Structuring Deposit Insurance for a United Europe

This paper analyzes the difficulties associated with bank regulation and deposit insurance in a unified Europe. The authors argue that the EEC will require a high degree of financial policy coordination among member states, not only as to nominal bank deposit insurance pricing, but also in reserve requirements and income taxes as well. Inevitably, such cooperation will require similar coordination in bank regulation. The Second Banking Director's concept for a unified European banking system hinges on the establishment of a reciprocity condition among regulators known as the "common passport." This principle allows for home country authorization of banking activity to be extended to branches of a bank located outside the home country, without the separate approval of the host country's regulator. The branch must conform to the regulations of the host, but need not seek independent regulatory approval in the host country. This paper attempts to develop a model to determine qualitative characteristics of an optimal regulatory strategy in such an environment. The model highlights the role of regulatory risk aversion and taxation policy, and by extension the need for international harmonization of policy with regard to these issues in a unified European banking system. The model presented by the authors is a two period representative agent model of an economy with a banking system. The results indicate that taxes and deposit insurance are interdependent in such a structure. There-fore, a common insurance fund not be sufficient for a unified insurance scheme; coordinated and even unified taxation may also be necessary. At the minimum, exceedingly close macroeconomic policy coordination will be necessary for the single market for financial services to truly come to fruition and be stable. A similar degree of cooperation will be necessary in the area of bank regulation as well.