessment cost through prudent operations, regulatory compliance and good gover- nance. Collectively, credit unions may influence deposit insurance by policy advocacy for coverage terms and target funds.
For some credit union industry stakeholders, deposit insurance policy is an acutely sensitive topic. Elevated, or unlimited, levels of deposit insurance coverage is a competitive advantage for some credit unions against Canadian banks. Over recent decades then B.C. credit unions have operated in regimes that offer both unlimited and limited coverage. There are advantages and disadvantages, costs and benefits of each policy and there are international best practices.
Deposit insurance policy may gain prominence due to federal credit unions and a current B.C. legislative review.
A hybrid future with federal and provincial credit unions may create four implications for deposit insurance - entity funding, policy inconsistencies, consumer confusion and deposit transition. Provincial ex-ante deposit insurance funds may retain historical premiums paid by federal credit unions, potentially creating material insurance surplus. Deposit insurance policies across Canadian jurisdictions and between entity types currently vary materially and may differ from international practices. There is a risk that consumers may not understand the difference in deposit insurance coverage offered by a federal credit union and a provincial credit union. The transition from a provincial to a federal credit union may displace a subset of deposi- tors, say those with relatively large account balances. This article does not expressly address federal credit union matters.
An active legislative review by the B.C. Ministry of Finance is considering the optimal level of deposit insurance for B.C. credit unions. FIA/CUIA submissions by the B.C. credit union system and by most, but not all, individual credit unions appear to significantly support the maintenance of the current regime of unlimited deposit insurance. Data suggests that this regime may have supported growth in membership, deposits and market share of the B.C. credit unions. Further, the regime may have contributed to the relatively strong market share by, and large average member deposits in, B.C. credit unions compared with provinces that have limited coverage. But a policy of unlimited deposit insurance is unknown outside of Western Canada, may cause moral hazard, and may be increasingly expensive to credit unions in terms of earnings, capital and compliance.
This article seeks to stimulate collaborative discussion. It may highlight history or facts that are unfamiliar. It may aid profes- sional education or support policy formulation by the Board or executive of a credit union or system entity. In this article, most analysis related to B.C. aggregates information for CUDIC and SCCU. The report is framed in the following sections-
- Overview: Deposit insurance; Deposit insurance in Canada; Deposit insurance in B.C; Pros & Cons of alternate regimes implications: Benefits of unlimited coverage; Costs of unlimited coverage; Regulation & Deposit insurer; Conclusions: Policy options; B.C. credit union system view
- References, About the author, Disclaimer
As a discussion document, it consciously does not provide a policy recommendation. But it does strive to gather objective data; present relevant analysis; consider advantages, disadvantages, and implications; and frame three discrete policy options.
Maintain current policy of unlimited deposit insurance
Re-introduce policy of limited deposit insurance
Seek policy alignment of deposit insurance across Canadian jurisdictions
DEPOSIT INSURANCE OVERVIEW
Many jurisdictions or legislatures require that their deposit taking institutions maintain deposit insurance. Most North American deposit insurers were established decades ago.
First deposit insurance entity - Reportedly by Czechoslovakia
US banks - US established the Federal Deposit Insurance Corporation (FDIC) following the 1933 banking crisis
Canadian banks - Canada established the Canada Deposit Insurance Corporation (CDIC) in 1967
US credit unions - US National Credit Union Share Insurance Fund (NCUSIF), administered by the National Credit Union Administration (NCUA), was created by Congress in 1970
BC credit unions - Credit Union Deposit Insurance Corporation of British Columbia (CUDIC) was formed in 1958
BC credit unions - Stabilization Central Credit Union (SCCU) was created by legislation in 1989
EU - Member state requirements introduced in 1994 with policies subsequently increased and harmonized
Deposit insurance entities actively manage risk and monitor deposits. Assumptions on risk drive actuarial models that typically frame target fund size. is mitigated through of legislative requirements; issuance of regulatory guidelines; maintenance of prudential supervision and oversight of market conduct. Each function may be operationally executed by the deposit insurer staff or outsourced to a government entity or other entity. Insurers may penalize financial institutions that are perceived as high risk. Assessed premiums may be elevated if a deposit taking institution is subject to active regulatory intervention; reports poor or deteriorating financial performance; or has other factors that suggest elevated depositor risk.
The terms of deposit coverage are determined by legislation and can change over time. Currently, coverage for Canadian institutions varies from C$100,000 to unlimited. European Union members coverage of EUR 100,000. U.K. offers coverage of GBP 85,000. Terms in jurisdictions, including the UK, are significantly more restrictive than in Canada - a UK depositor is insured for GBP 85,000 per financial institution where a Canadian depositor is insured per account type (e.g. C$300,000 across TFSA, RSP and taxable accounts in a jurisdiction with C$100,000 coverage) per financial institution. During the 2008 financial markets challenges the then B.C. government replaced limited with unlimited coverage for member deposits at B.C. credit unions. In 2012 then U.S. authorities consciously let lapse legislation that provided temporary unlimited insurance at FDIC, a major U.S. deposit insurer, thereby resuming coverage up to US$250,000.
