Deposit taking and loan provision are the main functions of commercial banks. To safeguard the stability of the banking system, regulators impose restrictions on market entry and regulate financial transactions. Licensing requirements dictate the internal organization of a bank. This means that financial institutions must maintain minimum capital, protect internal processes and market discipline while being subject to periodic supervisory review. Although the global financial system is safe, there are events that can shake and disrupt the foundations. Bank deposit insurance can then provide for an extra safety-net, alongside a strict legal framework to handle financial institutions in distress.
Bank account balance protection is provided by several pillars. It starts with the accessibility of corporations to the financial system. These incumbents are subject to internal and external audits and controls to ensure compliance with the applicable standards. Standards that include the internal and reserve capital of the bank, the conduct of its staff, and the way Know Your Client (KYC) and Anti-Money Laundering (AML) protocols are followed.
Financial institutions fail for financial reasons and can be stripped of their license because of regulatory violations. The latter is often unpredictable and comes unforeseen by most stakeholders and mostly occurs with privately owned financial institutions. To avoid disruption of the payment system and protect the public interest, the resolution authority places the troubled financial institution under external administration. A moratorium on transactions is announced while the authority tries to resolve the issues. If such takes too long, the local deposit guarantee scheme (DGS) can be activated.
Deposit protection via a DGS supports retail deposits and account balances held by small businesses. The level of protection and the eligibility of claims is subject to local regulation. The result is that not all bank deposits are covered by a DGS. The central bank, a local regulator, or the designated legal person(s) responsible for deposit insurance publishes the applicable legal framework on their website. Supervised financial institutions are required to inform their customers about the scheme and its applicability as well. When the fund is activated, announcements are made by the failed financial institution, the DGS administrator and sometimes the resolution authority as well. An announcement is made in the national gazette, often one of the major local newspapers.