Deposit Insurance is a system established by the Government to protect depositors against the loss of their insured deposits. The role of the banking sector, the financial safety net, and other financial institutions that accept deposits from the public are important in the economy because of their involvement in the payments system, their role as intermediaries between depositors and borrowers, and their function as agents for the transmission of monetary policy. By their nature, banks are vulnerable to liquidity and solvency problems, among other things, because they transform short-term liquid deposits into longer-term, less-liquid loans and investments.
They also lend to a wide variety of borrowers whose risk characteristics are not always readily apparent. The importance of banks in the economy, the potential for depositors to suffer losses when banks fail, and the need to mitigate contagion risks, lead countries to establish financial safety nets. Financial safety net is usually made up of three components: prudential regulation & supervision, a lender of last resort and deposit protection scheme. The distribution of powers and responsibilities between the financial safety-net participants is a matter of public-policy choice and individual country circumstances. For example, some countries incorporate all financial safety-net functions within the central bank, while others assign responsibility for certain functions to separate entities.
A deposit insurance system is preferable to implicit protection if it clarifies the authorities’ obligations to depositors and limits the scope for discretionary decisions that may result in arbitrary actions. To be credible, however, and to avoid distortions that may result in moral hazard, such a system needs to be properly designed, well implemented and understood by the public.
A deposit insurance system needs to be part of a well-designed financial safety net, supported by strong prudential regulation and supervision, effective laws that are enforced, and sound accounting and disclosure regimes. A large variety of conditions and factors that can have a bearing on the design of the DIS system need to be assessed. These include: the state of the economy, current monetary and fiscal policies, the state and structure of the banking system, public attitudes and expectations, the strength of prudential regulation and supervision, the legal framework, and the soundness of accounting and disclosure regimes.
CONCEPT, PRACTICE AND MANAGEMENT OF DEPOSIT INSURANCE
The role of the banking sector, the financial safety net, and other financial institutions that accept deposits from the public are important in the economy because of their involvement in the payments system, their role as intermediaries between depositors and borrowers, and their function as agents for the transmission of monetary policy. By their nature, banks are vulnerable to liquidity and solvency problems, among other things, because they transform short-term liquid deposits into longer-term, less-liquid loans and investments. They also lend to a wide variety of borrowers whose risk characteristics are not always readily apparent. The importance of banks in the economy, the potential for depositors to suffer losses when banks fail, and the need to mitigate contagion risks, lead countries to establish financial safety nets. Financial safety net is usually made up of three components: prudential regulation & supervision, a lender of last resort and deposit protection scheme. The distribution of powers and responsibilities between the financial safety-net participants is a matter of public-policy choice and individual country circumstances. For example, some countries incorporate all financial safety-net functions within the central bank, while others assign responsibility for certain functions to separate entities.
A deposit insurance system is preferable to implicit protection if it clarifies the authorities’ obligations to depositors and limits the scope for discretionary decisions that may result in arbitrary actions. To be credible, however, and to avoid distortions that may result in moral hazard, such a system needs to be properly designed, well implemented and understood by the public. A deposit insurance system needs to be part of a well-designed financial safety net, supported by strong prudential regulation and supervision, effective laws that are enforced, and sound accounting and disclosure regimes. A large variety of conditions and factors that can have a bearing on the design of the DIS system need to be assessed. These include: the state of the economy, current monetary and fiscal policies, the state and structure of the banking system, public attitudes and expectations, the strength of prudential regulation and supervision, the legal framework, and the soundness of accounting and disclosure regimes.
Concept of Deposit Insurance
Based on its role and focus in the financial system, a deposit insurance scheme has been defined as a financial guarantee to protect depositors in the event of a bank failure and also to offer a measure of safety for the banking system (Ebhodaghe 1997). In most economies where the scheme exists, it serves as one of the complementary supervisory agencies employed by the monetary authorities for effective management and orderly resolution of problems associated with both failed and failing depository institutions. In addition, the scheme also offers some form of deposit guarantee to depositors such that their confidence in the banking system is not eroded in situations where deposit-taking financial institutions fail. The scheme also provides government with a framework for intervention and sterilization of disruptive effects on the economy following the failure of deposit- taking institutions.
Policymakers have many choices regarding how they can protect depositors. Some countries have implicit protection that arises when the public, including depositors and perhaps other creditors, expect some form of protection in the event of a bank failure. This expectation usually arises because of the governments’ past behaviour or statements made by officials.
Implicit protection is, by definition, never formally specified. There are no statutory rules regarding the eligibility of bank liabilities, the level of protection provided or the form which reimbursement will take. By its nature, implicit protection creates uncertainty about how depositors, creditors and others will be treated when bank failures occur. Funding is discretionary and often depends on the government’s ability to access public funds. Although a degree of uncertainty can lead some depositors to exert greater effort in monitoring banks, it can undermine stability when banks fail.
Statutes or other legal instruments usually stipulate explicit deposit insurance systems. Typically, there are rules governing insurance coverage limits, the types of instruments covered, the methods for calculating depositor claims, funding arrangements and other related matters. A deposit insurance system is preferable to implicit protection if it clarifies the authorities’ obligations to depositors and limits the scope for discretionary decisions that may result in arbitrary actions. A deposit insurance system can also provide countries with an orderly process for dealing with bank failures.
