Even when a small institution fails it causes disruptions and a loss of confidence in banks in general. We have recently had bad experiences in Sweden, so if you intend to introduce risk-based supervision I advise you to do it with caution. Going one step further – how to set the boundaries between banks and other financial institutions? In my opinion, it is very important to safeguard the general public’s confidence around the concept of a bank and it must be protected by a clear definition of a bank and what it can do. In Sweden, the definition is based on the combination of a bank receiving deposits and being active in the payments system. However, a more common definition of a bank focuses on the combination of two activities, namely the receipt of deposits from the general public and the granting of credits to borrowers using these funds. In accordance with international practice, this combined activity should be a privilege of banks. Other institutions may issue deposit-like instruments in high amounts and not directed to the small savers. To highlight their different characters, such instruments should not be protected by any depositor guarantee scheme. But apart from the deposits, most bank activities might also be open to other financial institutions and vice versa. Insurance companies could sell savings products and banks could sell securities. Should you allow “financial conglomerates” mixing banks, securities companies and insurance companies in the same groups?
The public authorities must compensate for these weaknesses by implementing additional rules. For instance, the supervisors may need to require stricter rules for provisioning against loan losses, or to set a higher minimum level for bank capital. An important function of the banking system is to facilitate payments between various agents in society. This is based on the fact that bank accounts provide the basis for all payments except cash payments. Most payments are executed through the payments system infrastructure, such as the systems for large value payments, cheque clearing, securities settlement systems, stock markets, other exchanges and so on. These systems must be efficient and they must also be secure. If not, there is a risk that problems in one part of the financial system will spread to other parts, including to the banks. Many countries have neglected the need for an adequate financial safety net. The safety net includes limited but explicit depositor protection which has to be supported by the necessary legislation, institutions and procedures to conduct an orderly management, resolution or winding-up of problem banks. When bank weaknesses are identified in a country lacking a proper safety net, various problems may occur. The authorities will be reluctant to take adequate and timely remedial action since there are no clear guidelines and since they are afraid of the consequences from non-protected depositors and from other counterparts to the banks.