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The Perils of European Deposit Insurance

The European Commission and the European Central Bank are wrong to advocate a Europe-wide deposit insurance scheme. While some form of deposit insurance is not a bad idea, a one-size-fits-all state-provided solution would do more harm than good.

MUNICH – Discussions are now underway to establish a system of joint deposit insurance for eurozone banks. Proponents of the scheme, with the European Commission and the European Central Bank (ECB) taking the lead, point out that deposit insurance would avert the danger of a run on banks in times of crisis. While this argument is true, critics emphasize the disparity in risks, owing to the high share of bad loans on the balance sheets of banks in some countries.

To address this risk disparity and move ahead with the plan, balance sheets will need to be cleaned up before considering the next step. While the share of bad loans for banks in the stable eurozone countries is just 2%, the most recently published International Monetary Fund statistics, from last April, show a share of 11% for Ireland, 16% for Italy, 40% for Cyprus, and 46% for Greece.

But this asymmetry is not even the main problem with the proposal. First and foremost, deposit insurance would induce irresponsible risk-taking on the part of banks. It would enable even the eurozone’s zombie banks to obtain savings deposits at will and use them to finance trash ventures worldwide.

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