This involves the payment of insured deposits up to the insurable limit to the depositors of the liquidated bank. Uninsured depositors and creditors would only have claim on the liquidator from the proceeds of liquidation. Also, part of the proceeds of liquidation would be used to defray the deposit insurance institution’s expenses connected with administering the liquidation process.
Deposits payout include costs that cannot be easily estimated such as administrative costs, staff salaries and other personnel emoluments of the Liquidator. Other operational costs involve hiring of debt collectors, lawyers, estate agents, security firms et cetera. In addition, there is the cost of publicity and enlightenment campaigns that should be mounted.
A clear advantage of this option is its ability to instill market discipline in the banking system. Negative consequences include; likely denial of banking services in the area where the failed bank operates and loss of public confidence in the banking system. Liquidation of assets could extend for many years. Consequently, uninsured depositors, other creditors and shareholders could wait for many years before being paid.
There are some issues relating to depositor reimbursement. These issues include whether the deposit insurer can make partial payment or advance payment when there are impediments to outright reimbursement or delay in realization of assets. Partial payments are made to cover the immediate living costs and other expenses of depositors, etc., in a financial institution that has been subject to an insurable contingency, when it is anticipated that insurance payments or the reimbursement of insured deposits will not begin for a considerable length of time.
Partial payment provides temporary relief to the distressed depositor. In addition, partial payment forces depositors (small and large) to be more diligent when choosing a bank. A major problem with partial payment is that it may create unnecessary excess burden on the information technology systems and thus delaying the whole process, thereby endangering the completion of the payment within statutory time frame.
Advance payment refers to payment to uninsured depositors in advance, prior to liquidation of the failed institution. It provides depositors immediate returns on the uninsured portion of their deposits. However, since the amount of payment depends on the conservative valuation of the failed institution, the risk of overestimation is real.