Danish banking: Lessons for deposit insurance reform

As an alternative to a large deposit insurance fund, some observers have recommended prompt closure of banks that fail to maintain a high level of market-value capital. Others, however, see such an early closure policy as impractical, and potentially damaging to the competitive position of U.S. banks. Because the Danes have employed a policy of early closure based on marked-to-market portfolios, their experience is relevant to this debate. The article describes Danish banking policy, and discusses its effects on the behavior of banks and on processes for resolution of weak banks. The Danish policy appears to have provided depositor protection and resolved problems with large and small banks without a deposit insurance fund and without significant burdens on either the banks themselves or the public purse.A previous version of this article was prepared while the author was vice president, Federal Reserve Bank of San Francisco for the 1991 Conference on Bank Structure of the Federal Reserve Bank of Chicago. The author wishes to thank Carl Aage Otholm, inspector of the Danish Supervisory Authority of Financial Affairs for reading and commenting on earlier drafts, Deborah Martin for her excellent research assistance, Ulrike Elofson for translation assistance, and George Kaufman and George Benston for encouragement. Data on Danish bank stock prices were obtained with the gracious assistance of Ellen-Margrethe Soelberg of the Copenhagen Stock Exchange.