Deposit insurance

Explicit deposit insurance is a measure implemented in many countries to protect bank depositors, in full or in part, from losses caused by a bank's inability to pay its debts when due. Deposit insurance systems are one component of a financial system safety net that promotes financial stability.

Banks are allowed (and usually encouraged) to lend or invest most of the money deposited with them instead of safe-keeping the full amounts (see fractional-reserve banking). If many of a bank's borrowers fail to repay their loans when due, the bank's creditors, including its depositors, risk loss. Because they rely on customer deposits that can be withdrawn on little or no notice, banks in financial trouble are prone to bank runs, where depositors seek to withdraw funds quickly ahead of a possible bank insolvency. Because banking institution failures have the potential to trigger a broad spectrum of harmful events, including economic recessions, policy makers maintain deposit insurance schemes to protect depositors and to give them comfort that their funds are not at risk.

Deposit insurance was formed to protect small unit banks in the United States when branching regulations existed. Banks were restricted by location thus did not reap the benefits coming from economies of scale, namely pooling and netting. To protect local banks in poorer states, the federal government created deposit insurance.

Many national deposit insurers are members of the International Association of Deposit Insurers (IADI), an international organization established to contribute to the stability of financial systems by promoting international cooperation and to encourage wide international contact among deposit insurers and other interested parties.

Deposit insurance institutions are for the most part government run or established, and may or may not be a part of a country’s central bank, while some are private entities with government backing or completely private entities.

There are a number of countries with more than one deposit insurance system in operation including Austria, Canada (Ontario & Quebec), Germany, Italy, and the United States.

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