The impact of Deposit Protection Agencies

The impact of Deposit Protection Agencies

Prof Dr Kriengsak Chareonwongsak

Senior Fellow, Harvard University’s Center for Business and Government

The Deposit Protection Agency Act, 2008, will go into effect on the 11^th of August 2008. Under this Act, bank deposits will be fully guaranteed during the first year of the Deposit Protection Agency having been established, but the guaranteed amount of deposit will be deducted every year from the fifth year onward; with the guarantee only for deposits of up to one million baht per person per agency (August 11, 2012).

The Deposit Protection Agency Act is sound in principle, requiring depositors to be informed about the true risk of a deposit, whereas in the past it was misunderstood that bankruptcy (insolvency) did not happen to banking businesses. Indeed, Deposit Protection helps to reduce depositors’ fear where financial institutions have problems or where the government is burdened to support financial institutions. It helps by identifying specific amounts of money to be paid back to depositors. Moreover, if the Deposit Protection Fund needs to be repaid to depositors at an earlier stage, the Deposit Protection Fund will still reserve prior right to receive its money back before the common creditors of all financial institutions. This differs from the restorative recovery and Financial Institution System Development Fund that reserves equal rights to the other creditors of financial institutions.

            Nevertheless, the establishment of Deposit Protection Agency might cause the change and impact in both positive and negative ways.

            The impact on depositors Sometimes there is no further change to one’s deposit account; there are 8.85 hundred thousand accounts that are not fully guaranteed or that equal just 1.18 percent of all deposit accounts. The amount of money runs as high as 5 million million baht, or 73 percent of all deposits. On the other hand, there may be a change to their deposit account by depositors. Assuming that depositors have distributed their funds to every financial institution (46 institutions), these deposits, which are not fully guaranteed, can still be as high as 2.87 million million baht, or 41 percent of all deposits.

It could be concluded that general depositors (depositing less than 1 million baht) will not be affected, and also that mid-level depositors (depositing 1-50 million baht) will distribute their money to financial institutions that are able to fully guarantee it as a total amount.  High- level depositors, on the other hand, (depositing more than 50 million baht), will distribute their money to every financial institution, but in an amount that is not fully guaranteed, which is a big proportion of deposit.

The impact on the financial institution system Deposit Protection will cause a deposit transfer from the financial institution system, in such investment as bonds, mutual funds, and stock exchange. These deposits will be transferred to government banks, especially banks guaranteed by the government, which are the Government Savings Bank, the Government Housing Bank, and the Bank for Agriculture and Agricultural Cooperatives. These deposits will be transferred to other government banks, such as the Krungthai Bank and the Nakhornluangthai Bank, in addition as depositors still believe that the government will not let government banks fall into definite bankruptcy. Apart from this, high-level depositors will tend more to transfer their deposits from small banks to large banks because their belief is that large banks have more stability.

This act will raise the financial system interest rate due to these deposits having been withdrawn from the financial institution system, thus causing a situation where funds lack. Due to the market situation, in order to maintain the deposit, financial Institutions must specify a higher interest rate for loans as well as an interest rate for deposits. However, the interest rate for deposits greater than 1 million baht should be higher than that for deposits of less than 1 million baht, so as to attract depositors who have deposits of more than 1 million baht. At the same time, the increased interest rate for deposits will cost financial institutions more, so the interest rate for loans will need to increase also with respect to maintaining the profit level of the institutions (organizations).

This law will encourage financial institutions to develop themselves to reach higher standards owing to depositors learning more about the risk of financial institutions. High risk financial institutions will also have high deposit mobilization costs and need to deposit in Deposit Protection Funds at a higher interest rate. However, large financial institutions may have to operate their businesses with risk if they think that they are too-big-to-fall. When a large bank is bankrupt, it will impact the system, and also cause the government to help with support eventually.

The impact on the economy Deposit Protection Agencies will give the economic system more stability owing to the structure of financial sources not only being banks, but also being distributed to other sources more. However, changing financial structures may result in a lack of credit. This will affect medium size enterprises where there is a lack of funds for investment and the cost of loans is higher. These enterprises mostly rely on loans from financial institutions. Thus, it might impact economic growth also.

The Deposit Protection Agency is a vital development in the Thai economic system. Related organizations should be prepared for the change and for the impact that may occur, according to my following recommendations.

-  Implement a risk index, ranking financial institutions, and regularly inform the people about the risk of financial institutions

- Specify a formula to calculate the deposit rate needed to send to the Deposit Protection Fund of each financial institution by using a risk index to calculate

- Increase the choice to save and invest by developing the bond market, promoting stock exchange market investment, deregulating fund investment such as in the social security fund and the government pension fund, and supporting the saving of money in community financial institutions, such as saving and credit cooperatives, and credit unions.

- Government banks should extend their role to offer more SME loans due to government banks having more deposits and fewer deposit mobilization costs, thus causing them to be able to offer low interest rates for loan.

- Promoting competition among Thai financial institutions by welcoming new financial institutions to compete and divide deposit proportion more

The Deposit Protection Agency is a good system to manage economic system risk. However, every change always causes advantages and disadvantages at the same time.  Hence, it is not only the government and financial sectors who must adapt themselves for change, the workforce must also change. An organization’s financial management joined to the willing cooperation of its entire population, pre-supposes that they must learn more in order to manage their own savings.