DEPOSIT INSURANCE AND ITS IMPLICATIONS FOR FINANCIAL CONSUMER PROTECTION

FINANCIAL CONSUMER PROTECTION AND FINANCIAL LITERACY

Sofia, 11th June 2014

Jerzy Pruski IADI President and Chair of the Executive Council

President of the Management Board, Bank Guarantee Fund, Poland

2

AGENDA

Deposit insurance and wider perspective on consumer protection in financial markets

Reasons for protecting and informing consumers and possible obstacles within these processes

Global and local examples of risks associated with consumer protection

The approach to consumer protection in the EU (new Deposit Guarantee Scheme Directive)

IADI research programs on consumer protection and Core Principles for Effective Deposit Insurance Systems

3

The deposit insurance fund is only one of the elements of a complex consumer protection scheme in

financial markets

Consumer protection is an attribute of not only deposit insurers but also of other financial safety-net players as well as policymakers

PERSPECTIVE OF DEPOSIT INSURANCE

Protection needs to be linked with the large variety of products available

in financial markets such as capital investments or credit

Because of the complexity of financial markets, consumer protection and the policy of informing consumers always need to be considered from a broad

perspective

The financial system should be equipped with a properly designed consumer protection scheme, comprising various entities with different responsibilities

The whole mechanism contributes to the financial stability of the economy

4

OBSTACLES TO INFORMING AND PROTECTING CONSUMERS IN FINANCIAL MARKETS

• Often have lack of basic market knowledge

• Sometimes buy complicated products designed for professionals

• Do not understand the risk associated with financial products nor the intent behind their design

• Have a strong tendency for confirmation bias and wishful thinking – especially dangerous in financial markets

• See only „one side” of the market

• Are susceptible to herd instincts

• Offer complicated products whose construction is unclear even for their sellers

• Do not sufficiently inform about the undertaken risk

• Transfer a large part of the risk to counterparties (consumers)

• Create uneven distribution of rights and obligations between counterparties involved in the product (in favour of the seller)

CONSUMERS OF FINANCIAL SERVICES

SELLERS & DESIGNERS OF FINANCIAL PRODUCTS

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PROTECTION IN FINANCIAL MARKETS

In recent years more consumers and retail investors have become active in financial markets and are being offered a more complex and wide-ranging

set of financial services and instruments

Consumers and retail investors need to be fully protected and supplied with extensive information about products and services, investments, and especially the risk

associated with their actions

Why is informing and protecting consumers in financial markets crucial?

This directly translates into a greater volume and value of transactions taking place in financial markets

Because consumers need to: • understand what they are doing • understand the potential consequences of their decisions • understand and accept the risk of an investment or financial transaction

MARKET IMPERFECTIONS IN THESE AREAS CAN HAVE SERIOUS RAMIFICATIONS IN THE FORM OF CREATION OF MARKET BUBBLES AND CAUSING DIFFERENT TYPES OF CRISES

6

CURRENCY RATE PLN / EUR 2007-2009

CURRENCY OPTIONS AMONG POLISH COMPANIES

DEP

REC

IATI

ON

OF

PLN

B

Y 53

% IN

7 M

ON

THS

POLISH COMPANIES PURCHASING CURRENCY OPTIONS

A csteady trend of PLN appreciation encouraged Polish exporters to purchase currency options with banks, hedging the value of their revenues from abroad

In 2008 Poland was hit by an economic crisis, which triggered the process of rapid depreciation of PLN

7

MECHANICS OF THE PROBLEM

LOSSES OF POLISH COMPANIES

CURRENCY OPTIONS AMONG POLISH COMPANIES

Companies that had purchased options were obliged to sell PLN to banks at a fixed price stipulated in contracts (e.g. PLN 3.5), also when the market price was PLN 4.8

This was in a large part a speculation game because the contracted amounts were much higher than the expected export revenues from particular companies

Negative valuation of currency derivatives issued by Polish companies amounted to PLN 16 billion

Negative valuation of currency options amounted in total to PLN 9 billion

99 public listed companies were affected by losses on options

NAME OF COMPANY CURRENCY OPTION LOSS IN MILLIONS PLN

Krosno 300

Ciech 300

Zakłady Police 124

Cersanit 53

Rudniki 13 Source: KNF

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OBSTACLES TO INFORMING AND PROTECTING CONSUMERS IN FINANCIAL MARKETS

• „Dotcom” bubble

• Credit boom during times of low interest rate levels

• Mortgage-backed securities (global financial crisis)

• Popularity of derivative products (currency options)

• Mortgage loans in foreign currencies for households

• Structured investment products as a way of ordinary saving

• Offering aggressive-strategy investment funds for those types of consumers that particularly need to be protected (e.g. the elderly)

EXAMPLES OF MARKET BUBBLE CREATION

GLOBAL CHARACTER LOCAL CHARACTER (EXAMPLES FROM POLAND)

