V. Žukauskas. Deposit insurance: the mandatory insurance undercuts the rates

Interest rates on deposits in Lithuania currently are extremely low. When placing one-year term deposits in major banks of Lithuania, the interest is less than half per cent. The fact that depositors indirectly purchase the deposit insurance services from the state contribute to the low interest rates – to purchase compulsory deposit insurance, the banks pay to the state company “Deposit and Investment Insurance” amounts similar to the existing interest rates. Currently, the deposit insurance rate for banks is 0.45 per cent, for credit unions 0.2 per cent.

Firstly, when we have this insurance the risk and the credit institution’s credibility becomes of secondary importance to the citizens. In order for the people to make appropriate and informed choices, they must feel not only the benefits of good decisions, but also the harms of the bad ones. However, the State deposit insurance ensures that no matter to what credit institution the deposit will be placed, it will be recovered with interest rates of up to 100 000 euros. One of the key principles of the market – responsibility for your decisions – disappears.

Secondly, deposit insurance distorts not only the motivation and behaviour of depositors, but also affects the credit institutions themselves. Over the period 2012-2014, four credit unions went bankrupt in Lithuania. The Ministry of Finance and the Bank of Lithuania are actively talking about the need to change the regulation of credit unions in Lithuania. And, according to the Bank of Lithuania, the disinterest in evaluating the risks of the credit union and in participation in their management (to make a deposit, one must become a member of the credit union) results in irresponsible activities of some of the credit unions.

The desire to have fewer insolvencies and stability is welcome. However, the stability of the market should not arise from the fact that no one goes bankrupt, but from the fact that if someone goes bankrupt, the one to suffer is the one who makes the bad decisions.

Trying to ensure stability through regulation and limitation of liability causes many negative consequences and harmful incentives. The security the state deposit insurance guarantees and the reduction in the systematic risk of the banks it offers are often observed and emphasized. What are left out, however, is the distorted incentives of people and financial institutions, personal losses to the taxpayers and, as a consequence of these losses, the ever-increasing desire to regulate the financial sector even more. When the regulation is most stringent, it is harder to abide, which means less competition, leading to more expensive services and lower deposit rates.