The introduction of a deposit insurance system can be more successful when a country’s banking system is healthy. A deposit insurance system can contribute effectively to the stability of a country’s financial system if it is part of a well-designed safety net. To be credible, a deposit insurance system needs to be properly designed, well implemented and understood by the public. It also needs to be supported by strong prudential regulation and supervision, sound accounting and disclosure regimes, and the enforcement of effective laws. A deposit insurance system can deal with a limited number of simultaneous bank failures, but cannot be expected to deal with a systemic banking crisis by itself.
A well-designed financial safety net contributes to the stability of a financial system; however, if poorly designed, it may increase risks, notably moral hazard. Moral hazard refers to the incentive for excessive risk taking by banks or those receiving the benefit of protection. Such behaviour may arise, for example, in situations where depositors and other creditors are protected, or believe they are protected, from losses or when they believe that a bank will not be allowed to fail. In these cases, depositors have less incentive to access the necessary information to monitor banks. As a result, in the absence of regulatory or other restraints, weak banks can attract deposits for high-risk ventures at a lower cost than would otherwise be the case.
Moral hazard can be mitigated by creating and promoting appropriate incentives through good corporate governance and sound risk management of individual banks, effective market discipline and frameworks for strong prudential regulation, supervision and laws. These elements involve trade-offs and are most effective when they work in concert.
Specific deposit insurance design features can also mitigate moral hazard. These features may include: placing limits on the amounts insured; excluding certain categories of depositors from coverage; using certain forms of coinsurance; implementing differential or risk-adjusted premium assessment systems; minimising the risk of loss through early closure of troubled banks; and demonstrating a willingness to take legal action, where warranted, against directors and others for improper acts.
Many of the methods used to mitigate moral hazard require certain conditions to be in place. For example, differential or risk-adjusted differential premium assessment systems may be difficult to design and implement in new systems and in emerging or transitional economies. Early intervention, prompt corrective action and, when warranted, bank closure require that supervisors and deposit insurers have the necessary legal authority, in-depth information on bank risk, financial resources, and incentives to take effective action. Personal-liability provisions and availability of sanctions can reinforce incentives of bank owners, directors, and managers to control excessive risk, but they depend on the existence of an effective legal system that provides the necessary basis for action against inappropriate behaviour.
Origin and Evolution of DIS
Deposit Insurance Scheme (DIS) developed out of the need to protect uninformed small depositors from the risk of loss of their deposits and also to protect the banking system from instability occasioned by runs and loss of depositors’ confidence. The origin of the scheme is credited to the United States of America (USA), where it is on record that six states established deposit insurance schemes during the pre-civil war years in that country, to protect state bank notes. However, it was in 1924 that the first nation-wide deposit insurance scheme was introduced by former Czechoslovakia (now Czech and Slovak Republics). Following suit, the United States government in 1933 established the Federal Deposit Insurance Corporation (FDIC). India, the Philippines and Sri Lanka all in the Asian Continent established their schemes in 1961, 1963 and 1987 respectively. In Continental Europe, the Germans’ scheme which is administered by private institutions was established in 1976. In Britain, the scheme was established in 1979 while France introduced its own scheme in 1980. In Africa, Kenya established its scheme in 1985 while the Nigerian scheme was established by Decree No. 22 of 1988.
Design Features of DIS
Mandates, powers and structure
Mandates and powers
A mandate is a set of official instructions or statement of purpose. There is no single mandate or set of mandates suitable for all deposit insurers. Existing deposit insurers have mandates ranging from narrow, so-called paybox systems to those with broader powers and responsibilities, such as risk-minimisation, with a variety of combinations in between. Whatever the mandate selected, it is critical that there be consistency between the stated objectives and the powers and responsibilities given to the deposit insurer.
Paybox systems largely are confined to paying the claims of depositors after a bank has been closed. Accordingly, they normally do not have prudential regulatory or supervisory responsibilities or intervention powers. Nevertheless, a paybox system requires appropriate authority, as well as access to deposit information and adequate funding, for the timely and efficient reimbursement of depositors when banks fail.
A risk-minimiser deposit insurer has a relatively broad mandate and accordingly more powers. These powers may include: the ability to control entry and exit from the deposit insurance system, the ability to assess and manage its own risks, and the ability to conduct examinations of banks or request such examinations. Such systems also may provide financial assistance to resolve failing banks in a manner that minimises losses to the deposit insurer. Some risk-minimisation systems have the power to set regulations, as well as to undertake enforcement and failure-resolution activities.
Ownership and Management
Fundamentally, the ownership of a DIS takes three forms. There is the purely public sector ownership in which the equity is held entirely by the government and/or its agency. An alternative arrangement is the purely private ownership of the scheme. Under this arrangement, the decision to establish a DIS may be that of the government which enacts the necessary legislation to enable the privately-owned banks to establish and manage the DIS. Another alternative arrangement is where the DIS is jointly owned by the public and private sectors. Under this type, the equity shares are held in specific ratio and the board is made up of representative of both parties.
