:: Banking On Safety Seminars - Kingston, Jamaica  :: 

Address By Mr. J.P. Sabourin 
Aspects Of Deposit Protection Within The Financial Safety Net
Held at Le Meridien Jamaica Pegasus, June 14, 2001

Thank you for that kind introduction and for this opportunity to speak to you today.

I was first invited to speak on deposit insurance by the Bank of Jamaica in 1987. I’ve visited here many times over the intervening 14 years, and as always, it’s a pleasure to be back. And as always, I have a good deal to say about my favourite topic: deposit insurance.

I see a number of very familiar faces: people who are not just my international peers, but I feel, my international friends and colleagues. This applies in particular to Winston Carr, the head of the Jamaican Deposit Insurance Corporation, as I think of his major contributions to the Financial Stability Forum (FSF) Working Group on Deposit Insurance, especially in acting as co-ordinator for a sub-group on Public Awareness, and in contributing to the development of three other major papers. When I was asked to Chair this Working Group, I agreed so long as I could choose certain country representatives. Winston Carr was first on my list.

It will come as no surprise to anyone here who’s worked with Winston, that he has brought a steady hand and much wisdom to the deliberations of the Working Group, and a keen insight. He chooses his words carefully, and when he speaks, everyone listens. He is not only highly regarded internationally, but I am proud to call him a colleague and close friend.

Let me say a bit more about the FSF Working Group. Its mandate is to develop guidance on the elements of an effective deposit insurance system for countries considering the adoption of a limited-coverage system or the reform of an existing system.

The guidance will cover such matters as public policy objectives and the basic conditions that should exist within a country wishing to put a system in place. The emphasis is on practical assistance that takes into account the basic principles that underlie successful deposit insurance systems, bearing in mind that the actual conditions in specific countries may vary and there may be different legal infrastructures, accounting rules, and regulatory arrangements.

The Working Group has been working for over a year now and it has held meetings, outreach sessions and conferences around the world, with over 400 senior representatives from central banks, supervisors, deposit insurers, finance ministries, and other agencies. They’ve come from almost 120 countries - some with deposit insurance, some not. One of the first meetings was held here, with the JDIC as our host.

Our work is drawing to a completion, and a draft report will be posted on our international website for comment next month.

There may be some here in Jamaica who might say, "too bad we didn’t have that report five years ago" - when Winston Carr led a task force to study proposals for implementing a deposit insurance scheme for this country.

They needn’t worry. The strategy put forward in the task force report, the decisions made by policy makers in your Government, and the execution of the implementation process match well to the guidance the Working Group is developing.

No, the report wasn’t entirely written by Winston Carr. There are 11 other countries represented on the Group along with Jamaica, as well as a couple of international agencies. The report reflects the input and efforts of all of them. But all of you here today should take pride in the fact that the choices Jamaica made are quite consistent with the views of the Working Group.

In fact, the Jamaican experience has been carefully studied by a number of countries - Group members and others - and widely seen as a model to emulate. I have, on a number of occasions, and with Winston’s approval, provided copies of your policy paper to countries that come to CDIC, in search for assistance in setting up deposit insurers.

You studied the issues carefully. You conducted a thorough analysis of local conditions here: the challenges you faced, the weaknesses you had to deal with, and the strengths you could leverage to succeed. Also, timing was important.

You also consulted other countries with deposit insurance systems to see what worked, and what didn’t. And most importantly, you adapted what you saw to Jamaican conditions and the needs of the Jamaican people. I has the honour of being asked to provide advice along the way and in the discussions that I attended, it was always apparent that you had a well thought plan and a sound process for implementing it.

The Jamaica Deposit Insurance Corporation is almost three years old, and from what I can see, doing well. You are all to be congratulated on a job done well.

And make no mistake, deposit insurance is an important job. Deposit insurance is a key public service. One reason is economic. Failed banks can interfere with the payments system. A wave of failures can shake depositor confidence, trigger bank runs, and bring into question the stability of the financial system.

A second reason is the human element. When ordinary people - in Canada, Jamaica, or any other country - see their life savings wiped out, the human cost is very real.

The value of the deposit insurance - or of the broader financial safety net that protects consumers and stabilizes the financial system - does not mean it should be above criticism. Indeed, given the important role it plays, there should always be a debate about the role of deposit insurance and how best to provide it. And for their part, deposit insurance practitioners must always look for ways grow and evolve, to do things better.

One reason is that the financial industry is constantly changing. There are always new financial products, new ways of doing business, new risks to deal with, and new opportunities to seize.

A second reason, is that like democracy, the price of a healthy financial sector is constant vigilance. Vigilance in particular against the dangers of moral hazard - the danger that if people expect to be fully compensated for any losses, they may well take excessive risks.

Some academic observers believe that deposit insurance fosters moral hazard. Based on my experience, they don’t look at the whole picture - because deposit insurance is not the father of all evils, nor the mother of all solutions.

In fact, moral hazard is more of an issue in other parts of the safety net. Easy access to lender of last resort facilities and lax supervision and supervisory forbearance can be worrisome contributors to moral hazard.

It’s also true that the governing framework of the financial sector - the rules and regulations put in place by government and its agencies - can create incentives that foster moral hazard. As a result, all participants in the financial system must constantly be on guard against that possibility.

I see a number of defences against moral hazard:

• Good corporate governance;
• Strong and independent regulation and supervision; and
• Market discipline.