Canadian provincial credit unions are mandated members of a provincial deposit insurance fund while banks and federal credit unions are mandated members of Canadian Deposit Insurance Corporation (CDIC). All Canadian deposit insurers are funded on an ex-ante basis. Under this approach then each financial institution member makes regular financial contributions to build a collective fund that is intended to settle the costs of any future claims.
Multiple types of Canadian entities provide deposit insurance. Depending on the applicable legislation then the provider may be a provincial government ministry, a provincial crown corporation, and/or a credit union system organization. Related stakeholder representation, nominations authority and regulatory independence vary.
Critics highlight moral hazard concerns, that escalate commensurately with the level of insurance. Depositors, reliant on full reimbursement, may place minimal effort to select or to monitor their financial institution. Deposit taking institutions may be incentivized to undertake elevated risks, underprice risk, and/or insufficiently adopt sound risk management practices.
DEPOSIT INSURANCE IN CANADIAN PROVINCIAL CREDIT UNIONS
Deposit insurance coverage terms vary materially. The monetary value, depositor profile and account type that are eligible under deposit insurance regimes are markedly different across different provincial credit union systems; between provincial credit unions and federal credit unions; and between provincial credit unions and banks.
Western Canadian provincial governments all currently have legislated regimes that provide unlimited deposit insurance to their provincial credit unions. Depositors in other provincial credit unions are subject to maximum coverage between C$100,000 and C$250,000. Federal credit unions and banks are subject to C$100,000 deposit insurance.
Deposit insurance is impacted by federal charter. Should it secure a federal charter then member deposits of Coast Capital Savings Credit Union would be insured to C$100,000. Coast Capital Savings Credit Union, in its member documentation related to federal credit union resolution, included informative tables that outlined the deposit insurance regimes of CUDIC (provincial credit union) and CDIC (banks and federal credit unions).
Where deposit insurance is capped, limits are usually by account type and may not apply to registered accounts. Depositors may have the ability to arrange their banking affairs across more than account type or deposit holder to achieve higher levels of aggregate deposit insurance.
Deposit insurance amounts typically apply per account type per person per financial institution. A couple residing in a jurisdiction with maximum C$100,000 deposit insurance may be able to access in excess of $500,000 deposit insurance coverage between RSP, TFSA and taxable accounts for each person - or multiple times that level if deposits are spread across multiple financial institutions. Some international jurisdictions have more restrictive policies that aggregate accounts per institution.
Some may question the strategic need for, and perhaps operational of, elevated or unlimited deposit insurance policy for any credit union. Historically, credit unions may have courted the operational banking needs of small community members rather than high net worth or institutional depositors.
All depositors do not appear to require unlimited insurance. At December 2015, 30% of member deposits in Ontario provincial credit unions were uninsured, being in excess of the maximum amount or otherwise ineligible under DICO terms. At March 2016, 73% of deposits with CDIC members were uninsured.
DEPOSIT INSURANCE IN BRITISH COLUMBIA CREDIT UNIONS
B.C. credit unions are required by the Financial Institutions Act to be members of Credit Union Deposit Insurance Corporation (CUDIC) and of Stabilization Central Credit Union (SCCU).
CUDIC is a provincial crown corporation that is administered by the Financial Institutions Commission (FICOM), an agency of the BC provincial government.
SCCU is a cooperative organization that is owned by BC credit unions and managed by a small dedicated team.
Each related entity is wholly governed by nominees of either the government or the credit union system. Currently, the Superintendent and Commission of FICOM are also the CEO and Board of CUDIC, with Commission/Board members appointed by the Lieutenant Governor in Council. While the Board of SCCU is comprised of executives and directors of credit unions, largely appointed by credit union peer groups.
CUDIC and SCCU collectively manage almost C$0.6 billion of investment assets. SCCU currently provides CUDIC with coverage of the first C$30 million of depositor losses. In the event of a deposit claim larger than available CUDIC assets, the B.C. government may - but is not required to - provide incremental funding to CUDIC to settle depositor losses.
The evolution of ex-ante investment assets, roles & responsibilities, and stakeholder relationships between SCCU and CUDIC /FICOM, while of potentially significant historical impact and future opportunity, are beyond the scope of this article.
