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This paper responds to a Financial Stability Board (FSB) request of IADI to provide guidance on mitigating moral hazard as it relates to deposit insurance. The paper sets out a number of instruments and best practices that can serve to mitigate moral hazard. With further details set out in the paper, it provides the following guidance: 

  1. Greater emphasis should be placed on market discipline from large-scale depositors, shareholders and other unsecured creditors (primarily unsecured senior and subordinated debt holders) to mitigate moral hazard; less reliance should be placed on discipline from small-scale (or retail) depositors.
  2. Deposit insurance design features can be effective tools for mitigating moral hazard. Deposit insurance systems should have coverage rules that limit the scope and level of coverage and that can, under certain circumstances, instill depositor discipline. Regulatory discipline can also be imposed by deposit insurance design features that directly affect the risk-taking behavior of insured depository institutions, such as risk- adjusted or differential premiums. Depending on its mandate, the deposit insurance system may have other powers or authorities that mitigate moral hazard.
  3. Relevant safety-net participants should place greater emphasis on developing and implementing effective, coordinated frameworks for early intervention and failure resolution.