(i) Compulsory membership
In general, membership should be compulsory to avoid adverse selection. There are some cases, however, where a strong commitment of banks to participate in a deposit protection system can be observed and broad participation of banks may be achieved without a legal obligation. This can occur if depositors are aware of and sensitive to the existence of deposit insurance, thus creating strong incentives for banks to be part of a system. In other cases, if depositors are less concerned about deposit insurance or are not aware that coverage is limited to certain banks, then the stronger banks may opt out. Further, in a voluntary system strong banks may opt out if the cost of failures is high and this may affect the financial solvency and the effectiveness of a deposit insurance system.
There are two circumstances that may require different approaches to granting membership to banks. First, when a deposit insurance system is established and second, when membership is granted to new banks in an existing system.
When a deposit insurance system is created, policymakers are faced with the challenge of minimising the risks to the deposit insurer, while granting extensive membership. Generally, two options are available: automatic membership or requiring banks to apply for entry.
Automatic membership for all banks may be the simplest option in the short term. However, the deposit insurer may then be faced with the difficult task of having to accept banks that create an immediate financial risk or that pose other adverse consequences for the deposit insurance system.
Alternatively, banks may be required to apply for membership. This option provides the deposit insurer with the flexibility to control the risks it assumes by establishing entry criteria. It also can serve to enhance compliance with prudential requirements and standards. In such cases, an appropriate transition plan should be in place that details the criteria, process and time frame for attaining membership. The criteria should be transparent.
Scope and level
Insurable deposit should be defined clearly in law or by private contract. In doing so, the relative importance of different deposit instruments, including foreign-currency deposits and the deposits of non-residents in relation to the public- policy objectives of the system should be considered. Once the relevant deposits are selected, exclusions of specific deposits and/or depositors can be determined.
Many deposit insurance systems exclude deposits held by depositors who are deemed capable of ascertaining the financial condition of a bank and exerting market discipline. Examples include deposits held by banks, government bodies, professional investors such as mutual funds, and deposits held by bank directors and officers. In some cases, deposits held by individuals who bear responsibility for the financial well-being of a bank are excluded from reimbursement. Also, deposits with extremely high yields are sometimes excluded from coverage; or reimbursement may be limited to the principal owed, with a lower rate of interest applied.
Once the scope is determined, the level of coverage can be set. This can be done through an examination of relevant data, such as statistical information describing the size distribution of deposits held in banks. This gives policymakers an objective measure, such as the fraction of depositors covered, with which the adequacy of a certain level of coverage can be assessed. Whatever coverage level is selected, it must be credible and internally consistent with other design features, and meet the public-policy objectives of the system. The relationship between coverage levels and moral hazard should always be considered by the policymakers.
Deposit insurance assessments: flat-rate versus risk-adjusted differential premium systems
Countries have a choice between adopting a flat-rate premium system or a premium system that is differentiated on the basis of individual-bank risk profiles. The primary advantage of a flat-rate premium system is the relative ease with which assessments can be calculated and administered. However, in a flat-rate system, low-risk banks effectively pay for part of the deposit insurance benefit received by high-risk banks.
Most newly established systems initially adopt a flat-rate system given the difficulties associated with designing and implementing a risk-adjusted differential premium system. However, because flat-rate premiums do not reflect the level of risk that a bank poses to the deposit insurance system, banks can increase the risk profile of their portfolios without incurring additional deposit insurance costs. As a result, flat-rate premiums may be perceived as encouraging excessive risk taking by some banks, unless there is a mechanism to impose financial sanctions or penalties.
Risk-adjusted differential premium systems can mitigate such criticisms and may encourage more prudent risk-management practices at member banks. When the information required to implement a risk-adjusted differential premium system is available, relating premiums to the risk a bank poses to the deposit insurer is preferable.
In order for a deposit insurance system to be effective, it is essential that the public be informed about its benefits and limitations. Experience has shown that the characteristics of a deposit insurance system need to be publicised regularly so that its credibility can be maintained and strengthened.
A well-designed public-awareness program can achieve several goals, including the dissemination of information that promotes and facilitates an understanding of the deposit insurance system and its main features. Also, a public-awareness program can build or help restore confidence in the banking sector. Additionally, such a program can help to disseminate vital information when failures occur, such as guidance regarding how to file claims and receive reimbursements.
Sound funding arrangements are critical to the effectiveness of a deposit insurance system and the maintenance of public confidence. A deposit insurance system should have available all funding mechanisms necessary to ensure the prompt reimbursement of depositors’ claims after a bank failure. Inadequate funding can lead to delays in resolving failed banks, to significant increases in costs and a loss of credibility of the deposit insurance system. Funding can be assured in many ways, such as government appropriations, levies or premiums assessed against member banks, market borrowings, or a combination thereof.
Premiums or levies can be assessed on an ex-ante or ex-post basis. Beyond the decision of how to fund a deposit insurance system, some additional important are: how deposit insurance assessments should be determined, verified, and collected; and whether it is appropriate to establish separate deposit insurance funds for different types of deposit-taking institutions.