9

-10

-5

0

5

10

15

20

25

30

35

40

45

II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Housing loans - real

Corporate loans - real

Consumer loans - nominal

Limited lending

Expansion of housing loans

Housing loans -the main factor of loan growth

DEVELOPMENT OF LOANS IN POLAND

Availability of cheap financing allowed banks to create an attractive housing loan offer, which in combination with a high demand of households for flats/houses allowed dynamic development of lending

LOANS BY CATEGORIES – QUARTERLY CHANGES (IN BILLIONS PLN)

Source: NBP

10

-40%

-20%

0%

20%

40%

60%

80%

100%

-10

-5

0

5

10

15

20

25

II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20132014

PLN-denominated

foreign currency

annual change

PLN bn

Low volume of housing loans

Expansion of housing loans

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

-15

-10

-5

0

5

10

15

20

25

II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20132014

foreign funds

foreign currency housing loans

CHF/PLN

PLN bn

EXPANSION OF FOREIGN CURRENCY HOUSING LOANS

The dynamic growth of housing loans was possible mainly due to the growth in foreign currency loans, which were cheaper than PLN-denominated loans because of banks’ access to foreign funding

Quarterly and annual changes in housing loans (real)

Quarterly changes (real) and exchange rate

Source: NBP

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LIABILITIES TO AN EXTERNAL FINANCIAL SECTOR

0

100

200

300

400

500

600

700

800

900

1 00019

96

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Q1 20

14

Stocks (PLN bn)

Loans for non-financial clients Liabilities to external financial sector

Excess liquidity in banking sector; small share of foreign funds

Growth of liabilities to external financial sector

Years 2005 - 2008 – a period of increased inflow of foreign funding

12

372 376 469 394 304 341

442

680

829 1 096 57578 411 97

-94 -398

-600

-400

-200

0

200

400

600

800

1000

1200

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Change in loan volume (EUR bn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

ECB MRO interest rate (right axis)

Intensive growth of bank lending to Non-MFIs in pre-crisis period

Source: ECB

5

6

7

8

9

10

11

12

1997

Sep

1998

Feb

1998

Jul

1998

Dec

1999

May

1999

Oct

2000

Mar

2000

Aug

2001

Jan

2001

Jun

2001

Nov

2002

Apr

2002

Sep

2003

Feb

2003

Jul

2003

Dec

2004

May

2004

Oct

2005

Mar

2005

Aug

2006

Jan

2006

Jun

2006

Nov

2007

Apr

2007

Sep

2008

Feb

2008

Jul

2008

Dec

2009

May

2009

Oct

2010

Mar

2010

Aug

2011

Jan

2011

Jun

2011

Nov

2012

Apr

2012

Sep

2013

Feb

2013

Jul

2013

Dec

Loans for Non-MFIs – change in volume

Loans for Non-MFIs (EUR trillions)

In 2005-2008 annual change in volume between 0.6-1.1 EUR bn, in comparison to 0.3-0.4 EUR bn in 1998-2004

LOANS FOR NON-MFIS – EURO AREA

13

8371 318 1 164

1 505

645991

1 554

2 280 2 319

3 540

2 336

-686

1 0631 327

-839

-2 250-3 000

-2 000

-1 000

0

1 000

2 000

3 000

4 000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Change in asset volume (EUR bn)0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

ECB MRO interest rate (right axis)

10

15

20

25

30

35

1997

Sep

1998

Mar

1998

Sep

1999

Mar

1999

Sep

2000

Mar

2000

Sep

2001

Mar

2001

Sep

2002

Mar

2002

Sep

2003

Mar

2003

Sep

2004

Mar

2004

Sep

2005

Mar

2005

Sep

2006

Mar

2006

Sep

2007

Mar

2007

Sep

2008

Mar

2008

Sep

2009

Mar

2009

Sep

2010

Mar

2010

Sep

2011

Mar

2011

Sep

2012

Mar

2012

Sep

2013

Mar

2013

Sep

2014

Mar

Total assets – change in volume

Total assets (EUR trillions)

Intensive growth of total euro area bank assets in pre-crisis period

Source: ECB

TOTAL BANK ASSETS – EURO AREA

14

0.1

2.3

1.41.5

0.9

0.0

0.5

1.0

1.5

2.0

2.5Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Structured finance (total) - outstandingMBS - outstanding

76130 115 155 141

223309

369

529

93

-137-165

-273

-197

-400-300-200-100

0100200300400500600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Change in structured finance volume excl. MBS (EUR bn)Change in MBS volume (EUR bn)

0.00.51.01.52.02.53.03.54.04.55.0

ECB MRO interest rate (right axis)

Source: Sifma

European structured finance 1999-2014 (EUR trillions)

European structured finance – change in volume

2005-2008 – dynamic growth of outstanding balance of European securitized products (including mortgage-backed securities) In 2008 the annual increase in volume was 4 times higher than in 2004

EUROPEAN STRUCTURED FINANCE

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European 3-5 Yr AAA RMBS Prices

After intensive growth in the volume of securitized products, the prices of residential mortgage-backed securities (RMBS) started to decrease in 2008

POTENTIAL MBS-RELATED LOSSES IN EUROPE

European 3-5 Yr BBB RMBS Prices

2008/2009 – decline in RMBS prices

Source: Afme.

