Deposit Insurance and Bank Insolvency in a Changing World: Synergies & Challenges

Abstract

As commerce and finance become more global, international economic stability depends both on the stability of national systems and the stability of the global interrelationships between different national systems. An effective international legal infrastructure requires both effective domestic laws and effective means for coordinating the effects of those laws. This is particularly crucial in dealing with the effects of the insolvency by an internationally-active financial institution or corporation.

On the national level, effective insolvency rules, and the commercial infrastructure which they presuppose, are central to developing and maintaining the confidence of domestic, as well as foreign, businesses and investors. In some cases, national insolvency laws may not provide certainty to creditors or investors even in local insolvencies. In other cases, the laws may not be up to the task of coping with instability in the most important financial institutions. In systems with deposit insurance, an effective insolvency system is vital to control risk-taking and to ensure that financial assets remain productive. As a result, improving the effectiveness and efficiency of national insolvency systems is a crucial component of strengthening national and international financial systems. This paper reviews some of the developing standards for effective insolvency systems and offer examples from the U.S. system of specific laws reflecting these standards. In today's global economy, even effective national insolvency laws cannot fully address the failure of an internationally-active financial institution. Unfortunately, there are few internationally-recognized insolvency rules. The absence of international rules and norms would not be overly troublesome if national insolvency laws were not inconsistent between countries. Differences in the treatment of secured creditors, rights to set-off and net, finality of transactions, and philosophical approaches to debtor-creditor relationships all increase the difficulties of responding to instability in larger, more complex banks with international operations. These inconsistencies are most important when they create uncertainty among other market participants and impair the ability of regulators and insolvency authorities to limit disruptions in key linkages between international financial firms. In this context, national laws and the few international rules may not fulfill the insolvency goals of reducing uncertainty, promoting efficiency, or providing equitable treatment to creditors. The second part of this paper reviews some of the current international rules and norms, and offers suggestions for future work.

Keywords: international law, insolvency law, deposit insurance, best practices

JEL Classification: E61, G20, G21, K12, K2