Periodic premium contribution by insured institutions is the major source of funding. The Corporation maintains two Funds, namely:
The Deposit Insurance Fund (DIF) for Universal banks; and
Special Insured Institutions Fund (SIIF) for other insured deposit-taking financial institutions such as Microfinance Banks (MFBs) and primary Mortgage institutions (PMIs)
The Funds are used to meet the primary obligations of the Corporation in the form of payment of guaranteed sums and/ or provision of financial assistance to eligible insured institutions. The operations of the Corporation are financed from the proceeds of investment such as Treasury Bills (TBs) and Federal Government Bonds. The Corporation does not receive government subvention for its operations . As at 31st December 2010 the DIF and SIIF stood at 295.72 Billion(=N=) and 2.28 Billion(=N=) respectively.
1.1 Deposit Insurance Funding
Sound funding arrangements are critical for the effectiveness of a deposit insurance system. According to the Financial Stability Forum (FSF) Working Group on Deposit Insurance (2001), a deposit insurance system should have available all funding mechanisms necessary to ensure prompt reimbursement of depositors’ claims. For most deposit insurance schemes worldwide, premium contribution by insured institutions constitutes the major source of funding.
1.2 Deposit Insurance Premium Assessment
Deposit Insurers collecting premiums from member financial institutions which accept deposits from the public (hereafter referred to as banks) usually choose between adopting a flat-rate premium or a system that seeks to differentiate premiums on the basis of individual-bank risk profiles. A Flat-rate premium system has the advantage of being relatively easy to understand and administer. Also, it allows the strong banks to subsidize the weak ones for the stability of the financial system. However, it does not take into account the level of risk that a bank poses to the deposit insurance system, and can therefore be perceived as unfair in that the same premium rate is charged to all banks regardless of their degrees of risk. The implementation of a differential premium assessment system poses numerous challenges in spite of its seeming fairness. Some of these challenges include: finding appropriate and acceptable methods of differentiating banks by risks; obtaining reliable, consistent and timely information for risk differentiation, and ensuring that rating criteria are transparent.
1.3 Differential Premium Assessment System (DPAS)
Primarily for the above reasons, differential premium assessment systems are being canvassed in recent years. A DPAS is an attempt to classify banks into various risk buckets and apply different premium rates depending on the perceived riskiness of each risk bucket.
The first recorded differential premium assessment system was introduced by the United States Federal Deposit Insurance Corporation (FDIC) in 1993. Since that time, the number of deposit insurance schemes (DIS) adopting DPAS has grown and it was estimated that there were around twenty-five countries that are either implementing or in the process of introducing the DPAS as at March 2007 out of about 119 deposit insurance agencies worldwide. Apart from Nigeria, no other country in Africa has initiated the process of introducing the differential premium assessment system.
1.4 Adoption of Differential Premium Assessment in Nigeria
With the emergence of bigger banks post-consolidation, sound risk management becomes one of the key factors in ensuring the safety and soundness of the banking system. Given the on-going initiative to adopt a risk-based supervisory framework and the emphasis placed on risk management by the Basle II Capital Accord, the Corporation has deemed it imperative to transit from the flat rate premium assessment system to a differential premium system. Furthermore, the NDIC Act No. 16 of 2006 has given the Corporation the power and flexibility to vary the rate, the assessment base as well as the method of premium assessment. It is against this background that the Corporation has deemed it appropriate and timely to develop a framework for DPAS.
2.0 THE PRACTICE OF DPAS IN SOME JURISDICTIONS
2.1 In virtually all jurisdictions, the starting point for deposit insurance system pricing is the flat rate approach before migration to the differential premium assessment approach mainly because of the complexity in implementing the latter. For instance, it took the Federal Deposit Insurance Corporation (FDIC) of the United States of America, which was established in 1933, sixty (60) years before it introduced DPAS while it took the Canada Deposit Insurance Corporation (CDIC) thirty-two (32) years before migrating to DPAS from the flat rate approach.
2.2 Evidence from countries currently adopting the differential premium assessment system shows the preference for a combination of both quantitative and qualitative factors. Nonetheless, the tendency has been to give more weight to quantitative elements than qualitative factors. All DPAS models are virtually the same in that they all have base premium rates for banks in the best (lowest) risk category and with escalated premium rates for banks in higher risk classes. The only major difference however, is that some DPAS models have predetermined number of risk/premium categories whilst others do not.
3.0 ISSUES FOR CONSIDERATION WHILE DESIGNING AND IMPLEMENTING DPAS
3.1 One of the necessary conditions for a successful implementation of a differential premium regime is ensuring that information to be used for risk classification are readily available. The information equally should be timely, consistent and reliable. Furthermore, the deposit insurer should be able to validate the integrity of such information from time to time. In the main, great attention should be paid to data integrity in order to ensure effective implementation of a DPAS. In this regard, NDIC has noted with concern the significant reduction in the deposit liabilities of some banks at year ends.
3.2 Another factor to consider for a successful implementation of a differential premium system is categorization of banks into different risk buckets. The process of risk differentiation and eventual categorization of banks into risk buckets should not be too complex. Stakeholders especially the insured banks that pay the premiums should be able to verify its risk class categorization.
3.3 In an effort to assure transparency, accountability, market discipline and sound management through public disclosure, the deposit insurer should be careful about what to disclose about insured institutions, so that competitors would not use disclosed information to achieve competitive edge or exacerbate a bad situation. In that regard, each bank would be given only its own risk categorization and applicable premium rate.
