Modelling Deposit Insurance Scheme Losses in a Basel 2 Framework |
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Authors: | Riccardo De Lisa Stefano Zedda Francesco Vallascas Francesca Campolongo Massimo Marchesi |
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Institution: | (1) University of Cagliari, Viale S. Ignazio 17, 09124 Cagliari, Italy;(2) University of Leeds, Leeds, UK;(3) European Commission, Joint Research Centre (JRC), Institute for the Protection and Security of the Citizens, Ispra, Italy;(4) European Commission, DG Internal Market and Services, Financial Institutions Directorate, Brussels, Belgium |
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Abstract: | This paper extends the existing literature on deposit insurance by proposing a new approach for the estimation of the loss
distribution of a Deposit Insurance Scheme (DIS) that is based on the Basel 2 regulatory framework. In particular, we generate
the distribution of banks’ losses following the Basel 2 theoretical approach and focus on the part of this distribution that
is not covered by capital (tail risk). We also refine our approach by considering two major sources of systemic risks: the
correlation between banks’ assets and interbank lending contagion. The application of our model to 2007 data for a sample
of Italian banks shows that the target size of the Italian deposit insurance system covers up to 98.96% of its potential losses.
Furthermore, it emerges that the introduction of bank contagion via the interbank lending market could lead to the collapse
of the entire Italian banking system. Our analysis points out that the existing Italian deposit insurance system can be assessed
as adequate only in normal times and not in bad market conditions with substantial contagion between banks. Overall, we argue
that policy makers should explicitly consider the following when estimating DIS loss distributions: first, the regulatory
framework within which banks operate such as (Basel 2) capital requirements; and, second, potential sources of systemic risk
such as the correlation between banks’ assets and the risk of interbank contagion. |
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