Risk-based contributions to EDIS

• Author: Dobkowitz, Sonja; Evrard, Johanne; Carmassi, Jacopo; Silva, André; Parisi, Laura; Wedow, Michael
• Pages: 24-41

ECB Occasional Paper Series No 208 / April 2018

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5 Risk-based contributions to EDIS

5.1 Rationale

One concern which is frequently voiced regarding EDIS relates to the possibility that

the pooling of resources could lead to cross-border subsidies, i.e. the eventuality of

one or several banking systems structurally contributing more and benefitting less

from the scheme than other, potentially riskier, systems. The pooling of resources

could also lead to increased moral hazard and incentivise risk-taking behaviour by

banks given the existence of a larger deposit guarantee scheme and fund. There

might also be the risk that certain banking systems would be more likely to tap into

the EDIS funds than others, even though all banking systems would benefit from the

enhanced capacity of the deposit scheme to withstand larger crises.

The post-crisis review of the European Deposit Guarantee Scheme Directive

(DGSD) applied the concept of risk-based contributions to national DGSs.32 The

Commission proposal on EDIS also foresees the use of risk-based contributions to

the DIF, the methodology of which would be determined in a Commission Delegated

Act. The use of a “Banking Union methodology”, i.e. a methodology comparing

banks across the banking union rather than within each national banking system,

would have the potential to reduce the risk of cross-border subsidies compared to a

system where banks’ contributions would be calculated only relative to their national

peers. This is because, following a “polluter-pays” principle, a national banking

system would contribute more to the DIF overall if it is riskier relative to other

banking systems in the banking union. This approach would have the benefit of

aligning incentives and tackling moral hazard, since banking systems which include

riskier banks would contribute more to the DIF overall than they would if

contributions were solely based on the amount of deposits or calculated only taking

into account the riskiness of banks within the national banking system.

5.2 Methodology

Given that the exact methodology for the calculation of banks’ contributions to the

DIF is yet to be developed, the analysis below is based on a modified version of the

methodology developed by the EBA for national DGSs in which banks’ contributions

are risk-based.33 It must be stressed that, while the EBA methodology for national

DGSs applies the risk adjustment at a national level, the risk adjustment in this

analysis is carried out at the banking union level.

According to the EBA Guidelines, the calculation of an institution’s contribution is

based on five risk categories: (1) capital, (2) liquidity and funding, (3) asset quality,

32 Directive 2014/49/EU.

33 See EBA Guidelines on methods for calculating contributions to deposit guarantee schemes to be

found here : Guidelines.

ECB Occasional Paper Series No 208 / April 2018

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(4) business model and management, and (5) potential losses for the DGS (this

factor is not considered in this analysis due to limited data on unencumbered

assets). For the purpose of this study, the leverage ratio and the total risk-based

capital ratio are included for category (1), liquid assets per total assets34 are included

for category (2), and the Return On Equity (ROE) and Risk Weighted Assets (RWA)

per total assets are used for the category representing an institution’s business

model and management (4). Furthermore, the analysis includes a measure of (part

of) MREL-eligible liabilities.35 The higher the MREL, the higher the likelihood of a

bank going into resolution rather than liquidation, the higher the bank's expected

capacity to absorb losses and, all else being equal, the lower the potential exposure

for EDIS.36 The combination of these indicators shall hereinafter be referred to as

“DGS-baseline indicators” and is comparable to the list of indicators proposed for

EDIS. As these indicators are still under discussion, the set used here does not

prejudge the final calculation method that will be decided by the Council of the EU

and the European Parliament. In a first modification of the baseline list of indicators,

the indicator for MREL-eligible liabilities is excluded to test the impact of this

indicator on the contributions. In a second modification, the established baseline set

of indicators is extended by additionally including an indicator for interconnectedness

measured as the sum of loans and advances from and to banks relative to the total

amount of these items in the sample. The non-performing loans ratio (category (3)) is

not included in the baseline analysis because of data limitations. However, it is

reported separately in column 7 in Table 3, where it is added to the baseline

indicators to indicate its potential relevance for the purpose of future analyses.

Finally, the established baseline indicator set is extended by including the World

Bank index for the strength of insolvency frameworks, since the proper functioning of

the insolvency framework will have an impact on the deposit insurance's capacity to

recover money in insolvency after a payout.37

The EBA Guidelines suggest two alternative approaches to constructing aggregate

risk weights (ARW) that are used in the contribution calculation: a bucket approach

and a sliding scale approach. The results presented are those for the sliding scale

approach, since this approach requires fewer assumptions and uses a normalisation

method that is better suited to preserving the level of information of the indicators.38

The 25th and 75th percentiles are used as lower and upper boundaries,

34 Defined as: (Cash & balances with central banks + Net loans and advances to banks + Level 1 assets

(fair value hierarchy)) / Total Assets.

35 Senior unsecured bonds only: regulatory capital is not included to avoid double consideration, given

that it is already used for category (1) on capital.

36 The EDIS exposure could be lower for several reasons: for example, MREL-eligible liabilities cannot be

suddenly withdrawn, e.g. in a run, because they must have residual maturity of at least one year;

losses in inso lvency tend to be higher than in resolution; th e losses for the deposit guarantee scheme

in resolution cannot be higher than in insolvency (see Article 109 of the BRRD and Article 79 of the

SRMR).

37 See Resolving Insolve ncy

38 See OECD and JRC (2008). The construction of the composite risk i ndicator is a crucial to pic in the

calculation o f risk-based contributions as contributions strongly depend on the choice and design of the

various steps tak en to calculate the ARW. The aforementioned work of the OECD and JRC gives an

insightful overview of indicator construction in general.