3.4 Finally, in order to ensure the sustainability of the system, a differential deposit insurance regime needs to be constantly reviewed, up-dated and fine-tuned. Such reviews can result from experiences garnered over time or through scenario testing. Again, reviews can be necessitated by structural changes in the industry, changes in reporting requirements and/or changes in approaches to supervision.
4.0 OBJECTIVES OF THE FRAMEWORK
The overall objective of the framework is to promote sound risk management in insured institutions without jeopardizing the deposit insurance fund by differentiating premiums paid by insured institutions on the basis of their risk profiles.
5.0 METHODOLOGY OF THE FRAMEWORK
The methodology applied to achieve the above objectives is a combination of the lessons learnt from the approaches adopted by other jurisdictions and our lessons of experience in implementing the deposit insurance scheme in Nigeria. These led to the development of the proposed framework based on both quantitative and qualitative factors. The adoption of the methodology will entail the following two primary stages:
- i. The determination of a base premium Rate Ro for banks in the best (lowest) risk category.
- ii. The determination of add-ons based on the individual bank’s risk profile using both quantitative and qualitative factors.
6.0 APPLICATION OF THE FRAMEWORK METHODOLOGY
Differential Premium Rate Matrix for the Determination of Add-ons based on Individual Bank Risk Profiles
Basic Premium Rate (Ro) % S/N Parameters Criteria Add-ons Quantitative Factors 1 Capital Adequacy:
(a) Capital to Risk Weighted Assets Ratio
(b) Adjusted Capital to Net Credit Ratio
X < 5
5 ≤ X < 8
8 ≤ X < 10
X > 1: 10
2 Asset Quality:
(a) Non performing Credits to Total Credits Ratio
(b) Violation of Aggregate insider lending: (all insiders & related party interest)
(c) Non Performing Insider Credits
(d) Violation of single obligor limit
X ≥ 20
15 ≤ X < 20
10 ≤ X < 15
X > 60% of paid up capital
X > 0
Credits > 20% of shareholders’ funds:
(a) Liquidity Ratio
X < 15
15 ≤ X < 20
20 ≤ X < 25
Qualitative Factors (Mgt) 4 Poor Internal Control 0.02 5 Late Rendition of Returns 0.01 6 Financial misreporting 0.03 7 Poor Risk Management System 0.02 8 Non implementation of examiners’ Recommendations 0.02 Total Add on Premium Points ≤ 30 0.30 PREMIUM RATE (Ro+Total Add-ons) Ro+0.30
* For all the quantitative factors, prudential/regulatory stipulated thresholds have been used as the benchmarks.
7.1 The Flat-rate Premium System is relatively simple to understand and administer. DPAS ensures fair pricing but is more complex, hence the greater need for more timely, accurate and reliable information from insured institutions. The proposed model attempts to classify banks into various risk buckets and apply different premium rates depending on the perceived riskiness of each bank.
7.2 The DPAS models practised in various countries show the preference for a combination of both quantitative and qualitative factors, with a tendency to give greater weight to quantitative than qualitative factors. All DPAS models are virtually the same because they all basically have base premium rates for banks in the best (lowest) risk category with escalated rates for riskier banks. The only major difference is that while some have predetermined number of risk/premium rate categories others do not.
7.3 The Framework has been developed to encourage sound risk management and hence, reduction in premium payable by banks.
INTERNATIONAL NETWORKING WITH OTHER DEPOSIT INSURANCE SYSTEMS
In order to promote cooperation among different deposit insurance organizations as well as promote the stability of the international financial system, the International Association of Deposit Insurers (IADI) was founded in Basel, Switzerland in May, 2002. The vision of the Association is “sharing deposit insurance expertise with the world.” The forum provides deposit insurance practitioners opportunity to discuss leading issues in deposit insurance, net-working and information sharing.
The genesis of IADI was the Working Group on Deposit Insurance established by the Financial Stability Forum (FSF) in 2000. The Working Group, in turn, was established following the findings of the Study Group on Deposit Insurance, which the FSF constituted in 1999. The Working Group and the Study Group were headed by Mr. Jean Pierre Sabourin of the Canada Deposit Insurance Corporation.
Currently there are 52 member organizations, 6 associates, 3 observers and 12 partners. Member organizations are entities that, under law or agreements, have a deposit insurance system and have been approved for membership in the Association. (Nigeria, USA, Bangladesh, Sudan, Bulgaria, Canada, Russia, India, Trinidad and Tobago, Bahamas, Zimbabwe, Kenya, Hong Kong etc.). Associates are entities that do not fulfill all criteria to be a member, but are considering the establishment of a deposit insurance system, or are part of a financial safety net and have a direct interest in the effectiveness of a deposit insurance system. (Bank of Mangolia, Monetary Authority of Singapore, Bank of Algeria, etc). Observers are interested parties that are profit or not-for-profit entities which do not fulfill the criteria to be an associate but have a direct interest in the effectiveness of deposit insurance systems; may include international organizations, financial institutions and professional firms. (Bearing Point Inc., Deloitte & Touche LLP, Excel Technology International, Goodmans LLP). Partners are not- for profit entities, such as international financial institutions that enter into a cooperative arrangement with the association in the pursuit and furtherance of the objects of the association. (Asian Development Bank Institute, Association of Supervisors of Banks of the Americas (ASBA), The South East Asian Central Banks (SEACEN) Research and Training Center, etc).