But I strongly believe, based on my experience in dealing with member failures at CDIC and my observations internationally, that deposit insurance can play an important role as a fourth defence against moral hazard. This is especially the case where the insurer has a proactive mandate to foster stability and minimize loss - as do CDIC and JDIC.

Let me explain. I’ll start with the first three defences that I advocate.

The first line of defence should be with the "directing minds" - the Board and senior management - of financial institutions. The onus must be placed on them to ensure the safety and soundness of their institutions, through sound risk management, internal controls, and effective reporting.

In Canada, we impose a set of regulations called the Standards of Sound Business and Financial Practices on the "directing minds," with an emphasis on risk management systems and a culture of control. Adherence to these Standards is also a factor in the differential premium system we have implemented.

If an institution fails, we hold the "directing minds" responsible, and we take legal action against them if there are grounds to do so. Few deposit insurers, I believe, go as far as we do in forcing adherence to corporate governance standards - and in imposing sanctions where this adherence is lacking.

The second defence against moral hazard is regulatory and supervisory discipline. Regulatory discipline includes requirements for the establishment of a new bank, capital standards, qualifications for its managers and directors, approval for changes in control, and standards for risk management, internal control, and external audits.

While supervisors play a key role in monitoring institutions for soundness and compliance issues, keep in mind they are not responsible for an institution’s failure, nor can they prevent any failures from happening. In fact, one measure of an effective supervisor is its willingness to take prompt corrective action when problems warrant, including closure if necessary.

Market discipline is the third defence against moral hazard - exercised by shareholders and debt holders, as well as by certain classes of creditors and depositors.

But there’s an important caveat. For market discipline to work effectively, these groups must have the knowledge required to assess the risks they face. Information is the key: readily accessible and generally understandable by the investing public. This requires strong accounting and disclosure regimes and a critical mass of ratings agencies, market analysts, financial commentators and other professionals.

Where the information is imperfect, or where the critical mass of financial professionals is still being formed, market forces cannot be counted upon.

In such cases, the other two defences must pick up the slack. And this is where deposit insurance comes in. Remember I put a proactive deposit insurer forward as a fourth defence against moral hazard?

CDIC started out in 1967 as a "paybox." If a member failed, we simply paid the insured depositors. Based on our experience with a number of failures in the 1980s, CDIC was given an explicit mandate to minimize our losses. We could not simply sit by and watch our losses mount. We had to become proactive.

There are a number of important tools we bring to bear in addressing our objective of loss minimization: differential premiums that reflect variations in bank risk profiles, a policy of prompt corrective action before the losses associated with a failure mount, sanctions and powers to act, and a willingness to take legal action where warranted.

It’s important to note that we do not duplicate the work of the supervisor. Rather, our work complements theirs. And our mandate complements theirs. And to ensure that we complement each other operationally as well as in theory, we have put in place explicit rules detailing this accountability - and formal agreements, memoranda of understanding, or legislation on information sharing.

For example, CDIC and the supervisor have executed a Strategic Alliance Agreement to detail a framework in which both sides can coordinate their activities and exchange information. It addresses a number of areas, including:

• Applications for membership in CDIC, as well as incorporations and licensing;
   
• Risk assessment and risk management processes;
   
• Termination or cancellation of CDIC insurance, or interventions by either CDIC or the supervisor; and
   
• Development of guidelines, regulations, policies, by-laws and other initiatives

We also have a number of committees that meet regularly to exchange information, discuss issues and coordinate activities of mutual interest.

One of these committees is the Financial Institutions Supervisory Committee, with CDIC, the supervisor, the central bank, and the Ministry of Finance as members. Another is the Ministry of Finance Senior Advisory Committee, which assists with the development of financial sector legislation.

Other subgroups or working committees are created to address specific issues. In the past, these have included the Year 2000 readiness issue, the implementation of a tri-agency databank, and the reporting requirements for financial institutions.

Explicit rules and mandates foster certainty on the part of all stakeholders - thus building confidence in the financial system generally, and providing incentives for accountability and good governance.

In fact, we never stop looking for ways to work better with the other agencies making up the financial safety net. Legislation has just passed in Parliament to change the enabling legislation of both CDIC and the supervisor to put in statute the requirement that both must share information openly while protecting the confidentiality of the information we provide. We believe this will foster and enhance an even better flow of information between us.

This brings me to my last comment. The CDIC Act has now been amended 15 times in 34 years. That reflects all the lessons we’ve learned, and more importantly, it reflects the spirit of cooperation that exists between the safety net agencies in Canada.

One major lesson is that there must be a process for continuous improvement to ensure that we all remain in tune with the rapid evolution of our financial system. We know that this is a major undertaking. If banks are like greyhounds, safety net agencies are like bloodhounds. We know where the banks have been but we don’t always know where they are at the moment. So, we must learn well the lessons experience teaches, and plan for any eventuality. And we must remember that we are always playing catch-up. That’s just reality.

In this gathering today, I suspect that most of the key stakeholders in the Jamaican financial system are represented. The creation of the JDIC is your accomplishment. Its evolution, and the evolution of the entire financial safety net is your common challenge.

I have enjoyed meeting with you all in the past and I applaud your judgement of what was best for the people of this island. I look forward to working with you in the future as I have done in the past. That is important to me because I always feel at home in your country and I appreciate your hospitality and goodwill.

Thank You!

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