A system-led deposit insurance fund was introduced in B.C. in 1968 following credit union losses that required financial support from the B.C. credit union system to permit the refund of member deposits. Unlimited coverage, insured by the credit union system, was effective from 1968 to 1988. In 1988 then B.C. government formally legislated an explicit deposit insurance guarantee but imposes a limited regime that was capped at C$100,000. This compared to C$60,000 coverage at Canadian banks. Limited coverage applied until 2008, at which time the BC provincial government replaced the then limited regime with an unlimited regime, partly in response to the then turbulence in financial markets and economic conditions. To the knowledge of the author then, in 2008, the current unlimited deposit insurance regime in B.C. was proposed by the provincial government rather than requested by the credit union system.
Deposit insurance premiums represent a material cost to B.C. credit unions. CUDIC 2016 assessments represented approximately 18% of the net income reported by the B.C. credit union system (C$46.7m and C$260.9 million respectively).
The extent of credit union deposits that would become uninsured the B.C. government to re-introduce a regime of limited deposit insurance is not publicly quantified. But insight is available from Coast Capital Savings Credit Union. In documentation issued to members prior to its federal credit union resolution then Coast Capital Savings disclosed that “As of July 2016, fewer than 4% of Coast Capital Savings’ personal members require deposit insurance beyond $100,000. This means the eligible deposits of 96% of our personal members fall within CDIC’s coverage limits today.” The dollar value of member deposits in excess of C$100,000 may represent a materially larger amount than 4% of total member deposits given that, by definition, noted personal members have relatively large deposits and there may also be ineligible deposits from non-personal members. Further insight may be available from the significant level of non-insured deposits in Ontario credit unions and in Canadian banks, each of which currently has coverage capped at C$100,000.
“A credit union opting to continue into the federal jurisdiction would not be able to bring their funds that were provided to CUDIC to the federal jurisdiction. Those funds would be retained by CUDIC.”
PROS & CONS OF UNLIMITED AND LIMITED DEPOSIT INSURANCE
A significant number of policy and economic papers have been written on deposit insurance regimes and related topics. This may reflect the increased adoption, over recent decades, of deposit insurance regimes internationally. Most, if not all, papers that consider alternative regimes do so between those with limited deposit insurance versus no insurance. The absence of policy critique in regards unlimited coverage may reflect the exceptional rarity of such policies outside of Western Canada.
Deposit insurance can bolster depositor confidence, especially in times of uncertain market or economic conditions. Former US Treasury Secretary Tim Geithner, in his thoughtful book 'Stress Test', may frame such a policy as ‘putting money in the window’ to visibly demonstrate sufficient liquidity and to prevent bank runs - typically on a short-term basis. It may also represent a legislated competitive advantage, to encourage depositors to place savings at institutions with favorable insurance regimes. Regime competition can distort the profile of depositors and borrowers, and/or create treasury dependence on liquidity from non-consumer and/or out-of-market depositors.
Critics of deposit insurance typically frame two conceptual concerns - moral hazard and principal/agent gap. Each of these concerns applies in a limited coverage regime and is likely significantly augmented in a regime with unlimited coverage.
Moral hazard refers to the incentive for insured financial institutions to engage in riskier behavior than would otherwise be feasible. Depositors in insured institutions may conduct limited selection or ongoing monitoring. Executives in insured institutions may set an appetite, risk in products and/or tolerate poor risk management practices. In aggregate then this may cause excessive risk taking, economic resource misallocation, bank failures and/or higher remedial costs. Losses will be absorbed by the institution before deposit regulators may mitigate moral hazard risks through higher capital adequacy requirements; greater prudential supervision intensity; and/or rigorous intervention penalties or processes.
Principal/agent gap refers to potential disconnects between the incentives of the agent (regulator or elected official) and the interests of the principal (taxpayer). The FDIC notes that agents may “ignore the problems of troubled institutions and delay addressing them in order to cover up past mistakes; wait for hoped-for-improvements in the economy; avoid trouble ‘on their watch’ or serve some other purposes of self-interest”. the principal lacks the information or power to effectively monitor the agent. Challenges may delay remedial action and/or institution closure, ultimately increase the cost of a resolution.
This concludes the first article of a two-part series. The second part will present significant objective evidence and supporting commentary to explore related and regulatory implications; and will frame three discrete policy options. A list of sources and references will be appended to the final article in this series.
DISCLAIMER & COPYRIGHT
This article reflects the personal comments of the author, Ross McDonald. This article does not represent the views of any financial cooperative, corporate organization, regulatory body or government ministry. Comments are wholly based on information that is in the public domain.
Although the author has made every effort to ensure that the information in this article was correct at press time, the author does not assume and hereby disclaim any liability to any party for any loss, damage, or disruption caused by errors or omissions, whether such errors or omissions result from negligence, accident, or any other cause.
All rights reserved.