The Corporation joined IADI as a founding member in 2002 and was the pioneer Chair of the Africa Regional Committee (ARC) of the Association. Also, the Corporation’s Managing Director/Chief Executive Officer (MD/CEO), Mr. G. A. Ogunleye, OFR, was a pioneer member of the Executive Council of IADI. In addition, the Corporation had one of its staff as a member of the Association’s Research and Guidance Group (RCG).
As a founding member, the Corporation, since 2002, had participated in several fora organized by both IADI (Annual Conferences) and its member deposit insurers (Regional Committee Annual Meetings) to share experience with other members as well as share information on relevant issues and policies for strengthening deposit insurance mechanisms. The international networking had been mutually beneficial, through exchange of information at the level of IADI and collaboration among member agencies. The Corporation had contributed significantly to the sound growth and development of the IADI. In particular, staff members of the Corporation had been very active in, and integral to, several research projects aimed at enhancing deposit insurance effectiveness across the globe.
In 2004, the Corporation hosted the first international conference on deposit insurance organized by the Africa Regional Committee of the IADI in Abuja, Nigeria. As part of its activities in 2007 and in order to encourage the introduction of explicit Deposit Insurance System as well as strengthen the existing systems in Africa, the Corporation, under the auspices of the Africa Regional Committee (ARC) of the IADI, hosted an international workshop on deposit insurance. The theme of that workshop was “Bank Resolution and Differential Premium.” The workshop, drew its facilitators from Africa, Turkey, and Canada, and was attended by 35 delegates from Kenya, Tanzania, Zimbabwe, Cameroun, and Nigeria.
Also, in 2008, as part of its contributions to the building of capacity among middle level personnel in existing DIS in Africa and those intending to establish new deposit insurance systems, the Corporation under the auspices of the ARC hosted another international workshop on deposit insurance. The theme of the 2008 workshop was “Deposit Insurance System (DIS) Coverage and Public Awareness”. The workshop drew participants from Kenya, Tanzania, Zimbabwe and Nigeria. Key officials from Malaysia, Taiwan and IADI Headquarters (Switzerland) were among the facilitators at the workshop.
The Corporation had also in the last few years received staff of deposit insurance agencies from sister African countries for study tours/attachment programmes. Some of the agencies included the Deposit Insurance Protection Board of Tanzania, the Deposit Protection Board of Zimbabwe, Commission Bancaire de’Afrique Centrale (COBAC) of Cameroun as well as Delegates from Banque Centrale Des Etats De L’ Afrique De L’ Ouest (BCEAO) in Senegal.
A Non-Interest Bank means a bank which transacts banking business, engages in trading, investment and commercial activities as well as the provision of financial products and services without the conventional interest charges. Such banks may operate either in accordance with or without Shari’ah principles and rules of Islamic jurisprudence.
The establishment of Non-Interest Banks has necessitated the extension of Deposit Insurance coverage to the depositors of such banks in order to provide a level playing field for all deposit-taking financial institutions and ensure that holders of Non-Interest Banking products are adequately protected.
2.0 PUBLIC POLICY OBJECTIVES
The essence of the Framework is to specify the public policy it is expected to achieve as well as the basic features of Deposit Insurance for Non-Interest Banks. The principal objective for the Insurance of the Deposits of Non-Interest Banks is based on Public Interest and aims at providing equivalent protection similar to that of conventional banks. The objectives include the following:
i) Depositor protection against loss in the event of failure of any Non-Interest bank;
ii) Engender public confidence and enhance resilience of Non-Interest Financial Institutions;
iii) Encourage competitiveness of Non-Interest Financial Institutions;
iv) Help contain the cost of resolving failed Non-Interest Banks and provide an orderly Failure Resolution Mechanism.
3.0 MANDATE AND POWERS
The Nigeria Deposit Insurance Corporation (NDIC) protects deposit of Non-Interest Banks and Deposit Money Banks, provides incentives for promoting sound risk management principles and contributes to the stability of the Financial System in Nigeria. NDIC is to fulfil its mandates in an efficient and effective manner, having regard to the interests of its employees and other stakeholders.
NDIC’s mandate, as set out in its enabling Act, is a Risk Minimizer with powers to guarantee deposits of insured institutions, carry out supervision of insured institutions, partake in problem/failing banks resolution process and liquidate failed/closed financial institutions.
The roles of the Corporation in the Financial System are essentially to:
i) Administer a Deposit Insurance System
ii) Provide Insurance against the loss or part or all of deposits of a member Institution.
iii) Provide incentives for Sound Risk Management in Financial Institutions.
iv) Promote and contribute to the stability of the Nigerian Financial System
4.0 MEMBERSHIP AND COVERAGE
4.1 Compulsory Membership
Participation in the Non-Interest Deposit Insurance Scheme (DIS) is compulsory for the following types of Institutions:
- Full-fledged Non-Interest bank or full-fledged non-interest banking subsidiary of a conventional bank.
- Full-fledged non-interest Microfinance bank.
