Management of Deposite Funds

Management of Deposit Insurance Funds

When a deposit insurance system is primarily funded on an ex-ante basis, policymakers need to consider what investment or portfolio management policy to pursue. There is a trade-off between liquidity and return. A fund must have an adequate level of liquid assets on hand to enable it to readily compensate insured depositors should an institution fail. Depending on the mandate of the insurer, funds may also be required to support other forms of failure resolution. Funds will also be necessary to support day-to-day operations and to attract staff and the operational resources necessary for the functioning of an insurer. In many systems funds are held in low-risk, highly liquid assets – typically short-term government securities. This approach is used in countries such as Brazil, Canada and Finland and is by far the most common one. In other cases, policymakers may pursue an investment strategy that places more emphasis on achieving higher rates of return. Both of these methods have their advantages and disadvantages. If a conservative approach is adopted, the opportunity cost is the foregone return to the deposit insurance fund. The pursuit of a higher-return policy may result in funds not being available for insurance purposes when they are needed and/or the loss of principal, if securities have to be sold at an inopportune time. This, in turn, could cause an erosion of public confidence in the deposit insurance system. A more balanced approach would be an investment strategy that balances higher rates of return against the certainty that funds will be available when needed and which guards against loss of principal. Other considerations include whether a deposit insurer should invest in its own members. The advantage of this approach is that, effectively it places the capital withdrawn from the banking system by the deposit insurer back into the industry. However, a drawback is that the insurer runs the risk of...