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Proposal for a capital market-based guaranty scheme for the financial industry

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  • Hato Schmeiser
  • Joël Wagner
  • Alexandra Zemp

Abstract

In this paper, we introduce a capital market-based financial guaranty system as an alternative to current insurance guaranty funds and deposit insurance systems. The guaranty system secures clients' claims for the event of default by the financial company using a special purpose vehicle which issues bonds to investors. The proposed system, analogous to a credit-linked note, consists of one guaranty vehicle for each financial company. In a first step, we present equations in order to derive the two main input parameters of the special purpose vehicle: the premium and the principal. Subsequently, we analyze the impact of different investment actions taken by the financial companies protected by the guaranty vehicle on various shortfall measures. We find that it will be necessary to restrict the investment volume of investors from the financial industry in order to avoid systematic risk within the proposed guaranty scheme. By deriving practical implications, we show that the capital market-based solution has some key benefits compared to current deposit insurance and insurance guaranty schemes.

Suggested Citation

  • Hato Schmeiser & Joël Wagner & Alexandra Zemp, 2014. "Proposal for a capital market-based guaranty scheme for the financial industry," The European Journal of Finance, Taylor & Francis Journals, vol. 20(12), pages 1133-1160, December.
    • Handle: RePEc:taf:eurjfi:v:20:y:2014:i:12:p:1133-1160
    DOI: 10.1080/1351847X.2012.745007
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