- Non-interest branch or window of a conventional bank.
- Full-fledged non-interest merchant bank or full-fledged non-interest banking subsidiary of a conventional merchant bank.
Compulsory membership for all Non-Interest banking Institutions is essential for the promotion of Public Confidence in the Financial System. Voluntary participation has an inherent tendency to worsen instability in the Banking System during financial crises. Another major consideration in support of compulsory membership is the need to avoid the problem of adverse selection.
Adverse selection is the tendency whereby mainly Financially Weak or High Risk Institutions opt for the Deposit Insurance Scheme when it is voluntary.
4.2 Maximum Insurance Coverage
The Maximum Deposit Insurance Coverage (MDIC) for all Non-Interest Banking Institutions shall be the same as the Deposit Money Banks, which is presently ₦500,000 per Depositor per account and N200,000 per Depositor per account for Microfinance banks.
Funding of the Non-Interest Deposit Insurance Scheme (NIDIS) shall be ex-ante. The ex-ante funding is the most acceptable internationally because of its advantages of building up a Deposit Insurance fund to assist the Banking System in times of illiquidity, capital deficiency or liquidation.
The Framework takes into consideration:
- NDIC’s role in the Financial Safety Net
- Legislative powers relating to Sources of Funding
- Internal and External Sources of Funds
- Non-interest principles relating to the Sources of Funding
5.1 Sources of Funds
There are Internal and External Sources of Funds.
- Internal Sources are made up of:
- Contributions (Premiums) collected from Non-Interest Financial Institutions (NIFI)
- Investment Income from the Non-Interest Deposit Insurance Funds (NIDIF)
- External Sources include:
- Borrowing from the Government/CBN for the NIDIF is interest-free and if interest based, it must be under extreme circumstances of necessity.
- Raising of Funds from the Non-Interest Capital Markets (Sukuk)
- Special contributions by the insured Non-interest Financial Institutions (A call for additional premium by the Corporation when the circumstance arises, inline with section 17, subsection 5 of the NDIC Act, 2006 as amended)
5.2 Insurable Deposits under NIDIS
The following Non-interest Deposits are eligible for Deposit Insurance Coverage:
- Safe Keeping Deposit (Wadi’ah)
- Interest free Deposit for Investment (Qard)
- Profit Sharing /Loss Bearing Deposit (Mudarabah)
- Any other Deposit-type that is Non-interest based and approved by the Central Bank of Nigeria (CBN).
5.3 Uninsured Deposits under NIDIS
The deposits that do not qualify for deposit Insurance are mainly Partnership or Joint venture contract-types which include:
- Insider Deposits – Deposits of staff including Directors of Non-interest Banks or Financial Institutions
- Profit and Loss Sharing Partnership (Musharakah)
- Counter-claims from one person who maintains both a Deposit Accounts and a Non-interest Bearing Loan Account and/ or a loan based on Murabahah financing where the Deposit account serves as a collateral for either or both of the loans accounts.
- Inter Bank Takings
- Such other Deposit as may be specified from time to time by the Board
5.4 Determination Of Contribution By Insured NIBs
The Differential Premium Assessment System (DPAS) presently in use for the Deposit Money Banks which focuses on the Risk-profile of each Non-Interest Financial Institution would be applicable. Thus, the higher the risks of any financial institution, the higher the applicable contribution rate.
5.5 Segregation of Funds
The Corporation will ensure that the Non-Interest Deposit Insurance Fund are clearly segregated by establishing a Non-interest Deposit Insurance Fund (NIDIF) separate and distinct from the Deposit Insurance Funds (DIF) of the Deposit Money Banks and Special Insured Institutions Fund (SIIF) of Special Insured Institutions.
5.5.1 Guidelines for Segregation of Funds
The Corporation would have a mechanism to trace the Funds that are segregated for the NIDIS to ensure that the Funds are not only properly separated but also not involved in any transaction involving interest charges.
5.5.2 Deficit Financing
In the event of the need to raise additional funds for the NIDIS, the Corporation will:
- Raise the funds from other Non-Interest Financial Institutions. (this is a call for additional premium by the Corporation when the circumstance arises, inline with section 17, subsection 5 of the NDIC Act, 2006 as amended)
- Borrow from the Government/CBN on an interest-free basis
- Raise funds from Non-interest Capital Markets (Sukuk)
5.6 INVESTMENT OUTLETS
Legislative provisions, CBN-Advisory Council of Experts, Investments Guidelines and Board approved Investments Policy Guidelines will guide the investment of the NIDI-Funds. In addition, the NIDIF will be invested in safe and liquid instruments to enable easy access when the need arises e.g. Government and Central Bank Instruments and other Non-Interest Instruments.