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422581

9171 170 997

-263

-61 -72

67

-227 -95

-400

-200

0

200

400

600

800

1 000

1 200

1 400

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Change in mortgage-related securities volume (USD bn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Federal Fund Rate (right axis)

5.3

9.4

8.7

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

5.3

9.4

8.7

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Sifma, Reuters.

U.S. Mortgage-Related Securities 2002-2013 (USD trillions)

U.S. Mortgage-Related Securities – change in volume

Intensive growth of U.S. mortgage-related securities market in the pre-crisis period

U.S. MORTGAGE-RELATED SECURITIES

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DGS DIRECTIVE

DIRECTIVE 94/19/EC ON DEPOSIT-GUARANTEE SCHEMES

„ […] increasing the stability of the banking system and protection for savers ”

Tools: - protection of all depositors in the entire EU - min. level of protection – 20 000 euro - banks provide customers with information about the rules concerning deposit

guarantee schemes

Goal

DIRECTIVE 2009/14/EC AMENDING DGSD

„ […] restore confidence and proper functioning of the financial sector” „ […] take all necessary measures to protect the deposits of individual savers” „ […] improvement of that coverage”

Goal

Tools: - increasing level of protection to 50 000 euro and later to 100 000 euro - faster pay-out - up to 20 working days - eliminating the possibility of depositor co-insurance - strengthening information rules (additionally banks inform customers if financial

instrument is not covered)

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DGS DIRECTIVE

NEW DGS DIRECTIVE

2014

„As a result of this Directive, depositors will benefit from significantly improved access to DGSs, thanks to a broadened and clarified scope of coverage, faster repayment periods, improved information and robust funding requirements. This will improve consumer confidence in financial stability throughout the internal market.”

Goal

Tools: - shortening pay-out

period to 7 working days

- unified scope of coverage

- better information for customers: e.g. information template circulated to depositors at least annually

Basic information about the protection of deposits Deposits in „Example Bank” are protected by: Bank Guarantee Fund

Limit of protection: EUR 100 000 per depositor per credit institution

If you have more deposits at the same credit institution:

All your deposits at the same credit institution are "aggregated" and the total is subject to the limit of EUR 100 000

If you have a joint account with (an)other person(s):

The limit of EUR 100 000 applies to each depositor separately

Reimbursement period in case of a credit institution’s failure: 7 working days

Currency of reimbursement: *

Contact: Bank Guarantee Fund ul. ks. Ignacego Jana Skorupki 4 00-546 Warszawa

More information: www.bfg.pl Acknowledgement of receipt by the depositor:

* Possible options: the currency of the Member State where the DGS is located; the currency of the Member State where the account holder is a resident; euro; the currency of the account; the currency of the Member State where the account is located

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IADI CORE PRINCIPLES

A high degree of compliance with the Core Principles should contribute to financial system stability and enhance depositor protection.

The focus of protection should be on those depositors who are generally not in a position to make an informed assessment of the risk that the bank to which their funds are entrusted may fail (e.g. retail and small business depositors).

In order for a deposit insurance system to be effective it is essential that the public be informed on an ongoing basis about the benefits and limitations of the deposit insurance system.

the deposit insurer is responsible for promoting public awareness

the deposit insurer works closely with member banks and other safety-net participants

the deposit insurer receives or conducts a regular evaluation of the effectiveness of its public awareness program

Public awareness

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IADI RESEARCH PROGRAMS

Enhanced Guidance for Effective Deposit Insurance Systems: Public Awareness of Deposit Insurance Systems

Bank customers, in particular depositors, have the right to be informed and educated

In order to reinforce consumer protection, some deposit insurers have already shifted the focus of their public awareness campaigns from promoting awareness of the deposit insurance system to promoting safe banking practices

A well-informed public is less susceptible to rumors, and public confidence in the safety of deposits is a powerful force in preventing bank runs

Consumers who are financially informed and know their rights can impose additional discipline on the banking system

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IADI RESEARCH PROGRAMS

Financial Inclusion and Deposit Insurance

Financial inclusion is enhanced by introducing or extending explicit deposit insurance protection

Access to deposit insurance should provide a measure of protection to small savers, provided they are informed about safe places to store their money

Small savers should find the protection of deposit insurance appealing, provided there is public awareness and understanding of its benefits and limitations

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CONCLUSIONS

Historical examples show that consumers are often not aware of the undertaken risk related to the financial products they use, which may contribute to the creation of market bubbles and, in consequence, lead to consumers bearing losses

A clear information policy targeting consumers and investors is necessary for the protection of financial market retail clients

Well-informed consumers and investors are important factors in maintaining stability of the financial system as a whole

However, consumers and investors must be supported by a comprehensive network of financial safety-net institutions, which includes an infrastructure of micro- and macro-supervision as well as a highly robust deposit insurance system