6.0 FAILURE RESOLUTION
In the event of the failure of a Non-interest Financial Institution, the following Failure Resolution Options are available to the Corporation:
- Open Bank Assistance
- Assisted Merger & Acquisition
- Purchase & Assumptions
- Bridge Bank
- Reimbursement/ Pay out of Insured Deposits
- Asset Purchase
6.1 Intervention Thresholds
S/N CONDITION OF A BANK RESTRICTION/SUPERVISORY ACTION 1 Under capitalised Banks (i.e. Banks with Capital Adequacy Ratio (CAR) greater than or equal to 5% but less than the prescribed minimum of 10%. i) Conduct Special Examination
ii) Restrict Dividend distribution
iii) Restrict Investment in other subsidiaries/related companies
iv) Restrict investment in Fixed Assets
2 Significantly Under Capitalised Banks (i.e. Banks with Capital Adequacy Ratio (CAR) less than 5% but equal to or greater than 2%. i) Restrict new Investment to recoveries (Zero based Investment)
ii) Request for business plan on how fresh funds are to be injected into the bank
iii) CBN to review business plan within two weeks and communicate to the bank its acceptability or otherwise
iv) The CBN should make the final Capital call on the Bank within FOUR (4) months from time of acceptance of the business plan
v) Within two (2) months after the final capital call, the CBN may take over management and control of the Bank and hand it over to NDIC
vi) The CBN may appoint the NDIC which may consider the following option;
a) Recapitalisation and Restructuring by new investors
b) Create incentive for healthy Banks to take over the sick one
c) Sale of Assets to AMCON
d) Recommend the revocation of licence
3 Critically Under Capitalised Banks (i.e. Banks with Capital Adequacy Ratio (CAR) less than 2%. Take over management and control and /or revoke the licence. 4 Insolvent Banks (i.e. Banks with negative Capital Adequacy Ratio (CAR). Take over management and control and /or revoke the licence
7.0 DEALING WITH PARTIES AT DEFAULT
In the event of failure, the under-listed measures will be imposed on those responsible for the failure (and proven guilty) in addition to the provisions of the NDIC Act, CBN Act and CAMA.
- Members of the bank Advisory Council of Experts (ACE)
- Members of the Board and Management of the bank
8.0 REIMBURSEMENT OF DEPOSITORS
All cost/losses incurred will be first charged to the Non-Interest Deposit Insurance Fund (NIDIF) before any other payments. Payments are prioritized based on the deposit-type or nature of contract of NIB-products. Priorities of claim payments upon liquidation are as follows:
- NDIC’s insured Non-Interest Deposits
- Uninsured Non-Interest Deposits
- Uninsured Non-Interest claims
Priority of payments of Insured Non-interest Deposits is sequenced below:
- Safe Custody Deposits (Wadi’ah)
- Interest free Deposits for Investment (Qard)
- Profit Sharing/Loss Bearing Deposits (Mudarabah)
In the event of the failure of a Non-Interest Financial Institution, the following will be included as part of the measures to ensure recovery of Investments owed by customers of the NIFI:
- Disposal of pledged collateral
- Restructuring of the Facility
10.0 GLOSSARY OF TERMS
The following terms have the following meanings:
S/NO TERM MEANING 1 Safe Custody Deposit (Wadi’ah) Safe custody deposit which is based on trust and only the principal amount is obligated to be repaid to customer. 2 Interest free deposits for Investments (Qard) This is a loan contract whereby the borrower is only obligated to repay the principal amount of the loan. 3 Profit Sharing/Loss Bearing Deposits
This is like a form of partnership where one party provides funds (investor) while the other provides expertise and management (entrepreneurship). Profit is shared between the two parties on a pre-agreed profit sharing ratio, while any loss is borne by the Fund Providers, except in the case of proven negligence or breach of investment mandate on the part of the fund manager. 4 Profit & Loss Sharing (Musharakah) This is a partnership where profits are shared on agreed ratio basis while losses are shared in proportion to the capital of each partner. In a musharakah, all partners of the business undertakings contribute funds and have the right, but not obligation, to exercise executive powers in that project, which is similar to a conventional partnership structure and the holding of voting stock in a limited company. 5 Cost Plus (Murabahah) A sale on mutually agreed profit. Under this arrangement, the seller charges the buyer the cost plus a profit. Technically, Murabahah means a contract made for acquisition of an asset between the purchaser and the seller through a third party Non-Interest Financial Institution (NIFI). For instance, Mr. A may wish to purchase a computer from Mr. B, and then Mr. B seeks the financier (NIFI) to finance the purchase of the product as the third party. 6 Leasing
This is a form of leasing in which there is a transfer of ownership of a service for a specified period for an agreed upon lawful consideration. Instead of lending money and earning interest, ijarah allows the Non-Interest Financial Institution to earn profit by charging rentals on the Asset leased to the customer. 7 Sale with Advance Payment
(Salam and Parallel Salam)
Is a differed delivery contract in which advance payment is made for goods to be delivered at a future date. The seller undertakes to supply some specific goods to the buyer at a future date in exchange for an advance price fully paid at the time of contract. Parallel Salam is where the buyer in a Salam contract sells what he bought by the Salam contract to a third party in another parallel Salam contract. Islamic banks use parallel Salam to avoid the market-risk of holding on to a Salam product.
Certificate of equal value representing undivided share in ownership of tangible assets of particular projects, or specified investment activity, usufruct and services. 9. Project finance (Istis’na) A manufacture/construction contract of assets where one party places an order for the manufacture/construction of an Asset/Assets from the second party to be delivered at a future date according to the specifications given in the Istis’na contract, while allowing for cash payment in advance.
NIGERIA DEPOSIT INSURANCE CORPORATION [NDIC]